Jobs, Inflation and Tariffs

The stock market may continue to churn until a view of the likely course of Fed monetary policy becomes clearer.  The absence of official US economic data as a result of the government shutdown has obscured the view, helping to explain the large swings in the market.  The first major US economic data release will be the September Employment Report on Thursday.  Unemployment Insurance Claims, though, may be more important.

Employment

The evidence regarding September Payrolls is mixed.  /1/ The ADP monthly estimate of a decline that month points to a weak Payroll print (see table below).   ADP and First-Print Private Payrolls moved in the same direction (speeding up or slowing down) each month since April.  /2/  But an improvement in Unemployment Claims suggests a speedup in September Payrolls.  Continuing Claims fell between the August and September Payroll Survey Weeks, suggesting a pickup in hiring.  They too have a good record predicting speedups and slowdowns in Payrolls -- better than ADP for Final-Print Payrolls.

The market reaction may be muted if ADP is right and September Payrolls are weak.  This is because the latest monthly ADP Estimate indicated a rebound in October.  Nonetheless, what should be important for the Fed is the trend in job growth.  Along with the latest bi-weekly 4-week moving average of -11k, the 3-month average of ADP suggests the trend is flattish -- and argues for a Fed rate cut. 

A speedup in September Payrolls, in contrast, would argue against a Fed rate cut at the December FOMC Meeting.  However, at this point it should be viewed as history.  The path of the jobs market over October and November is more important.  Unemployment Claims, particularly Continuing, would offer the best evidence.  The Fed will likely have up-to-date data on Initial and Continuing Claims in time for the December FOMC Meeting.  Unemployment Claims may be the easiest data to compile and release.  They are collected by state governments, who continued to do so while the federal government was closed. 

Unemployment Insurance Claims are the best measured, broadest and most up-to-date labor market data.  They are a universal count, unlike the Payroll data which are based on surveys, so there is no measurement error.  They are among the broadest measures because they cover the whole private economy.  (Federal government workers are covered by a separate unemployment insurance system, so are not included in Initial or Continuing Claims.)  

Initial Unemployment Claims -- which measures the number of people filing for Unemployment Insurance for the first time after being laid off -- were in a tight range around 225k during the first 9 months of the year.  They did not show any significant uptrend in layoffs.  In contrast, Continuing Claims -- which measures the number of people filing for Unemployment Insurance in the weeks after the first -- had ratcheted up from May through July, suggesting hiring had pulled back.  They began to trend down in August and reached a low of 1.926 Mn in mid September.  The swing from worsening to improving is consistent with other data suggesting the weakest point in the economy occurred in the middle of the summer, as discussed in last week's blog.  

 Inflation

A catch-up in the release of CPI data does not look likely according to news reports, since the government shutdown prevented BLS from canvassing prices during October.  This is unfortunate, because there's reason to think it would be a benign print.  Besides the possibility that Owners' Equivalent Rent would stay low as in September, seasonal factors work to hold down airfares.  Used Car Prices could be soft, as well.  These components could offset tariff-related price boosts in other components.  

 Tariffs

There is almost no question that tariffs reduce the US standard of living -- acting as a tax on consumers and directing resources to more costly production.  So, it is not surprising that voters voiced their displeasure in the recent elections.  (Tariffs would not impact the US standard of living if foreign exporters bore all of them by lowering their prices as an offset --  which was not the case.)  Trump recognizes the popular displeasure by raising the possibility of $2,000 payments to presumably lower-/middle-income people.   There is a theoretical justification for this kind of payment.  The impact on a consumer of a change in the price of a good or service can be de-composed into a substitution and income effect.  The substitution effect shows how the consumer will adjust purchases to the change in the relative price of the item.  The income effect shows the lost purchasing power from the price hike.  Trump's proposal could be viewed as an attempt to offset the income effect of the tariff-induced price hikes.   The substitution effect still would be in play.

 

                                         Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS    Continuing Claims *        

    March               155                          209                            120

    April                   62                          167                            133                                14                            

    May                    37                          140                              69                               -74           

    Jun                    -33                            74                             -27                               -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                                na                               -8                            

   Sep                    -32                            na                                na                               18 

   Oct                     42                             na                                na  

 * the inverted change in Continuing Claims between Payroll Survey Weeks, 000s

 

 

 

 

Market Stabilization

The stock market may stabilize this week, as the macroeconomic background may be improving and an end to the government shutdown remains a potential positive.  As for the monetary policy outlook, this week's Fed speeches are not likely to tilt the odds of a rate cut at the December FOMC Meeting one way or the other, as they most likely will stick to the positions taken at the last meeting in September.  So, uncertainty about a December rate cut should remain, particularly as the balance of risks may be shifting.

There is a lot of evidence that the economic weakness seen during the summer is over, which would reduce the downside risk to the labor market.  Besides the pickup in the ADP measures of job growth, most commodity price indices, such as CRB, have moved up from their August lows.   The indices could be responding to stronger economic activity.  It also may be telling that longer-term Treasury yields have been steady, contrary to the decline that would be associated with a weaker economy.  There could be further evidence of an improved labor market when ADP releases it's bi-weekly 4-week moving average on Tuesday.  The question is whether it will exceed the 14.25k in the latest report, adding to the more positive evidence regarding the labor market.  Or, will it weaken, reflecting the large layoff announcements highlighted by the Challenger Report, many or which are likely AI-related?  

What may be more important for the Fed would be a benign October CPI Report (assuming it will be released at some point), suggesting lower upside risks to the inflation outlook.  At this point, the evidence is mixed.  Anecdotal evidence suggests that businesses will begin to pass through the tariffs soon.  So, the Fed will likely be interested to see if the pass-through is significant enough to show up in the CPI.  However, private surveys suggest little change in price inflation in October.  Inflation Expectations, as measured in separate surveys by University of Michigan and New York Fed, are contained.  The Price component of the Mfg ISM slipped.  The Manheim Used Car Price Index fell.  And, the ADP measure of Pay Growth shows steady wage inflation.  If these survey results are correct, the next CPI Report (presuming it will be released) may be the trigger for a December rate cut.

The irony of Trump's tariff policy is that while it may have given the US a "stick" to use in foreign policy, it cut domestic support for the Republican Party by hurting the US consumer through higher prices -- particularly food prices.   The Democratic Party used the "affordability" argument to win some key elections last week -- even though their policy prescriptions may, in fact, worsen the economic situation.  And, Trump and his advisors appear to understand the political problem:  Although Trump disputed the "affordability" argument, he announced a Department of Justice anti-trust investigation into meat pricing.   It remains to be seen what the Supreme Court will decide regarding Trump's tariffs and what he may do in their place if the Court decides his actions were unconstitutional.  An end of the tariffs would lower the Fed's and market's inflation risks substantially.

 

 

 

Consolidation WIthin a Bullish Background?

The stock market may consolidate this week, as most earnings reports have been released and uncertainty over the next Fed policy move has increased.  However, a year-end rally cannot be ruled out, as there are still some potential positives near term including an end to the government shutdown and seasonal bullishness in November and December.  Moreover, even if the Fed does not cut rates at the December 9-10 FOMC Meeting, it plans to stop selling off its portfolio of long-dated securities, particularly mortgage-backeds, on December 1.  This action represents an easing in monetary policy.  

Although Fed Chair Powell did not promise another rate cut at the December 9-10 FOMC Meeting, he did not rule it out either.  There are two main reasons for the uncertainty.  First, in the absence of almost all official economic data, Powell said monetary policy is like driving in a fog -- when a prudent slowdown is often called for.  To be sure, information the Fed has suggests little change in the economic outlook from the one presented at the September FOMC Meeting, as described below.  And, the situation should improve if the government shutdown ends soon.  Second, there are mixed views among FOMC members on whether the funds rate is now above or below the neutral level.  The latter is unobservable, thereby allowing for disagreement.  Powell did say that if the Fed skips cutting rates in December, rate cuts could resume at some point afterwards.

There is a problem with Powell's arguments for skipping a rate cut at the December meeting.  He always states that policy is focused on the outlook, particularly since monetary policy impacts the economy with a lag.  Not knowing the current state of the economy because of the data blackout should not alter the outlook significantly, unless there has been a dramatic change.  The latter has not been the case, according to Powell.  So, the absence of government-supplied data should not affect monetary policy now, which presumably is based on the Fed's outlook.  Fed officials could easily stick with their rate forecasts in the September Central Tendency Forecasts, the majority of which calls for one more cut this year.

Powell, indeed, said economic conditions have not changed much since the September FOMC Meeting. He said that Real GDP Growth appears to be growing faster than the 1.6% H125 pace so far in H225 -- thanks to stronger consumption and AI investment.  Nevertheless, the labor market looks to be little changed.  State data on Unemployment Insurance Claims have been steady since the Meeting, despite the recent spate of large layoff announcements.  This suggests layoffs in the aggregate are not moving up.  Nonetheless, Powell observed that newly laid-off people are finding it hard to land a new job (consistent with the higher level of Continuing Claims that I highlighted in past blogs).  The most recent ADP measure of job growth over the prior 4 weeks suggests a modest pickup in October.  Consensus looks for this to be confirmed in the monthly ADP Estimate this week.   A pickup in job growth is not unreasonable to expect, if the Atlanta Fed model's estimate of 3.9% Q325 Real GDP Growth is right.  It would dampen market fears of recession.

Powell made one point that raises doubt about the correctness of the Fed's earlier view of rate cuts through year end.  He attributed most of the weak job growth to fewer immigrants and a decline in labor force participation, i.e, a labor supply issue.  Unless the lower participation rate reflects discouragement in the face of weak labor demand, these supply issues imply that slow economic growth is enough to keep the labor market at full employment.  In other words, easier monetary policy to boost growth would not be necessary.

Powell made some positive comments about inflation.  He said tariffs are largely behind the currently above-target inflation rate, with the y/y of the September PCE Deflator estimated at 2.8% for both Total and Core.  The Fed still thinks the tariffs' impact on the inflation rate likely will be gone after a few months, possibly by Spring (although not the impact on the price level).  Inflation should then move down to the Fed's 2% target.  Important as well, Powell said he expects housing-related inflation to continue to slow.  This benign longer-term inflation outlook suggests that the current high inflation prints should not stand in the way of easier monetary policy.

The Fed's decision to end its portfolio selling is a form of easier monetary policy.  It should help lower longer-term yields, particularly mortgage rates.  Powell said that after December 1, the Fed will buy short-term Treasury bills to offset maturing mortgage-backeds, keeping the Fed's balance sheet steady.  The latter's composition would shift to having a greater share of Treasuries.  Also, the duration of the Fed's holding would shorten, moving it closer to the duration of all outstanding Treasury securities.  These changes could flatten the Treasury yield curve without signaling an upcoming recession, which would be a positive for stocks.