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.
