The stock market is now focused on whether and when the Fed will ease next year. Although this week's key US economic data -- November Employment Report and CPI -- may shed light on the answers to these questions, they will probably not be conclusive since the Fed believes they could be subject to measurement problems related to the government shutdown. A better sense for the answers may be inferred from Fed Chair Powell's comments at his post-FOMC news conference last week. They suggest the most likely window for another rate cut is from the Spring on.
Powell provided guidelines on how the Fed thinks the economic background will unfold in 2026. The Central Tendency Forecast for Real GDP Growth was raised to 2.1-2.5% (Q4/Q4), putting it above the longer-run estimate of 1.8-2.0%. He said that 0.2% pt of the 2026 growth results from a bounce-back from the government shutdown, which had subtracted a like amount from 2025 GDP growth. Most of this bounce-back should be seen in Q126 -- adding 0.8% pt to the annualized q/q growth rate then. A resilient consumer and strong business investment, in part due to AI, are also behind the GDP speedup. The $2,000 tariff-offset tax refund should help the consumer in H126, as well.
Regarding inflation, Powell says the Fed's best guess is that the impact of tariffs will be a one-time boost to the price level, so that the impact on inflation will be short-lived. He expects most of the boost will occur by Q126, then flatten out in the Spring and disappear in H226. A goal of the Fed is to prevent this one-time boost from precipitating a sustained speedup in inflation, in other words a wage-price spiral. He mentioned that the slowdown in the Q325 Employment Cost Index was a good sign that wage inflation remains in check. And, he reiterated that the tariff-impacted goods prices are the main reason for this year's pickup in inflation, as services inflation has been soft.
If the Fed is right that economic growth and inflation may be highest in Q126, then the window for a Fed rate cut will become more of a possibility in the Spring and in the second half of the year. Nonetheless, Powell did say that the upcoming slew of US economic data will be important considerations at the January FOMC Meeting. However, he pointed out they could be distorted by technical problems. So, the Fed may be reluctant to rely on them to make a policy decision.
In particular, the CPI and Unemployment Rate could be mi-measured because of deviations from the standard timing of their surveys in October and November. Besides a question of full survey information, the timing could be out of sync with seasonal adjustment. And, the m/m change in Nonfarm Payrolls will be overstated by about 60k (as they have been in recent months) because of a persistent problem in the way jobs are estimated for the net change in new and closed businesses.
Powell also mentioned the importance of the Unemployment Claims data, highlighting that the recent decline in Initial Claims had suggested fewer layoffs while the still high Continuing hinted at more cautious hiring. December-January Claims data, however, are tricky to seasonally adjust because of the varied timing of holidays from year to year. The sharp swings in Initial and Continuing in last week's report are illustrative. So, the Claims data may not be reliable measures of the labor market at this time, making it more difficult for the Fed to figure out what's happening.
This week should see the Employment Report and CPI for both October and November. Given the Fed's estimate of a 60k overstatement of the m/m change in Payrolls, the chances are that both month's figures will be viewed as weak by the market. Payrolls averaged 62k m/m (2k after subtracting 60k per month) during Q325. The m/m change in the Unemployment Rate could confirm or raise doubt about the weak jobs figures. Continuing Unemployment Insurance Claims suggest the Unemployment Rate has risen since September. The sampling issue Powell alluded to, however, suggests it should be viewed with caution.
The October-November CPI also may be impacted by sampling problems, according to Powell. Market-friendly prints would be 0.2% m/m or less, with the Core more important than Total. Such a low print would be below the 0.3% m/m increase implicit in the Fed's Central Tendency Forecast for the Q4/Q4 inflation rate. A low print can't be ruled out. Owners' Equivalent Rent would need to be soft, as in September, and Airfares and Lodging Away From Home need to rise at most modestly. Seasonals help to hold down Airfares in these two months, but they boost Lodging Away From Home.
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