Evaluating Likelihood Of A Fed Rate Decision

The stock market is back to being concerned about the Iran war and tech consolidation.  Nevertheless, the possibility of Fed tightening at some point remains in the background after Fed Chair Warsh downplayed the low June inflation data -- essentially saying one month does not make a trend --  and the real-side data continue to be decent.

The Unemployment Claims data indicate a still firm labor market.   The latest week showed a dip in both Initial and Continuing, although it remains to be seen whether the dips reflected the impact of the July 4th holiday.  If they stay at their lower levels for a couple more weeks, they would point to a speedup in July Nonfarm Payrolls from the +57k in June.   The July Employment Report will be released August 7.

The Claims data may very well be highlighted positively by Warsh's Task Force on improving economic data.  This is because they are not subject to sampling error, being a universal count of all people filing for unemployment insurance -- either for the first time or an additional week.  Moreover, they represent the labor market for the entire economy.  Other economic data --such as Retail Sales, Durable Goods Orders, Industrial Production, Housing Starts -- reflect only a sliver of the economy.  None gives a complete picture.  They are important in providing clues on the areas helping or hurting economic growth, thus helpful for looking ahead, but can distort a picture of the overall economy at the current time by giving only a partial view.

With Warsh suggesting an ending of the Fed's forward guidance, the question becomes how to determine what will push the Fed to raise or lower rates.  Warsh has said the Fed will get clues on how to proceed by looking at the markets if they are allowed to move without being told the Fed's intentions.  One important clue presumably would be longer-term Treasury yields.  If they break above a recent range, particularly if they move up faster than the shorter end of the yield curve, they could be signaling the need for the Fed to tighten.  Conversely, if they break below the recent range, they could point to an easing.  To be sure, longer-term yields can be impacted by a number of factors, some of which should not affect monetary policy.  These include expectations of the Federal Deficit, volatility in the FX market, and other risk factors.  Nevertheless, an upward breakout could reflect higher inflation expectations and vice versa.  

A breakout in Treasury yields would likely have to be of significant magnitude and duration.  The recent history of the 10-year Treasury yield shows this to have been the case.  It rose sharply (about 50 BPs) since the start of the Iran war in February and is now hovering around this elevated level until recently when it has begun to move up again.  The yield curve has begun to steepen again, as well.  Concern about the potential inflationary impact of the renewed US/Iran fighting is likely behind the move up in longer-term yields.  If the high long-term yields continue, they will raise the risk that the Fed may soon hike rates.

 

 

 

 

 

 

 

 

 

 

 

June CPI and Fed Chair Testimony

The stock market may be helped by a couple of developments beginning this week --  possibly a low inflation print and the start of strong corporate earnings.  The market also will face a reminder of the Fed's anti-inflation stance with Fed Chair Warsh's semi-annual Congressional testimony on monetary policy.  However, he is unlikely to provide a clue regarding the July FOMC rate decision.

Consensus looks for a decline in the June Total CPI but a high Core.  It sees -0.1% m/m Total and +0.3% Core.  High prices for World Cup games (as well as for intra-/inter city transportation) and a moderate boost to Airfares from seasonal factors could be behind the high Core estimate.  However, price hikes in some components in May (Tax Preparation, Communication Services) will not likely repeat in June.  And, the drop in energy prices may pull down Total and their pass-through hold down Core by more than consensus expects.  So, downside risk to the consensus estimates can't be ruled out.  Moreover, if Core is boosted by World Cup-related components, the high print could be discounted as temporary.

Fed Chair Warsh gives the semi-annual Monetary Policy Testimony this week.  Typically, the summer testimony reflects the consensus view at the June FOMC Meeting.  So, the latter's Minutes likely offers clues to his testimony.

Warsh will probably continue to emphasize the Fed's anti-inflation focus, as he did at the post-FOMC Meeting news conference.  He also may talk about the many issues regarding the measurement of inflation, mentioning how they will be addressed by his newly created task forces.   Nevertheless, the Minutes indicated what is truly of concern to Fed officials:

"The majority of participants highlighted the possibility that, after several years of inflation above 2 percent, continued elevated inflation rates could begin to affect inflation expectations and wage-and price-setting decisions."  

The m/m decline in the Michigan Survey's 5-year Inflation Expectations to 3.3% in June from 3.9% in May should be a relief for Fed officials, although it does not eliminate their concern since the Expectations remain above the 2.8-3.2% range of 2024..  

They still are concerned about the start of a wage-price spiral.  However, so far, there is no evidence of a wage-price spiral developing from this year's various price shocks.  The Minutes said:

"Many participants remarked that the labor market was not currently a source of inflationary pressures, or that nominal wage growth remained consistent with inflation moving toward 2 percent." 

The absence of a wage-price spiral suggests there is no pressing need for the Fed to tighten.  

However, Warsh is unlikely to hint at the next policy move, particularly since the FOMC members' views were mixed at the June meeting.  The Minutes said;

"Regarding participants’ individual assessments of appropriate monetary policy under what each participant judged to be the most likely scenario for the economy, many participants indicated that the appropriate level of the federal funds rate would be within or slightly below the current target range at the end of this year. Many other participants, however, assessed that the appropriate level of the federal funds rate would be above the current target range at the end of this year."

Warsh will likely acknowledge the Fed's other mandate regarding the labor market, but indicate it is not a problem for now.  The Minutes said:

"Participants generally expected labor market conditions to remain stable in the near term, with the
unemployment rate staying close to current levels. Some participants remarked that their concerns
earlier this year about labor market deterioration had eased with recent data, and several participants
noted that the solid payroll employment data in recent months could signal increased labor market
momentum." 

"Several participants cited, however, the possibility that uncertainty related to geopolitical
developments or the broader economic outlook could lead firms to reduce hiring or begin
implementing layoffs. Some participants commented on the possibility that AI could, over time, affect
employment prospects for some classes of workers."   

Similarly, Warsh should give a fairly positive description of the current state of the economy.  The Minutes said:

"Participants generally observed that economic activity had continued to expand at a solid pace,
despite elevated uncertainty, supported by strong business investment and resilient consumer
spending."  

On balance, Warsh's testimony will not likely change market perceptions that the balance of risks tilts toward inflation and that the Fed is focused on it.  However, whether or when the Fed will act may remain uncertain.

 

 

 

  

June Employment Not Soft Enough, But Market Relief Ahead

The stock market may continue this week to be concerned about the possibility of a Fed rate hike at the next FOMC Meeting, with the Minutes of the June 16-17 FOMC Meeting the focus.  The Minutes should emphasize the need to bring down inflation, but the market could find relief if they show many participants still expecting inflation to slow on its own.  The market soon may get relief from a couple of other sources.  The Q226 corporate earnings season is expected to be strong.  And, the June CPI, due July 14, may very well be soft.  

The June Employment Report was not likely soft enough to derail the possibility of a Fed rate hike (or a hint of one at a coming meeting) at the July 28-29 FOMC Meeting.  The 59k increase in Nonfarm Payrolls is consistent with population growth, cited by Fed Chair Warsh as a reason to think the labor market is in good shape.  Moreover, the Unemployment Rate fell to 4.2% from 4.3%.  A drop in the Labor Force more than offset lower Civilian Employment.  However, the declines in both may be largely a result of the small sample bias of the Household Survey.  The calculation of the Unemployment Rate eliminates this bias.

A closer look at Payrolls shows a somewhat stronger picture than seen in the headlines.  Excluding the unusual volatility in Leisure and Hospitality jobs, Payrolls would have risen 118k m/m in June after +89k in May (official data: +57k in June after +129k in May).  However, once again job gains were concentrated in only a couple of sectors -- Health and Private Education and Professional and Business Services.  That said, the Report points to modest economic growth ahead.  Total Hours Worked in June were only 0.3% (annualized) above the Q226 average -- a soft take-off point for Q326.  Similar m/m THW gains as in June would put the THW average up 1.0% (q/q, saar) in Q326, versus +1.3% in Q226.  

Corporate earnings are expected to be strong in Q226.  Consensus looks for a whopping 23% y/y increase in S&P 500 corporate earnings.   This is close to the even greater 28.4% growth seen in Q126.  The macroeconomic evidence is mixed, but is positive on balance.  On the downside, Real GDP Growth and European Mfg PMI slowed on a y/y basis from Q126.  Also, the softer dollar provided a smaller boost to earnings abroad than in Q126.  On the positive side, oil company earnings should be helped by higher oil prices by even more than in the prior quarter.  And, profit margins may have expanded, as the Core CPI sped up while Average Hourly Earnings slowed.  

                                                                                                                                        Euro  Area   

                  Real GDP     Oil Prices      Trade-Weighted Dollar    AHE     Core CPI    Mfg PMI  

                     [                y/y percent change                                                            ]          (level)

Q424             2.5               0.0                      +3.5                               4.1           3.4               45.4       

 

 Q125            2.1              -6.5                      +6.0                               4.1           3.1               47.6                                       

Q225            2.0             -16.0                      +3.5                               3.9           2.8               49.3     

 

Q325            2.3              -11.0                      -1.5                               3.9           3.1               50.0  

 

Q425            2.0              -14.0                      -4.0                                3.9           2.6               53.3  

 

Q126            2.7               40.0                       -8.0                               3.6           2.5                50.6     

 

Q226            2.0 *            75.0                       -4.0                               3.5           2.8                51.7                                                                  

                                                                           

* Based on the Atlanta Fed Model's latest projection of 1.2% for Q226 (q/q, saar).