Trending Up Into Corporate Earnings

The stock market may trend up into the corporate earnings season, as the latter is expected to be strong.  Although the government shutdown prevents the release of economic data (and presumably the collection of data for subsequent reports), the stable longer-end of the Treasury market and dollar indicate little change in the overall picture -- modest growth and contained inflation.  The latest ADP Estimate suggests a weak September Employment Report, but there is mixed evidence.  The stock market impact should be subdued even if the eventual September Payroll print confirms ADP.  The prospects of multiple Fed rate cuts would balance fears of recession.  

Fed monetary policy should not be affected by the government shutdown if the latter is short in duration.  Any drag stemming from it would be viewed as temporary.  Monetary policy could be pushed to further rate cuts if the Administration uses the shutdown as an excuse to permanently cut financial support for infrastructure building or other forms of government spending, such as subsidy or transfer payments.  It is too soon to say whether this will be the case.  The cutbacks announced so far may end with the shutdown.

The September CPI, when it does get released, looks like it should be in line with the prints of the past few months.  Total looks to be a little on the high side, up 0.3-0.4% m/m.  Core looks to be contained at 0.2-0.3%.  Some of the increase in the CPI could be viewed as temporary.  This is the case for boosts from tariffs, the impact of which the Fed thinks is likely to be one-time.  However, other components remain stubbornly high.  In particular, Owners' Equivalent Rent remains in a 0.3-0.4% range.  It needs to get down to 0.2% for the Fed to be successful in achieving its 2% inflation target.  Failure to do so, along with a desire to prevent a wage-price spiral developing from tariffs, could keep Fed monetary policy in a somewhat restrictive stance even after some rate cuts.

The labor market looks soft according to private surveys, such as ADP.  It put September Private Payrolls at -32k m/m.  ADP did a better job than the Bureau of Labor Statistics (BLS) First-Print Payrolls in predicting the final print for a month from March through June (see table below).  It missed in July, but the BLS data for that month will be revised in the September Employment Report.  So, it's too soon to say which was a better predictor of the final print for August.  

There is mixed evidence regarding September Payrolls.  ADP suggests a weaker BLS print in September than in August.  However, the Claims data suggest a speedup.  If the eventual Payroll print confirms a decline like ADP's, talk of recession and 2-3 Fed rate cuts in Q425 could heat up.  The prospect of substantial Fed easing should offset concern about recession, allowing the stock market to be little damaged by a weak September Employment Report.  Alternatively, a soft Payroll print could be the fall-out of AI and other efficiency drives by companies.  In this case, GDP may not indicate recession but strong productivity growth.  The latter would help lift corporate earnings -- a positive for stocks.

There is also the possibility that higher unemployment will free up resources to meet the needs for the investments and production being re-shored.  It would allow the re-shoring to proceed without putting upward pressure on inflation.  This would be good for the longer-term market outlook.

                                            Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS         

    March               155                          209                            120

    April                   62                          167                            133

    May                    37                          140                              69          

    Jun                    -33                            74                              -27                                    

    Jul                    104                            83                               77     

   Aug                     54                            38                                na                            

   Sep                    -32                            na                                na

 

  

   

  

 

 

 

 

Caution Ahead of Key US Economic Data and Govt Shutdown?

The stock market may continue to trade cautiously this week as the federal government risks a shutdown and key US economic data are not expected to change the overall picture.  However, there is reason to think these factors may be taken in stride.  Both the September Mfg ISM and Nonfarm Payrolls are seen improving somewhat from their August prints.  However, their improvement is expected to be modest and should not change the markets' probabilities of further Fed easing.  A more positive market tone could reemerge afterwards as Q325 corporate earnings are released.

Consensus looks for Nonfarm Payrolls to rise by only 39k m/m, versus +22k in August.  However, the latest Unemployment Claims data suggest the risk is for a somewhat larger increase.  Consensus estimates for the other important parts of the Employment Report are more of the same: a steady 4.3% Unemployment Rate and 34.2 Nonfarm Workweek, and 0.3% m/m Average Hourly Earnings.  Rounding analysis suggests a better chance of a 3.4% than 3.2% Rate.  The unrounded Unemployment Rate was 4.32% in August.  Consensus prints shouldn't change the Fed's view of the outlook -- still cautious but not overly concerned about the economic outlook.

Consensus looks for the September Mfg ISM to edge up to 49.2 from 48.7.   This would remain at a level suggesting modest economic growth.   It would be a bit below the 49.4 H125 average.  Real GDP Growth averaged 1.6% (annualized) in H125.

The stock market has not liked government shutdowns in the past.  However, it may be different this time for two reasons.  The long end of the Treasury market appears to be sensitive to large shifts in the 10-year projection of the Federal Deficit, as seen in a rise in yields when the courts threatened an end of Trump's tariffs.  The government revenue impact became more important as the inflationary impact has so far been modest.  The markets may view a shutdown as a way that Trump will cut government spending.  And, it would prevent the renewal of some government subsidies being pushed by Democrats.   

Consensus looks for about 7.5% (y/y) growth in Q325 corporate earnings.  This is below the 12.0% seen in Q225.  However, it is still strong.   And the consensus estimate tends to be too low, so a stronger quarter is conceivable.  The macro evidence supports this risk.  Real GDP Growth sped up on a y/y basis,  based on the Atlanta Fed model's estimate for Q325.  The dollar weakened as economic activity abroad improved.  Both boost earnings made abroad.  There is a possibility that domestic profit margins improved, as the Core CPI climbed by more than Average Hourly Earnings.  Although some of the strength in the CPI reflects tariffs, which don't lift profits themselves, they offer domestic producers room to increase profit margins.  Finally, there should be a smaller drag from oil companies. 

                                                                                                                                      Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)

 Q124            2.9                +14.0                  0.0                              4.3           3.8              46.4 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.5                   0.0                 +3.5                              4.1           3.4               45.4       

 

Q125            2.1                  -6.5                +6.0                               3.9           3.1               47.6                                       

Q225            2.0                -16.0                +3.5                               3.9           2.8               49.3     

 

Q325            2.2                -11.0                -1.5                                3.8           3.1               50.0                 

                                                                           

* Based on the Atlanta Fed Model's latest projection of 3.9% for Q325 (q/q, saar).

 

A Growth-Friendly Fed

The stock market should continue to be buoyed by a growth-friendly Fed.  The 25 BP rate cut shows the Fed will respond to economic weakness.  And, the "dot" plot indicated a leaning toward further easing by most members of the FOMC meeting.  Fed Chair Powell and other Fed officials will likely reiterate the Fed's new emphasis on the downside risks to the economic outlook in speeches this week.

Soft US economic data, in real terms or inflation, should support expectations of further Fed easing and thus be positive for the stock market.  And, most of this week's US economic data are expected to be on the soft side.  Consensus looks for August Durable Goods Orders to dip, both in Total and Ex Transportation.  It also expects declines in August New and Existing Home Sales and a rebound in Initial Unemployment Claims.  The August PCE Deflator is seen up a modest 0.2% m/m for Core.  However, August Consumption is expected to rise 0.5% m/m -- a  decent gain even after adjusting for inflation.

The Fed expects modest economic growth and a temporarily higher pace of inflation into early next year, according to Fed Chair Powell at his post-meeting news conference.  The 1.4-1.7% Central Tendency Forecast for 2025 (Q4/Q4) implies 1.4-2.0% Real GDP Growth for the second half of the year, given the 1.4% growth in the first half.  If the Atlanta Fed Model's estimate of 3.3% for Q325 Real GDP and the Central Tendency forecast are right, then Real GDP has to weaken t o -0.5% to +0.7% (q/q, saar) in Q425. Except for a possible recession in Q425 in this scenario, the annual Central Tendency forecast is at or slightly below the Fed's estimate of longer-run growth.

Such a growth pace would likely be acceptable for the stock market inasmuch as labor costs should remain contained.  Powell acknowledged that wage inflation has moderated and that both labor demand and supply have fallen.  Although the pass-through of tariffs has been slower and smaller than the Fed expected, it still sees the tariffs to be more fully passed through over time -- a positive for the path of corporate earnings.  Specifically,  the Fed looks for the tariffs' boost to prices to grow through the rest of the year and possibly into 2026.  

The future path of monetary policy will depend on economic developments ahead, but the likely direction is for lower rates.  Although there was only one vote for a 50 BP rate cut at last week's FOMC Meeting, nine of 19 participants look for 2 or more 25 BP cuts this year.  There are reasons to expect a persistence of the current combination of modest growth and moderate inflation for the rest of the year, supporting more rate cuts.  The slowdown in immigration has been a major factor holding back labor force growth (and a negative for demand for goods and services).  This restraint is not going away.  And, besides modest wage inflation, most measures of longer-term inflation expectations continue to be consistent with the Fed's projections, according to Powell.   This is not the case, however, with the University of Michigan Survey's 5-Year Inflation Expectations figure, which, at 3.9% in mid August, is well above its 3.0-3.2% pre-tariff range.  The final print for the month will be released this week.

A rising stock market would be desirable for the Fed, since it is a major channel (via consumption) through which easier monetary policy supports the economy.  Lower short-term rates also help through the reduction in borrowing costs on credit cards and auto loans.  However, the channel through lower longer-term yields may be hampered in the near term by their being lifted by the variability of short-term rates and the dollar.  They raise the risk premium in the term structure of interest rates.

 

 

 

 

A 25 BP Fed Rate Cut, More To Come?

The stock market rally should be sustained by this week's FOMC Meeting.  Besides a 25 BP rate cut, the Statement or, more likely, Fed Chair Powell could signal that more easing will be coming if needed.  And, this week's US economic data are expected to keep that possibility alive by underscoring a sluggish growth pace.

A Fed easing path will likely embody a number of 25 BP rate cuts.  There are several reasons to expect such a cautious path.  First, inflation remains higher than target, with the culprits including more than just tariffs.  In particular, housing rent (primary and owners' equivalent rent) continue to run 0.3-0.4% m/m.  It likely needs to slow to 0.2% in order for the Fed to hit its 2% inflation target.

And, tariffs remain a problem for the inflation fight, although there were some signs of a moderation in their impact in the August CPI.  A jump in Food Prices At Home in August may have been caused in part by tariffs.  The unusually large 0.6% in these prices most certainly is a factor behind the depressed level of consumer confidence.  In contrast, Household Furnishings and Recreational Commodities flattened out after a couple of months of large increases, suggesting the impact of tariffs on them is settling down, in line with the Fed's best guess that the tariffs will have a one-off impact on inflation. 

Nevertheless, the Fed may be concerned by signs that longer-run inflation expectations have ratcheted up.  The University of Michigan Consumer Sentiment Survey shows 5-year inflation expectations at 3.9%, well above the 3.0-3.2% range seen before the start of tariffs.  

As a result, allowing a somewhat softer labor market for a while may be optimal monetary policy in the context of tariffs.  It would prevent a wage-price spiral from developing by dissuading labor from bargaining for higher wages to offset the loss of purchasing power.  The Fed would never admit to this reason.  However, Powell acknowledges that wage inflation has not been a source of inflationary pressure, showing that Fed officials are cognizant of this potential.

A sluggish pace of economic growth is expected to be apparent in this week's US economic data releases.  Consensus looks for a slowdown in Retail Sales to 0.3% m/m in August from 0.5% in July.  Ex Auto Sales are seen repeating July's modest 0.3% increase.  This gain is even smaller in real terms, that is once inflation is taken into account.  Consensus sees flat August Industrial Production after -0.1% in July.  There is downside risk from a likely decline in Manufacturing Output after a flat July.   Consensus expects little m/m change in August Housing Starts and Permits.

 

  

Green Light For A Fed Rate Cut

The stock market should continue to climb this week, anticipating a Fed rate cut at the September 16-17 FOMC Meeting.  After the soft August Employment Report, this week's release of the August CPI should not derail the expected decision.  A rate cut, even a modest 25 BPs, would signal that the Fed will act to combat economic weakness ahead -- making the possibility of future economic weakness less problematic for stocks.

The consensus estimate of 0.3% m/m for Total and Core CPI looks reasonable, as the tariff impact should still be noticeable -- which the Fed could view as unavoidable but temporary.  A lower Core is not out of the question, nonetheless, but probably requiring a slowdown in Owners' Equivalent Rent to 0.2% from 0.3%.  Consensus has the Core's y/y steady at 3.1%.  However, a rounded-up 0.3% print could result in a dip in the y/y to 3.0%.  The markets may pay attention if this happens.

The August Employment Report already gave the Fed the excuse it needed to cut rates at the September 16-17 FOMC Meeting.  Besides soft job growth and an uptick in the Unemployment Rate, Total Hours Worked are down q/q in Q325.

The +22k m/m increase in Nonfarm Payrolls was the 4h month in a row of only a double-digit gain.  It was well below the 125k m/m increase consistent with a steady Unemployment Rate (and steady labor force participation rate).  The Diffusion Index (percentage of industries with job gains) stayed below 50%: 49.6% versus 48% in July).  There were declines in cyclical sectors, like Construction and Manufacturing, but also in Professional and Business Services (some of which conceivably could be tied to AI).

The uptick in the Unemployment Rate to 4.3% from 4.2% can be attributed to an increase in the Labor Force Participation Rate.  However, there were some troubling signs from the Household Survey.  The politically sensitive Black Unemployment Rate continued to climb, rising to 7.5% from  7.1% (mostly women).   And the Duration of Unemployment rose for the second month in a row.  The broadest measure of Underutilized Labor Force, U-6, rose to 8.1% from 7.9%.  This is its highest level since October 2021.

Average Hourly Earnings remained at trend, rising 0.3% m/m.  However, only 7 of 13 sectors had changes of 0.3% or less, compared to 11 of 13 in the Q225 average.  So, while the wage data have good news overall for the inflation outlook, there is not yet an all-clear.  Nevertheless, it should have assuaged some Fed concern about the potential for a wage-price spiral emanating from the tariffs.

With the Nonfarm Workweek unchanged from a downward-revised 34.2 Hours in July, Total Hours Worked were flat in August and are 0.5% (annualized) below the Q225 average.  As a result, the Atlanta Fed model's 3.0% estimate for Q325 Real GDP Growth continues to look too high.  However, if it is correct, it would be because of strong productivity growth -- a positive for Q325 corporate earnings and stocks.

Stock Market Helped By Benign Data and Court Ruling?

The stock market may be buoyed this week by expectations of a Fed rate cut, as the August Employment Report is expected to be soft.  A consensus-like Report would likely pave the way for a Fed rate cut at the September 16-17 FOMC Meeting.  Also, the Appeals Court ruling against most of Trump's tariffs could mollify some of the markets' and Fed's concern about the inflation outlook.

Consensus looks for a sub-trend +78k m/m increase in August Nonfarm Payrolls, slightly more than the +73k in July,  Both are lower than the +115k that would keep the Unemployment Rate steady, assuming no change in the Labor Force Participation Rate.  Moreover, the Unemployment Claims data tilt toward an even smaller Payroll increase in August than in July.  Consensus looks for the Unemployment Rate to tick up to 4.3% from 4.2%, which is a reasonable expectation based on the Claims data and the rounding analysis discussed in last week's blog.  Consensus also expects Average Hourly Earnings to climb a trend 0.3% m/m, the same pace as in July.  A trend increase would argue against a wage-price spiral being triggered by tariffs.  The consensus estimate of a steady 34.3 Hour Nonfarm Workweek would allow for an increase in Total Hours Worked in August and Q325, suggesting that economic growth is continuing.

Other key data this week should support the idea of modest economic growth, according to consensus estimates.   The Mfg ISM is expected to edge up to 48.6 in August from 48.0 in July.  Both are associated with Real GDP Growth of 1.5-2.0%.  The Services ISM is seen up a bit, as well, to 50.5 from 50.1.    

In contrast to the expectation of modest job and economic data, this week, the Atlanta Fed Model's estimate of Q325 Real GDP Growth was strong, revised up to 3.5% from 2.2% (q/q, saar), thanks mostly to a shift from a subtraction to an add by Net Exports.  However, this shift looks questionable given the wider Trade Deficit in July.  The latter was caused mostly by a rebound in imports of industrial supplies, which could have been due to higher prices as the model apparently assumed.  Nevertheless, the 3.5% GDP estimate should be viewed with caution.  The Model's estimate is still early, and softer data for August and September would pull it down.  So, at this point, the Model's estimate of strong Q325 Real GDP Growth should not stand in the way of a Fed rate cut as long as the August Employment Report is soft.

As for inflation, the July PCE Deflator was benign and should not be an impediment to a rate cut, particularly considering tariffs had some impact that could be temporary.  The Core PCE Deflator rounded up to 0.3% from 0.27%.  And, the Market-Based Core PCE Deflator rose only 0.2%.          

The Appeals Court's ruling against most of Trump's tariffs needs to be affirmed  by the Supreme Court to significantly reduce the markets' and Fed's concern about their inflationary impact.  Even without the termination of the tariffs, Trump's policies and actions have mixed implications for inflation.  

/1/ Tariffs will almost certainly boost prices -- putting aside the possibility that the Supreme Court will affirm the negative ruling of the Appeals Court -- as will Trump's weak dollar preference.  However, there are caveats that could dampen their impact on prices.  If companies are slow to pass through the higher costs of imports, the price level will eventually fully reflect them but the boost to inflation -- the rate of change of prices -- will be modest and extend for a longer time than if the tariffs were fully passed through immediately.  In other words, US purchasing power will be reduced slowly.   The other caveat is that foreign companies could lower their prices to maintain market share in the US.  In this case, there would be no increase in inflation.

/2/ If Trump's appointees force the Fed to lower the funds rate and keep it low, the risk is the policy will overly stimulate the economy as well as depress the dollar in the FX market,  Both would lead to higher inflation.  There are two caveats:  /a/ The policy could backfire: longer-term yields could rise in response to the inflationary threat, thereby pulling down stocks.  Both developments would hurt economic growth.  /b/ The easy monetary policy would not be inflationary if the economy is in the process of slowing sharply or falling into recession.  

/3/  If Trump damages the independence of the Fed, inflationary concerns will likely boost longer-term yields and depress the dollar.  In the short run, the former would hurt economic activity while the latter would lift inflation. 

/4/ Deporting illegal immigrants reduces the labor force, thereby tightening the labor market and putting upward pressure on wage rates. 

The yield curve would signal whether a Trump-forced monetary policy change would likely boost inflation or not.  A steeper curve, with longer-term yields having risen, would signal an inflationary implication and, ironically, hurt interest-sensitive spending such as housing -- the sector Trump thinks his easy monetary policy would help.

Some of Trump's actions have reduced prices.  He put pressure on the Saudis to keep oil prices down.  And, the drop-off in foreign tourism to the US in reaction to his tariffs may have held down hotel rates.  He also is putting pressure on pharmaceutical companies to lower prescription drug prices.  All these efforts have the undesirable effect of reducing incentives for domestic production and innovation, but they do help hold down inflation.

Trump's actions are not the only government policies that boosted inflation.  Some of the higher prices hurting the consumer may have been triggered by the hikes in the minimum wage during the past few years.  These hikes probably played a role in the surge of restaurant prices, for example.    

 

 

 

A Shift in Risks -- What Will Data Say?

Stocks may continue to be supported if not move up in expectation of a Fed rate cut at the September 16-17 FOMC Meeting after Powell kept open the door, acknowledging a possible shift in the balance of risks toward a softer labor market.  What will be important is evidence from upcoming data that economic growth has slowed and the labor market has indeed softened.

The important Unemployment Claims data support the idea that the balance of risks has shifted somewhat toward weaker economic growth and softer labor market.  Both Initial and Continuing Claims are slightly above their July average.  So far, they suggest a smaller increase in Nonfarm Payrolls in August than in July (+73k m/m Total, +83k Private).  And, they hint at an increase in the Unemployment Rate, which would put it above its recent range.  Note that the Unemployment Rate almost printed 4.3% in July, having rounded down to 4.2% from 4.248%.  The unrounded July level suggests a greater chance for the Rate to tick up than down in August.  A soft August Employment Report, due September 5,  would likely pave the way for a September Fed rate cut.

Powell also affirmed that the Fed is targeting 2.0% inflation, arguing that low, steady inflation is required to sustain a solid labor market.  Maintaining this target suggests the Fed will be cautious in easing, cutting by only 25 BPs in September and possibly skipping a cut at the following FOMC Meeting to see how inflation evolves.  Although Average Hourly Earnings in the August Employment Report will not likely be the critical component regarding a September rate cut, a 0.3% m/m or lower print would support the idea that tariffs are not leading to a broader pickup in inflation while a higher print could raise some doubt about this idea.

This week's release of the July PCE Deflator is expected to be a bit on the high side, up 0.3% m/m for Total and Core.  The y/y would rise for both.  High prints would not likely stand in the way of a September rate cut, as some of the increase is attributable to tariffs and could be one-off.  

Other data this week are expected to post modest gains, particularly after taking account of inflation.  July Personal Income and Consumption are seen speeding up to 0.4-0.5% m/m from 0.3% in June.  However, they would be up only slightly after adjusting for the expected 0.3% increase in the PCE Deflator.  July Durable Goods Orders are projected to decline sharply for the 2nd month in a row, likely resulting from a drop in aircraft orders.  The underlying Ex Transportation and Nondefense Capital Goods Excluding Civilian Aircraft are seen up slightly.  There is a risk the latter will rebound more sharply after falling 0.7% m/m in June.  The latter is a leading indicator of Business Equipment Spending, which Powell pays attention to.  But, a rebound should not get in the way of a September rate cut.