Will Stocks Like A Rate Hike?

The stock market may react positively to a Fed rate hike at this week's FOMC Meeting, while reacting negatively if the Fed does not hike.   The markets raised their probability of a Fed rate hike after the high August Core CPI was released on Friday.  Are they right?  There continue to be mixed considerations.

Possible Stock Market Reaction 

Stocks may view a rate hike positively for several reasons.  /1/ With the Fed finally moving against inflation, longer-term Treasury yields could fall.  The short-end would be taking on some of the anti-inflation work.  /2/ Tighter policy now may reduce the extent of tightening needed later.  /3/ A tighter Fed could reduce the risk premium in commodity prices.  Lower commodity prices, particularly oil, should be a positive for stocks.  It also would work to lower longer-term yields.

In contrast, steady Fed policy could lift inflation expectations and prompt further increases in commodity prices and longer-term yields, both of which would be negative for stocks.  Also, the risk of Fed tightening after the mid-term elections would increase, possibly by more than if the Fed had moved sooner.   So, this risk would continue to weigh on stocks.  And, the markets could conclude that the Fed was bowing to pressure from the Administration, damaging its reputation of being politically independent.  

Arguments For/Against a Hike 

1. While the 0.3% m/m August Core CPI was on the high side, large increases in a couple of components -- Airfares and Lodging Away From Home -- were mainly responsible.  Higher fuel costs were likely behind the jump in Airfares for the second month in row.  Volatility appears to be behind the bounce in Lodging after the latter dropped in July.  The bulk of the Core components were benign.  The Cleveland Fed's measure of the median CPI and trimmed CPI both rose only 0.2% in August.  So, "fence sitter" FOMC members could decide to keep policy steady despite the high print, blaming it on a "bad" distribution of "noise" and higher oil prices this month.  However, they may vote to tighten in response to the stickiness of inflation.  

2.  A desire not to tighten ahead of the midterm elections could hold back the Fed, as well.   

3.  However, the Fed's credibility could be in question if it doesn't tighten, particularly since Warsh has emphasized the Fed's intent to bring down inflation.  He has said that steady but high inflation is not acceptable.  Although the y/y for the Core CPI slipped to 2.4% from 2.5%, it remains above the Fed's 2% target.  The uptick in the University of Michigan Survey's 5-year inflation expectations to 3.4% from 3.3%, reported Friday, could add to the concern that the Fed is losing credibility, as could the recent sharp increase in longer-term Treasury yields.  

4.  Another consideration, away from the latest inflation data, is that the reasons for the 2024-25 rate cuts no longer apply -- /1/ real rates are not higher because inflation fell and /2/ the labor market is not weakening, unlike what appeared to be the case then.  Arguably, reversing these cuts could be appropriate.  This reason would point to another rate hike later this year even if the Fed hiked this week.

5.  In addition, the US economy is being propelled by several independent forces -- AI build-out, defense spending and re-shoring of production.  Higher rates are needed to make room for them, given the economy is at full employment.  Indeed, as Fed officials like to point out, an AI-caused ratcheting up of productivity growth would require higher market yields.  Otherwise, there could be over-investment.

 

 

 

 

 

 

 

 

All Eyes On The CPI

The stock market may trade cautiously into the release of the August PPI and CPI on Thursday and Friday, respectively, after the strong August Employment Report.   The inflation data may be the deciding factor in persuading FOMC "fence sitters" to vote for or against a rate hike.  One fence sitter, Fed Governor Barr, said last week that he may vote for steady policy if the CPI is benign.  

A consensus-like August CPI would not eliminate the possibility of a September rate hike, but it would not guarantee one either.   Consensus looks for a high 0.4% m/m increase in the August Total CPI, boosted by higher oil-related prices resulting from Iran war developments.  A high Total, however, could be dismissed as temporary.  In contrast, a consensus-like Core CPI would point to "sticky" inflation, which Fed Chair Warsh says is unacceptable.  The Core is expected to print 0.2% m/m, which would equal the January-July average and remain above the Fed's 2.0% target on an annualized basis.   The y/y would slip to 2.4% from 2.5% for Core.   The downtick could be viewed positively by the Fed and stock market. 

A lower-than-consensus print for both Total and Core also cannot be ruled out.  Housing Rent (both Primary and Owners' Equivalent) would have to slow from July's 0.3% pace.  And, Airfares need to be flattish to down as would some other typically volatile components like Used Car Prices and Lodging Away From Home.

Fed Chair Warsh, in his Jackson Hole speech, referenced a wide decomposition of the PCE Deflator among his arguments to hike rates (see last week's blog).  A decomposition of the Core CPI by broad components shows most printing 0.2% or less in each of the past three months (see table below).  However, the share was only just above 50% in May and July, when the Core CPI printed 0.2% overall.  So, even though the decomposition differs from Warsh's PCE Deflator figures, it still shows that a broadening slowdown among CPI components is needed to achieve the Fed's inflation target.  It is not clear whether FOMC fence sitters will need to see a broadening slowdown to keep rates steady and not hike rates.  However, a broadening presumably would raise the possibility they will vote to keep policy steady.

                               Number of Broad Core CPI Components                

                             0.2% or less            0.3%        0.4% or more           Core m/m % change

May                            8 (57%)               2                4                                     0.2

June                          11  (79%)              1                2                                      0.0

July                            8   (57%)              1                5                                      0.2

 * number in parentheses is % of the distribution 0.2% or less. 

The August Employment Report confirmed the Fed view of a solid labor market.  Along with upward revisions to June and July, the +162k m/m increase in August Payrolls showed widespread, albeit mostly small, increases among sectors, with notable increases in Manufacturing and Construction.  Payrolls in Leisure and Hospitality had the largest swing, rebounding 62k in August after falling 21k in July (mostly in restaurants).  Excluding Leisure and Hospitality, Private Payrolls rose 65k in August after +92k in July.  These are solid gains in this low job-creation environment. 

The Household Survey confirmed the strength seen in Payrolls.  The Unemployment Rate was steady at a low 4.1%.  The broadest measure -- U-6 -- fell 0.2% point m/m to 7.7%.  Both Civilian Employment and Labor Force rose.  The Labor Force Participation Rate jumped to 61.6% from 61.4%, after having been in a downtrend since November 2025.  The increase could reflect the small sample bias of the Household Survey.  So, an upturn has to be confirmed over the next few months.  However, it raises the possibility that an improving labor market is encouraging people to resume looking for jobs.

Besides the Payroll strength, the 0.1 Hour increase in the Nonfarm Workweek to 34.4 Hours shows better activity in the economy.  Total Hours Worked (THW) rose 0.3% m/m in August, putting it 1.8% (annualized) above the Q226 average.  THW rose 1.2% (q/q, saar) in Q226.

The 0.3% m/m increase in Average Hourly Earnings (AHE) in August supports the Fed's view that the labor market is not producing inflationary pressures.  AHE has averaged 0.3% m/m since the start of 2025.

Trump's call for the Fed to lower the funds rate threw another wrench into the monetary policy debate, doubling down in a sense on Treasury Secretary Bessent's previous announcement of a shift out of long-dated government financing.  Trump's call is puzzling, since it is a widely held belief that Presidential jaw-boning could backfire by pushing Fed officials to act in an opposite way to assert its independence.  Perhaps Trump wants to disassociate himself ahead of the midterms from a tightening decision that may happen this month.  Whatever the motivation, his jaw-boning is not likely to have an impact on the Fed.  Fed officials' views of the economy should be the deciding factors.

 

 

 

 

    

Warsh and Upcoming US Economic Data

The stock market may stay range bound this week, as key US economic data are not expected to change the overall macro picture.  The data are expected to be consistent with the broad outline of the economy described by Fed Chair Warsh at the Jackson Hole Conference last week -- solid labor market and strong manufacturing sector.  Upcoming inflation data could be more important for the Fed.

The Fed's main focus is bringing inflation down to its 2% target, according to Warsh.  He said the Fed will "have work to do" if it does not have confidence that underlying inflation is clearly moving in the right direction and with sufficient speed.  This comment does not guarantee a September rate hike, but suggests upcoming inflation data could trigger one.  The August inflation data will be released September 11 (CPI) and September 30 (PCE Deflator).   The FOMC Meeeting will be on September 16-17.

While Warsh reaffirmed the PCE Deflator as the main measure of inflation for the Fed, he emphasized that the Fed's focus is on the underlying inflation trend -- defined as the "generalized change in prices in the economy, unaffected by idiosyncratic factors."  He mentioned, perhaps for the first time by a Fed official, that more than 50% of the components of the PCE Deflator show increases above 3% over the past 12 months.  The market (and Fed) will likely focus on dis-aggregating upcoming inflation data this way to help judge whether the underlying trend is moving down.  

As for this week's economic data, Warsh reiterated the Fed's view that the labor market is "quite stable and consistent with full employment."  Consensus expects the August Employment Report to fit that description.   Nonfarm Payrolls are seen bouncing back to +45k m/m from -23k in July.  The risk may be for a larger increase, since the July decline reflected a drop in State & Local Government Education jobs that might have resulted from faulty seasonal adjustment.  More importantly, Private Payrolls are seen speeding up to +50k from +30k -- exceeding the prior +40k 3-month average.  (The Claims data suggest little change in the pace of Private Payrolls.)   

Consensus also expects the Unemployment Rate to edge back up to 4.2% from 4.1%, but this would keep it within its low range -- not changing the Fed view that the labor market is at full employment.  And, Average Hourly Earnings is seen speeding up a bit, but to a still below-trend 0.2% m/m from 0.1% in July.  Warsh acknowledged that wage inflation has been "moderate."  But, he did not take much comfort from this, saying that wages have not tended to be a good predictor of future inflation.  

Consensus looks for the August Mfg ISM to edge down to 55.3 from 55.6.  It would remain above the 46.3-53.0 range seen since early 2022.  Such a high level would be consistent with Warsh's view of the manufacturing sector.  He highlighted the strength of capital spending, much of which is tied to the AI build-out.  

Overall, Warsh's speech was essentially one more instance where he identified a problem -- too high inflation -- but did not decisively indicate a near-term rate hike.  Possibly, he does not yet have consensus among FOMC members to tighten policy.  His reference to the somewhat inflationary tilt in the distribution of price increases among PCE Deflator components as well as his sense that financial markets are not restrictive may suggest he is looking for more evidence to convince his colleagues.  Tracking Fed official speeches in coming weeks may offer clues if an absence of consensus in the Committee is the case or is ending.  Hawkish speeches should be expected by the three Committee members who dissented in favor of a hike at the July Meeting -- Cleveland Fed President Hammack (hawk), Minneapolis Fed President Kashkari, and Dalls Fed President Logan,   Fed Governor Waller (fence sitter) speaks on Thursday.  So does President Hammack.

Here is a breakdown of the FOMC Members in terms of hawk, dove and fence sitters, according to AI:

         Hawk                                Dove                Fence Sitter     

    Hammack                            Paulson              Barr           

    Kashkari                                                         Waller               

    Logan                                                              Bowman (slight dove)                                                     

    Warsh                                                             Jefferson       

    Cook (leans)                                                   Williams (slight dove)          

                                                                            Powell 

Fence Sitters would need to be convinced to tighten for there to be a rate hike.

 

   

Soft Macro This Week/Bessent's Attempt

The stock market will likely focus on corporate earnings and Iran developments this week.  It also will face evidence on three macroeconomic items -- the Fed's targeted inflation rate (PCE Deflator), consumer spending and Fed Chair Warsh's Jackson Hole Speech.  Their impacts on the market may be muted as they will not likely change the overall picture of subdued inflation, soft consumption and steady Fed monetary policy.  

Consensus looks for a slight speedup in the PCE Deflator in July from the June pace.  It sees Total up 0.1% m/m after -0.1% in June.  Core PCE Deflator is expected to rise 0.2% after +0.1% in June.  The risk is for a lower-than-consensus print, based on a smaller weight given to housing rent in the Deflator than in the CPI (where it was +0.3% in July), more weight given to apparel (which was +0.1% in July), and an offset to the +2.2% m/m airfares in the CPI with the -3.4% in the PPI.   The consensus estimate of the y/y for the Core PCE Deflator is a steady 3.3%.  The risk is for 3.2%.

Consensus expects a slowdown in Consumer Spending to +0.2% m/m in July from +0.3% in June, reflecting the drag from July Retail Sales reported last week.  Consumer Spending would still be up in real terms if the consensus 0.1% estimate of the PCE Deflator prints.  Even so, downward revisions to May and June Retail Sales are a factor behind the consensus estimate of a large downward revision in Q226 Real GDP Growth to 1.5% (q/q, saar) from 2.1%.  However, there is more to the overall economic picture than just consumption.  Strong business investment is expected to be seen in increases in July Durable Goods Orders and its major components.

BLS will announce its estimate of the Benchmark Revision to Nonfarm Payrolls.  The benchmark is based on a universal count (derived from unemployment insurance data) as of March 2026 and incorporated in the January 2027 Payroll figure released next February.  Some analysts look for a modest downward revision, which would likely be a non-event since it would be well within the historical range.  Benchmark revisions were downward in 7 of the past 10 years, ranging from -1k  to -898k (average -298k).  It was a huge -898k in March 2025.  Upward revisions ranged from +138k to +568k (average +360k). 

Fed Chair Warsh is likely to reiterate that economic growth is solid, labor market steady and inflation still too high -- and that the Fed is adamant to seeing the latter come down.  However, he also should stick to his plan to not specify future monetary policy or project the future path of the economy.  Instead, he may discuss the Task Forces that he has set up to evaluate Fed communications, Fed balance sheet, economic data, productivity and jobs, and inflation targets.  At this point, Warsh has said the Fed's Central Tendency Forecasts will not likely be published after this year.  Discussing these Task Forces will probably be academic and market neutral.

The so-far failed attempt by Treasury Secretary Bessent to lower longer-term Treasury yields by shifting Federal Government financing to the short end is reminiscent of the academic debate that, I believe, began in the 1970s.  The Yale school of thought,  pushed by Jim Tobin, argued that relative supply of longer-term Treasuries (relative to supply of  short-term Treasuries) affects their yield.  The MIT-Penn school of thought, pushed by Franco Modigliani and Albert Ando, argued that expectations of future short-term rates and inflation were the dominant determinants, not relative supply.  Work that another economist and I did at the NY Fed showed that expectations of the Federal deficit and the volatility of the dollar against major currencies in the FX market also had an influence on longer-term yields, besides short-term rate and inflation expectations.  The quick reversal of the dip in longer-term yields from Bessent's announcement would seem to support the MIT-Penn school of thought.  Similarly, my impression at the time was that Fed Chair Ben Bernanke's QE  (quantitative easing: Fed buying longer-term Treasuries) had more effect on the stock market than longer-term yields.   

Although the high Federal Government debt (hitting $40 Tn) received a lot of attention, the renewed increase in oil prices, with the risk that the Iran war will push them up further, may be the more significant factor behind the latest run-up in longer-term yields as it lifts inflation expectations.  Moreover, with the Fed so far reluctant to raise the funds rate, expectations of future rate hikes may have risen, as well.  Another way of putting this is that with Fed policy steady, the burden of fighting inflation falls more on future policy and thus longer-term yields.

  

US Data More Mixed Than Appears

The stock market may be range bound this week, as it focuses on the implications of recent US economic data for Fed monetary policy.  The data were more mixed than market commentators appeared to acknowledge and argue for steady Fed policy.  The July inflation data were ostensibly soft, but some aspects were troubling.  July Retail Sales were weak, but early estimates of Q326 Real GDP Growth remain strong.  These data printed after the July FOMC Meeting, so this week's release of the Minutes will not reflect this new information.  The next opportunity to get a sense of Fed thinking will be Fed Chair Warsh's speech at the Jackson Hole Symposium on August 27-29.  However, he already has said that he may focus on his Task Forces rather than future monetary policy.   He, of course, will emphasize the Fed's goal to bring inflation down.

The July CPI headlines (0.1% m/m Total and 0.2% Core) seem to confirm a slowing inflation trend, as the y/y slipped for both.  But, some components remain worrisome.  In particular, Primary Rent and Owners' Equivalent Rent both sped up to the old 0.3% trend (3.6% annualized).  It will be difficult to hit the Fed's 2% inflation target on a sustained basis if rent doesn't slow to a 0.2% or lower m/m trend.  Also, computer prices rose sharply both in the CPI and PPI, likely resulting from memory chip shortages.  Fed officials have mentioned the impact of AI investment on some prices as one factor making it difficult to hit their target.   This factor should be temporary, disappearing as the memory shortage is resolved.  However, the latter could take time.

The July PPI headlines (0.0% m/m Total and 0.2% Core) understated the underlying pace.  The underlying Core Less Trade Service rose 0.4% m/m (about 5.0% annualized) -- the same high pace as the H126 average and well above what would be consistent with the Fed's 2% target.  

Although July Retail Sales fell, the decline could be just the typical pause after a string of strong months.  It also could be just a one-off unwinding of the boost to sales from  tax refunds in the Spring.  Nevertheless, a slowdown in consumption would not be inconsistent with the slowdown in job growth over June and July.  The Atlanta Fed model lowered its forecast of Q326 Real GDP Growth to 4.3% (q/q, saar) from 4.8%, but it is still well above trend.  The model estimates that consumption will grow 2.5% in Q326 -- which would require a bounce-back in Retail Sales in August and September -- and that other components of GDP will grow, as well.

Although the July FOMC Minutes will not reflect these latest data, the markets will likely look for clues on participants' views of the likely path of monetary policy.  The Minutes of the June Meeting indicated a fairly even split between those expecting steady to slightly easier policy and those expecting tighter policy by year end:

   "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."    

The July Minutes could indicate a shift toward the tighter policy group, given that there were three dissents that favored a rate hike at the Meeting.  The markets should be cautious taking such a shift at face value, since some of the hawks could have pulled back their expectations of the year-end funds rate after the latest economic data.

 

 

 

                                                                  

                          

 

 

Macroeconomic Evidence Turning Benign For The Fed?

The stock market may be helped by soft inflation data this week.  Along with Friday's soft July Employment Report, they would argue for steady Fed policy at the September FOMC Meeting. 

Consensus looks for +0.1% m/m Total and +0.2% Core for the July CPI.  The y/y would fall to 3.3% from 3.5% for Total and to 2.5% from 2.6% for Core.  Moreover, lower-than-consensus prints for Total and Core can't be ruled out.  Owners' Equivalent Rent would need to stay low.  Lodging Away From Home needs not to rebound after falling in June, and Airfares need to stay low despite a boost from seasonal factors.  Retail Gasoline Prices should fall again, despite the renewed Iran war.

The July Employment Report showed a soft labor market, possibly reflecting the impact of AI on jobs.  Besides the decline in Payrolls, there appears to be a continuing amount of discouragement to look for jobs.  So, while the Unemployment Rate fell, it may overstate the strength of the labor market.  Indeed, the slight uptick in Average Hourly Earnings also hinted at a soft labor market.

The -20k m/m drop in Nonfarm Payrolls was concentrated in State and Local Government Education jobs (-50k), likely temporary and related to the end of the school year.  More importantly, the below-trend 30k increase in Private Payrolls -- the second such modest gain in a row, both less than half the 80k 3-month average ending in June --  reflected a sharp slowdown in Service-type sectors -- possibly sectors in which implementation of AI is concentrated.  Private Service-Providing Payrolls rose only 5k, after +16k in June.  Both months were substantially weaker than the prior trend.  Cyclical sectors (manufacturing and construction), in contrast, continued to climb.

At this point, it is possible a productivity jump may offset the weak job growth -- consistent with a boost from AI.  With  the Nonfarm Workweek flat and Total Hours Worked up only slightly, the latter stands just 0.1% (annualized) above the Q226 average.  Productivity should be strong in Q326 if the Atlanta Fed Model's early estimate of 5.8% (q/q, saar) for Q326 Real GDP Growth is right.  A productivity jump would support the idea of substitution of AI for labor being responsible for the weakness in job growth.

The dip in the Unemployment Rate to 4.1% fro 4.2% in June may overstate labor market strength to the extent it resulted from people dropping out of the labor force.  The Labor Force Participation Rate has trended down since a peak of 62.5% in November 2025.  This downtrend continued in July, as it slipped 0.1% point m/m to 61.4%.  The downtrend looks to be more than just the effect of the small Household Survey or fully explained by an aging population in which older people are less inclined to work than younger people.

Although it is too soon to say that the soft 0.1% m/m increase in Average Hourly Earnings (AHE) is the new normal, it opens the door to this possibility.  The slowdown from a 0.3% m/m trend was widespread.  10 of 13 major sectors slowed from June and 9 were slower than their Q325 average. Along with the soft Q226 Compensation/Hour and Unit Labor Costs (2.7% and 1.3% (q/q, saar), respectively) reported last week, July AHE is good news for the inflation outlook.  

 

 

 

  

Fed Leading From Behind?

The stock market will be entering a period of seasonal volatility and weakness in August and September with little guidance from the Fed.  Fed Chair Warsh appears content to let the markets decide how to react to incoming data by themselves.  He does not want them to react to how they think the Fed will view the data.  The risk is that the markets' tendency to overreact to information will be even greater, although he didn't say this.  This week, key data are mostly expected to be on the stronger side.  They would indicate solid economic growth (stock market positive) but possibly lift longer-term Treasury yields (stock market negative).  Iran war developments may have turned positive, at least for the moment.  Dollar-Yen intervention in the FX market could have mixed implications for stocks

Fed Chair Warsh gave the impression the Fed is not ready yet to take a leadership role in steering the economy toward the 2% inflation goal at last week's post-FOMC news conference.  He said Committee members focused at the Meeting on analyzing issues -- separating the effects of price shocks (stemming from the Iran war, tariffs and AI) from underlying inflation and how monetary policy tools could work to bring inflation down.  He said there was broad consensus on the Fed's commitment to hitting its inflation target and that it has the tools to do so.  Warsh did not say members focused on how or when the Fed would use them.  And, the whole discussion, as described, seems to have been academic and an avoidance of debating the timing of a rate hike.

Warsh seems to want to wait to hear from his Task Forces before making a decision.  And, he said he will be hearing from them within the next several weeks.  He suggested he might discuss the Task Forces' missions at the Jackson Hole Conference (August 27-29).  Meanwhile, he is counting on the markets to take the lead and react to incoming data.  However, he said the Fed will not be constrained by market views on monetary policy.  So, a market's expectation for a September rate hike is not a guarantee the Fed will move then.

Indeed, Warsh conceivably may view a reliance on markets to tighten as a way to avoid a politically sensitive hike in the Fed funds rate.  By insisting the Fed wants to lower inflation, he signals the Fed's goal to the markets, expecting them to move in ways that will achieve that goal.  If this interpretation is right, the funds rate will stay where it is in coming months and Warsh will continue to assert the Fed's desire for lower inflation while the markets react to incoming data.  The question will be whether Warsh loses credibility by not following his words with action. 

Alternatively, it is conceivable that last week's decision to keep rates unchanged reflected a desire by a majority of FOMC members to maintain former Fed Chair Powell's "wait and see" policy approach.  If that's the case, Warsh may not control the FOMC, unlike prior Chairs.  His talk of the Fed having a "laser focus" on fighting inflation may have to be discounted.  Also, upcoming July and August inflation data could be critical to the Fed's decision whether to hike rates at the September 15-16 FOMC Meeting.  Benign data could keep rates steady.  The July CPI will be released August 12 and the August CPI September 11.  

This week could test Warsh's reliance on markets to respond appropriately to US economic data.  Key data are expected to improve m/m, pointing to a speedup in economic growth in Q326.  The strength would be consistent with the Atlanta Fed model's preliminary estimate of 5.0% (q/q, saar) for Q326 Real GDP Growth, after Real GDP rose 1.5% in Q226.  

The July Employment Report is expected to show a speedup in job growth.  Consensus looks for Nonfarm Payrolls to climb 91k m/m, versus +57k in June.   The Unemployment Claims data support the idea of a speedup.  Although consensus expects a rebound in the Unemployment Rate to 4.3% from 4.2%, both the dip in June and uptick in July could be chalked up to noise.  The Bureau of Labor Statistics says such small moves are not statistically significant.  Moreover,  the risk is that the Unemployment Rate prints below consensus, based on the Claims data.  Rounding analysis also suggests the risk is for a below-consensus print.  The un-rounded Unemployment Rate was 4.19% in June.

The wage data can be important, as well.   Consensus sees a trend-like 0.3% m/m increase in Average Hourly Earnings,(AHE) matching June's increase.  This pace would be consistent with 2% price inflation if Productivity Growth is trending in the 1.5-2.0% (annualized) range.  A problem, however, is that Productivity has been weak so far this year, up only 0.7% (q/q, saar) in Q126 and expected at 0.3% in Q226 (released on Thursday).  Productivity will most likely jump in Q326 if the Atlanta Fed model's GDP estimate is right, which could bring this year's trend back in the desired range.  So, a 0.3% m/m print for AHE would probably be taken in stride by the market.  A higher print should be a negative and vice versa.

Most other data this week are expected to improve.  In particular, the Mfg ISM is expected to rise to 54.0 in July from 53.3 in June, bringing it back to the March level.   Construction Spending also is expected to speed up, to +0.2% m/m in June from +0.1% in May.  However,  the JOLTS Data' Job Openings are seen pulling back to 7.25 Mn in June from 7.59 in May, suggesting a dip in the demand for workers (belied by a stronger Payroll print in July). 

 

 

 

 

 

A Fed Rate Hike This Week?

The stock market could be surprised by a Fed rate hike at this week's FOMC Meeting, as a case can be made for the Fed to act now.  To be sure, arguments for the Fed to wait also can be made.  So, it's far from a slam dunk.  And, if it does hike, a consequential stock market hit conceivably could be quickly reversed.  The market also will have to contend with Iran war developments and tech consolidation.  Strong corporate earnings should be in the background, as well.

Market expectations lean toward a Fed rate hike at September's FOMC Meeting, but a case can be made for the Fed to act now.  /1/ The latest rebound in oil prices underscores the inflation problem.  Besides its direct and indirect boosts to inflation data, it could lift inflation expectations -- that could feed into wage negotiations and thus a wage-price spiral.  /2/ The rise in longer-term yields reflects market fears that inflation will climb.  The higher yields send a troubling signal from the markets to the Fed that inflation expectations are moving up.  /3/ The real economy is doing fine and even may be accelerating.  It should not stand in the way of a hike.  /4/ A quick response by the Fed would demonstrate its seriousness in fighting inflation.  After Fed Chair Warsh's insistence that the Fed will nip inflation, a quick move would show his words are not an empty promise.  /5/ Congress gave approval to go against inflation at his recent Semi-Annual Monetary Policy testimony.  /6/ A rate hike in July hike would be further ahead of mid-term elections than in September, making the tightening less of a political issue in the fall.  /7/ The reasons for the 2024-25 rate cuts no longer apply -- /a/ real rates are not higher because inflation fell and /2/ the labor market is not weakening, unlike what appeared to be the case then.

Arguing against a July hike is the flat June Core CPI, which supports the Fed's expectation that the recent increase in inflation will be temporary.  This week's release of the June PCE Deflator should show a soft Core, as well.  Consensus looks for +0.1% m/m.  Also, the Fed's practice has been to set the stage for a hike before actually raising rates at the subsequent meeting.   However, Warsh may drop this practice, which would be in line with his intent to change Fed communication methods and with his view that the Fed should not tell markets.of the Fed's policy projections.  

The real economy is not standing in the way of a Fed rate hike.  Growth is being propelled by increased defense spending and AI investments.  Consumption growth remains on trend.  This week's advance report on Q226 Real GDP is expected to indicate decent growth.  Consensus looks for 2.3% (q/q, saar) Real GDP Growth, a bit higher than the 2.1% in Q126 and above the Atlanta Fed model estimate of 1.7%.  The consensus estimate is at the high end of the Fed's 2.0-2.3% Central Tendency Projection for 2026 as well as being above the Fed's 1.8-2.0% estimate of longer-run growth.  

And, the Unemployment Claims data show the labor market improving and possibly at a fast clip.  Both Initial and Continuing fell further in the latest week, with Initial making a new low for the year.  They indicate that layoffs have fallen and that hiring may have picked up.  The data point to a speedup in July Nonfarm Payrolls, due August 7.  

This week's Labor Cost data, nevertheless, are expected to be benign.  Consensus looks for the Q226 Employment Cost Index to rise 0.8% (q/q), versus 0.9% in Q126.  A slowdown would be consistent with Average Hourly Earnings. 

Ironically, the stock market may recover quickly after a Fed rate hike this week.  This could be the case if, as is likely, the hike pushes down commodity prices and, as a result, the 10-year Treasury yield, as it undermines the more extreme expectations of higher inflation ahead.  The reduction in the drag on the consumer from higher oil prices and the boost from lower long-term yields would be stock market positives.  

 

 

 

  

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).

A Soft Enough Employment Report?

The stock market may continue to be pressured by the potential for adverse developments affecting the US-Iran agreement, consolidation in the tech sector, and fear of a Fed rate hike at some point.  Last week's May PCE Deflator data did not allay this fear.  So, this week's June Employment Report contains the next set of evidence that could argue against a rate hike (or at least a hint of one coming) at the July 28-29 FOMC Meeting.  The evidence would presumably have to show a significant softening in labor market conditions to allay market fears.

The softening may have to be broader than a slowing in Nonfarm Payrolls.  Consensus looks for Payrolls to slow to +114k m/m from +172k in May.  The Claims data support a slowdown expectation, as Continuing Claims rose between the May and June Payroll Survey Weeks (see table below, which shows the inverted change between survey weeks).  The consensus estimate, however, is above the 50-60k pace consistent with Population Growth, so jobs would still be growing sufficiently to satisfy Fed Chair Warsh.  He had indicated at his post-FOMC news conference that job growth close to population growth shows a satisfactory labor market.

The Employment Report may need to show both an increase in the Unemployment Rate, perhaps a large increase to 4.5% from 4.3%, as well as soft Average Hourly Earnings to convince Fed officials that a rate hike would be undesirable.  Consensus, however, looks for a steady 4.3% Unemployment Rate and a trend-like 0.3% m/m increase in Average Hourly Earnings in June.    The Insured Unemployment Rate, based on Continuing Claims, does not suggest a significant change in the official Unemployment Rate in June.

The May PCE Deflator remained high, with Total up 0.4% m/m and Core up 0.3%.  The y/y rose for both.  The Trimmed Deflator, Warsh's favorite measure of inflation, worsened, as well (see table below). 

                                Private Payrolls (m/m change, 000s)   

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

    April  25             62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                41                               14

    Dec                   41                            37                                 48                               30     

    Jan 26               22                          172                               146                               94   

   Feb                    63                           -86                              -148                              -14   

   Mar                   62                           186                               202                                 6     

   Apr                  109                          123                                177                               40                

   May                122                           120                                   na                               -9       

   Jun                   98                             na                                     na                             -36              

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

 

                 Dallas Fed Trimmed PCE Deflator

One-month PCE inflation, annual rate

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	4.0	4.3	4.9	8.3	5.0	5.5
PCE ex F&E	4.0	5.5	4.8	3.6	3.0	3.9
Trimmed mean	2.2	2.7	2.0	2.9	2.4	2.8

Six-month PCE inflation, annual rate

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	2.9	3.3	3.6	4.4	4.9	5.3
PCE ex F&E	2.8	3.2	3.6	3.8	3.8	4.1
Trimmed mean	2.1	2.2	2.0	2.2	2.3	2.5

12-month PCE inflation

	25-Dec	26-Jan	26-Feb	26-Mar	26-Apr	26-May
PCE	2.9	2.9	2.9	3.5	3.8	4.1
PCE ex F&E	3.0	3.1	3.0	3.3	3.3	3.4
Trimmed mean	2.4	2.4	2.3	2.4	2.3	2.4