Tariffs and Employment

The stock market's rally should not be derailed by this week's key US economic data if consensus-like data print.  Trump's vow to impose tariffs on Canada, Mexico and China will hover over the stock market in coming weeks.    However, for the moment at least, the headlines may not be all bad for the market.

Consensus looks for a benign November Employment Report, showing only a moderate bounce-back in jobs from the adverse effects of October's bad weather and strikes.  Nonfarm Payrolls are seen bouncing back to +183k m/m from +12 in October.  If the adverse effects amounted to about -100k in October, a full bounce back would result in a print over 200k.   So, the consensus estimate implicitly assumes some softness in labor demand outside of these effects.  The Claims data support such assumption, as they hint of weaker hiring more than offsetting fewer layoffs.  With the consensus estimate, the two-month Payroll average is close to 100k -- below the level consistent with a steady Unemployment Rate.  Nevertheless, the Rate is expected to be steady at 4.1%.  Average Hourly Earnings (AHE) could be the most important part of the Report.  Consensus sees a slowdown to the old trend of 0.3% from 0.4% in October.  If AHE does not slow, it would provide more evidence that wage inflation has become problematic.

It's too soon to say whether Trump's announced intention to impose 25% tariffs on Canada and Mexico and 10% on China will have a significant impact on US economic activity or inflation.  The tariffs may be bargaining tools to push these countries to clamp down on drug traffic and immigration to the US.  Presumably, the tariffs will not be implemented if agreement is reached in these areas.  Any news of a start of bi-lateral negotiations between any of these countries and the US will be a market positive.  The Mexican President's promise to stop immigrants from crossing her country and reports of US/Venezuelan discussions move in that direction.        

The direct impact of the tariffs are likely to be less than the stated increases.  Dollar appreciation against these three countries, which has begun already, will offset the inflationary impact.  These countries' currencies have depreciated a lot (the mirror image of the dollar appreciation) over the past few months and will likely depreciate further (see table below).  The timing of the currencies' depreciation is not coincident with the tariffs, but could allow exporters to absorb at least some of the tariffs instead of passing them through to prices.  

There are other potential consequences of the tariffs.  Some production could shift to the US or other countries, with inflationary consequences stemming from higher costs of production and/or greater pressure on labor markets.  The latter could be offset by weaker US exports to these countries, as the stronger dollar make them less competitive with the rest of the world.  On balance, the size of the impact of the tariffs on the US economy is not clear.  Regardless of the impact on the US economy, the stronger dollar lowers the dollar value of profits earned abroad by US companies.

                               Approximate Change in Value Against the US Dollar

                               Canadian Dollar        Mexican Peso        Chinese Yuan

                               -5% since Sept          -23% since May      -4% since Sept

 

 

A Positive Holiday Week?

The stock market has a couple of potential positives going for it this week -- an historical tendency to climb during the Thanksgiving Week and a possible below-consensus print for the Fed's favorite measure of inflation.  

The S&P 500 has tended to rise in the Thanksgiving Week, particularly on the day before and after the holiday.  This year, the most important US economic data for the week -- the October PCE Deflator -- will be released the day before, November 27.  Consensus agrees with Fed Chair Powell's seeming forecast of 0.2% m/m Total and 0.3% Core (see last week's blog).   However, there is a possibility of a lower print as a result of the different weightings in the PCE Deflator from those in the CPI.  In particular, Used Car Prices -- which jumped 2.7% in the CPI -- gets much less weight in the PCE Deflator.  Meanwhile, Apparel Prices -- which dropped 1.6% in the CPI -- gets greater weight in the Deflator.  To be sure, there are other differences between the CPI and PCE Deflator, as well.  So, a below-consensus print is not certain.

Unemployment Claims are sending mixed signals about the labor market.  Initial Claims are making new lows for the move down, indicating a decline in layoffs.  Continuing Claims, however, have moved up, suggesting some softening in hiring.  Although early, at this point, the Claims data suggest that November Payrolls could be on the soft side once the rebounds from bad weather and strikes (about 100k) are taken out.  Note that the best way to evaluate November Payrolls will be to average the m/m change with October's.  The November Employment Report is due December 6.

The combination of benign inflation and soft underlying job growth could keep open the door for a Fed rate cut at the December FOMC Meeting.  However, Powell's more cautious comments and the uncertainties of fiscal policy under the new Administration next year argue against one.

Regarding fiscal policy, the termination of Trump's Attorney General nominee, Gaetz, may have potentially positive implications for stocks.  Trump's acquiescence of the shift to another candidate raises the possibility that he will compromise on other policy decisions when faced with strong opposition.  As a result, some of his extreme election promises may not be as likely as feared, particularly those that would be harmful to the economy.

 

 

Fed Policy Shift?

The stock market may remain under pressure this week, as prospects of a Fed rate cut in December fade amidst typical year-end tax-related selling.  However, keeping rates steady is not necessarily bad for stocks, although it shifts the counter-cyclical burden to the markets.

Fed Chair Powell and other Fed officials continue to hint that rates will be held steady at the December  17-18 FOMC meeting.  Powell said "the economy is not sending any signals that we need to be in a hurry to lower rates."  He appears to be finally acknowledging that the economy's recent strength is sustainable, suggesting that the Fed's Central Tendency update at the meeting will show stronger GDP Growth as well as a higher funds rate for next year than in the September Central Tendency forecasts.  

Steady rate Fed policy may not be entirely bad for stocks.  It would preserve room for the rate to be cut when the economy in fact needs it.  This potential to ease represents an insurance policy for stocks regarding the economic outlook, which is a market positive.  

The markets, however, will play a greater role in determining whether financial conditions should be tighter to fight inflation or easier to fight the risk of recession.  The long end of the Treasury market will sell off if inflation and/or the economy look to be speeding up or it will rally if inflation/economic growth appear to be slowing.  The long end's actions could determine the path of the stock market, with stocks moving inversely with the long-end yields.  Handing over counter-cyclical policy to the markets may be the best approach for the Fed in the face of uncertain fiscal policy in 2025.  The markets will move more rapidly in response to events than would Fed monetary policy and be immune to political flak.

Between now and the December FOMC Meeting real-side economic data risk speeding up as they rebound from bad weather and strikes.  The markets may not react sharply to this strength,  however, discounting it as temporary.   What may be more important will be data on wages and prices, as measured by Average Hourly Earnings (AHE) and the CPI.  A slowdown would be a relief for long-term Treasuries and stocks, while a still-high pace could spark a sell-off.  There is no reliable evidence for November AHE.  There is a possibility that the November CPI could move down to 0.2% if the handful of components with large changes in October flatten out and Owners' Equivalent Rent returns to 0.3% from 0.4% in October.

Powell still does not acknowledge an inflation problem.  He downplayed the high October Core CPI and Core PPI, translating them into sub-3.0% y/y increases in the Total and Core PCE Deflators.  Citing y/y increases, however, is disingenuous since they are dominated by past inflation prints.  His figures imply 0.2% m/m for Total and 0.3% for the October Core PCE Deflator, the same as in the CPI.  These would not be good prints, as the Core would be elevated for the second month in a row.  To be sure,  perhaps he just applied the CPI m/m increases to the PCE Deflator, although his figures appeared to be presented as forecasts.  Smaller increases can't be ruled out because components are weighted differently in the PCE Deflator than in the CPI.  The PCE Deflator will be released November 27.

 

  

     

 

"Trumponomics" and the Fed

The stock market rally should continue this week, with possible help from a below-consensus October CPI.  Prospects of a pro-growth Trump economic policy should underpin the market's strength.  However, the policy could create problems down the road, as it generates inflationary pressures.  Indeed, labor cost inflation remains an issue, even though it has not gotten much, if any, mention in the press or by the Fed.

 "Trumponomics" will be an extension of Bidenomics in one way.  It will try to redirect the US economy to being more insular, using tariffs as one tool.  The goal in both overall polices is to bring manufacturing from abroad to the US.  This includes the operations of non-US as well as US companies.  In contrast to Bidenomics, Trumponomics presumably will not direct  investments to particular sectors, e.g., alternative energy EVs.  Instead, it will include tax cuts, deregulation, and presumably increased defense spending (also part of Bidenomics).  In both cases, the associated stimulus help propel US economic growth. 

The problem with both approaches is that the associated stimulus needs to crowd out other domestic spending if inflation is not to speed up, particularly when the economy is operating near full employment as it is now.  Higher inflation is one way the markets crowd out spending.  In the Biden case, the large influx of immigrants -- legal and non-legal -- mitigated the need for crowding out as it boosted the labor force.  This cushion may not exist under Trump, given his threat to stop or reverse the immigration.  As a result, inflation risks could be higher under Trump. 

To be sure, labor cost inflation remains high, even with the influx of immigrants.  Compensation/Hour -- the broadest measure of labor costs -- has sped up on a y/y basis for the second year in a row:  5.5% in Q324 versus 4.8% in Q423 and 2.4% in Q422.  Productivity Growth has been a partial offset, up 2.0% or more (q/q, saar) in each of the past four quarters.  Unit Labor Costs were up 3.4% (y/y) in Q324, versus 2.1% in Q423.  ULC rose 1.9% (q/q, saar) in Q324 (above the 0.5% consensus as was the risk), but they have tended to slow in the second half of the year so they could be understating trend.  They need to stay around 2.0% both on a q/q and y/y basis to be consistent with the Fed's inflation target.

Labor cost inflation along with increased stimulus could lead to a reversal of the Fed's policy easing at some point.  Higher longer-term yields will likely lead the Fed in efforts to restrain demand.  At this point, however, the Fed appears to be steadfast in its policy to lower the funds rate to what it views as a neutral level with regard to the economy.  In his post-FOMC news conference, Fed Chair Powell said that while the Fed is not on a preset course of easing policy, the current policy stance is in a very good place and that the Fed is trying to stay on an easing path that is neither too fast or too slow.  He said the Fed would slow the pace of easing if the rate is closing in on a reasonable estimate of a neutral level.  Fed officials are beginning to think of this possibility, but their baseline forecast is to continue to ease into next year.

Fed Chair Powell made several comments, nonetheless, that raise the possibility of a pause in rate cuts.  He acknowledged that the latest data have reduced the downside risks to the economy.  Some business leaders, he said, think the economy will be better in 2025 than in 2024.  He also acknowledged that wage inflation is currently above the pace consistent with 2% price inflation -- unless productivity remains strong.  However, he said the Fed does not see wages as a significant source of inflationary pressures now.  

Powell blamed housing rent for keeping price inflation above target.  Re-negotiated rent on long-term leases are seen as catching up to more recent rent hikes and that this catch-up will end at some point, suggesting the rent component of the CPI will slow eventually.  There was hope for the latter in the September CPI, where Primary and Owners' Equivalent Rent (OER) slowed to 0.3% m/m from a 0.4% trend.  A repeat 0.3% OER in this week's October CPI Report increases the risk of a below-consensus print.  Consensus looks for +0.2% m/m Total and +0.3% Core.  Moderation in airfares and apparel, both of which jumped in September, are likely needed for a below-consensus print, as well.

Powell made one comment at the news conference that allays concern about Trump's threat to become personally involved in monetary policy decisions.  Powell said he would not resign nor give up the chair of the Fed Board if ordered to do so by Trump.  Apparently, the law prevents Trump from firing or demoting him.  Powell's determination to stay would sustain the independence of the Fed, which is a positive for all the financial markets.

 

Elections and FOMC Meeting This Week

The markets will finally see the results of the US Elections and the November 6-7 FOMC Meeting this week.  They could trade cautiously into these events.  What may be most important for the markets is whether the Presidential Election is resolved without a problem or if neither party dominates all branches of government.  The stock market could have a relief rally in either case.

To be sure, the market impact (stocks, Treasuries and dollar) of the Presidential Election could depend on who wins. But both candidates have policy proposals that are problematic for the economy and markets.  The potential implementation of these proposals could restrain a positive market impact.  Questions will remain whether the proposals will be put into effect, either legislatively or by executive order. 

Some market commentary has attributed the recent sell-off in the long end of the Treasury market to the potential for a blowout Federal Deficit, particularly if Trump is elected.  This explanation, however, may not be entirely right.  If fears of a sharply higher Deficit (and the presumed inflationary result) were the reason, the dollar should have fallen in the FX market, as well.  This did not happen.  Instead, the dollar has strengthened.  An explanation for the combination of higher long-term yields and stronger dollar could be an increasing concern about Trump's proposed tariffs.  The latter would boost the dollar on the expectation of a smaller trade deficit.  The tariffs also would boost inflation initially and thus the long end of the Treasury market through higher inflation expectations.  (Note, that the direct impact of the tariffs on prices should unwind over time as the dollar strengthens.)   If Harris wins, these market moves could unwind --  which would be a positive for the stock market.

The Fed is likely to cut the funds rate by 25 BPs at this week's FOMC Meeting.  And, while Powell should keep open the door for further rate cuts, he may be more cautious about their timing.   The economy appears to be growing moderately, but wage increases may be somewhat problematic.  Total Hours Worked in October are above the Q324 average, despite being held down by bad weather and strikes in the month.  They suggest another quarter of good-sized GDP growth, particularly taking account of a post-hurricane/post-strike bounce-back in economic activity.  The renewed downtrend in Initial Unemployment Claims in the past two weeks also suggests economic growth is fine.  The Atlanta Fed model's early estimate of Q424 Real GDP Growth is 2.3% (q/q, saar).

On the wage front, Average Hourly Earnings (AHE)  rose an above-trend 0.4% m/m in October, the second high print in the past three months.  The y/y rose to 4.0% from 3.9% in September.  The broader Employment Cost Index, in contrast, had better news.  It slowed to 0.8% q/q in Q324 from 0.9% in Q224.  The slowdown fits with the Fed's expectation of a gradual deceleration in inflation.  The ECI averaged 0.6-0.7% before the pandemic.

This week's report on Q324 Productivity/Compensation/Unit Labor Costs, however, risks adding to the labor cost problem.  Consensus looks for Compensation/Hour -- the broadest measure of labor costs -- to rise by only 2.8%, which would be a good number.  But, the risk is for a larger increase.  To be sure, speedier wages would not be inflationary if offset by higher productivity growth.  And, productivity in Q324 stands to be strong.  Consensus looks for 2.3% (q/q, saar) Productivity -- in line with the strong 2.4% average since Q123.  And, the risk is for a higher print.  But, the balance of risks between Compensation and Productivity weighs toward a higher print for Unit Labor Costs (ULC) than the consensus estimate of 0.5%.   The recent trend in ULC has been down, with the y/y hitting a slight 0.3% in Q224, well below the 1.7% y/y increase in Q423.  Anything below 2.0% suggests slower price inflation ahead.

Election Uncertainty, Earnings and Key US Data

Corporate earnings and election uncertainty should continue to dominate the stock market this week.  Although consensus looks for moderate prints for this week's key US economic data, uncertainty about the labor cost measures could dampen the market ahead of the prints.  This week's key data will be the last Fed officials see before the November 6-7 FOMC Meeting.  It is unlikely the data will deter a 25 BP rate cut, but they could influence the Fed's forward guidance at the meeting.

One of the election issues relates to Fed policy.  Trump wants the President involved with FOMC rate decisions.  This relates to Fed independence and, if he wins, would be a negative for the dollar (offsetting in part the positive impact from the threat of tariffs) and lift long-term yields, as the risk would be for political considerations to restrain rate hikes when needed to curb inflation.  

Trump supporters say the Fed makes mistakes and thus needs to be changed.  Ironically, one mistake they accuse the Fed of is representative of what Trump wants.  They accuse the Fed of not tightening soon enough in 2021-22, which they say resulted in higher inflation.  Although Fed Chair Powell attributes the delayed tightening to forecasts of a "transitory"pickup in prices, it would not be surprising if political considerations played a role.  Powell did not want to act in a way that would run counter to Congress' legislative aim to boost the economy.

This is not to say the Fed never makes mistakes.  The Fed did make mistakes in 2007-08, which exacerbated if not triggered the Great Recession.  They made 3 major mistakes:  /1/ They analyzed the problem as an illiquidity issue at banks that required interest rate cuts.  Instead, the problem really was a lack of confidence among banks regarding the extent of subprime mortgage risk in their balance sheets.  A guarantee of bank liabilities for say 5 years by Treasury or the Fed to let them unwind their subprime positions likely would have solved the problem, similar to how the ECB tackled a bank confidence problem in 2011.  Lowering interest rates in 2007-08 boosted commodity prices, particularly oil, which hurt the consumer.  /2/ Fed Chair Bernanke and Treasury Secretary Paulson went on TV to say the US economy was heading into a big recession.  This destroyed business confidence, leading to massive layoffs.  /3/ The Fed did not save Lehman Brothers, punishing the company for its mistakes rather than acting to bolster market confidence (again not understanding the confidence problem).  By the way, this is not the conventional explanation for the Great Recession.

The Fed gets into perception trouble with its Central Tendency forecasts, which are often wrong.  In a sense, the forecasts are bound to fail because markets will move in a way to prevent them from happening.  For example, longer-term Treasury yields could fall if the Fed presents a weak economic forecast.  Lower yields would lift stocks, boosting consumption as well as housing demand.  A better approach could be to publish targets for GDP Growth, Unemployment Rate and Inflation rather than forecasts.  Then, the Fed could be held accountable without seeming clueless about the outlook.

Regarding this week's key US economic data:

Consensus looks for a benign October Employment Report.  Payrolls are seen slowing sharply to +140k m/m from +254k in September, while the Unemployment is seen steady at 4.1%.  Average Hourly Earnings (AHE) are expected to slow to the 0.3% m/m trend, after climbing 0.4-0.5% in the prior two months.  Unemployment Claims data support the idea of slower job growth in October.  In addition, there were 41k additional strikers (including Boeing workers) that will subtract from Payrolls but should be added back to get a clearer picture of the underlying demand for labor.  A 180k Payrolls gain would be somewhat high from the Fed's perspective and be consistent with a lower Unemployment Rate.  Strikers, themselves, do not affect the calculation of the Unemployment Rate, as they are not counted as unemployed.  There is no evidence regarding AHE -- unfortunate since this may be the most important part of the Report.

Regarding labor costs, consensus looks for the Q324 Employment Cost Index to rise 0.9% (q/q), the same as in Q224.  Even though high from a pre-pandemic perspective, a steady pace would be tolerable.  Evidence from AHE is mixed.  AHE sped up in Q324 after slowing in Q224.  In the past 6 quarters, ECI and AHE sped up or slowed together half the time.  The other half the speedup or slowdown in ECI matched that of AHE in the prior quarter, which suggests a slowdown in the Q324 ECI. 

            (q/q percent change)

            AHE            ECI

Q324   1.06              na

Q224   0.87               0.9

Q124   1.02               1.2

Q423   0.97               1.0

Q323    0.92              1.0   

Q223    1.2                1.0    

Q123    1.1                1.2

Q422    1.2                1.1

Q322    1.1                1.2

Consensus looks for 3.0% (q/q, saar) Q324 Real GDP, in line with the Atlanta Fed Model estimate of 3.3%.  A sub-3.0% print cannot be ruled out.  Consensus also looks for the October Core PCE Deflator to rise 0.2% m/m, smaller than the 0.3% increase in the Core CPI and better in line with the Fed's 2% inflation target.  A consensus print for the Core Deflator should be a market positive.

Fed Policy Intentions Helping Stocks

The stock market is likely to continue to grind higher this week, buoyed by the Fed's intention to cut the funds rate further even with above-trend economic growth in Q324.  Indeed, the Atlanta Fed model raised its estimate of Q324 Real GDP Growth to 3.4% from 3.2% (qq, saar) after the strong September Retail Sales report more than offset the implications of the soft Industrial Production and Housing Starts reports. However, the risk of higher wage inflation could become an issue ahead.

The strength of Q324 Real GDP does not appear to have stopped the Fed from planning to cut the funds rate further, albeit at a smaller 25 BP pace from the initial 50 BP cut.  To be sure, the model's estimate may be too high.  Other data show softening in manufacturing output (mostly outside of high tech), housing starts, and Total Hours Worked.  (The official report on Q324 GDP will be released October 30.)  Even if the model's estimate is correct, the Fed's intention appears to be to bring the funds rate down to its longer-term neutral level in order to sustain solid, non-inflationary economic growth -- as long as inflation remains near its 2% target.  The Fed presumably would stop easing if if looks as if the trend in inflation has turned up.

This presumed requirement suggests that the most important part of the October Employment Report could be Average Hourly Earnings (AHE).  It would be problematic if AHE does not fall back to its 0.3% m/m trend after rising 0.4-0.5% in August and September.  Away from the Report, the recent outsized wage gains in the Boeing and Longshoremen contracts are a concern, particularly if it influences other wage demands.  The Payrolls part of the Report should be comforting for the Fed, as the Unemployment Claims data suggest (at this point) a smaller increase than the large +254k gain in September.   The Report is due on November 1.

Fed officials, including Chair Powell, insist that their policy path is data dependent.  Powell says the way to think of data dependency is in terms of the impact on the Fed's outlook.  This approach has two problems, one from the perspective of  the markets and the other from the perspective of the Fed.  The markets' problem is that the impact on the Fed's outlook is not clear.  At the extreme, the Fed's rate decisions could seem arbitrary, with little if any relationship to the data.  The Fed's problem is that its ability to forecast accurately is not particularly good.  Officials could incorrectly dismiss a strong report as one-off, for example -- thus sticking with easing instead of holding back.  They will know whether the dismissal was correct from seeing future data releases, although the more immediate reaction of the longer-end of the Treasury market can offer a hint.  For example, a sell-off in the longer end on a Fed move would hint that the Fed overdid its policy move.