By Tiffany Wilding, North American Economist, and Allison Boxer, Economist, at PIMCO

Very important and busy macro week ahead. At November FOMC market participants will be looking for a signal on how the Fed is planning to downshift the pace of hikes before ultimately pausing. Attention will then turn to the first major economic releases for October, where we think the employment report will again show solid job gains, but slower economic momentum.

Federal Reserve:

The Fed releases a new FOMC statement at 2pm EST on Wednesday. There is a press conference but no dots or economic projections at this meeting. The Fed is widely expected to hike rates 75 bps, bringing the midpoint of the range up to 3.875%. We think statement changes will be modest, and instead all attention will be focused on Chair Powell’s discussion of the Fed’s plan to slow the pace of rate hikes.

  • We think statement changes will likely be very minor at this meeting. Economic data has held a similar pattern since the September meeting (strong employment reports and too high inflation), and we don’t think the Fed will change the existing forward guidance or make any changes to the balance sheet runoff.

 

  • Instead, all focus will be on the press conference after Fed officials started to send trial balloons about slowing the pace of rate hikes in the coming meetings. We expect Chair Powell to signal the committee’s intent to slow the pace of rate hikes at some point relatively soon, before holding rates at a high level in 2023, while also saying that policy is not on a preset course. We think the Fed faces a tough balancing act on communication in the coming months, as they try to balance slowing the pace of hikes without easing financial conditions too much, and as a result, Chair Powell’s comments could sound hawkish relative to market participants looking (hoping) for a sharper Fed pivot. Since inflation is likely to remain elevated ahead of this eventual pause period, this will represent a step back from the data dependent Fed that market participants have gotten used to in recent months.

 

  • We still ultimately expect the Fed to get the funds rate up to a 4.5-5% range before pausing. However, we think the outlook for December is somewhat less clear after a few recent developments. While we lean towards a 50 bps hike, it now looks like more of a coin toss between 50 and 75 for a few reasons. First, the employment cost index (ECI, see below) was an unwelcome reminder that more progress is needed in cooling the labor market. Second, we see a risk that CPI is temporarily boosted in the coming months by the impact of Hurricane Ian, which would make awkward timing for a Fed trying to downshift. Third, we thought that WSJ reporter Nick Timiraos seemed to back off his earlier article signaling a slower pace in December on Twitter on Friday.

 

This week’s data:

  • Early PMIs for October have been weak across the manufacturing and services indexes. Regional Fed manufacturing indexes fell 1.9 ppts on average and 4/5 of the October surveys we focus on are below 50 ppts. ISM manufacturing finally caught down to the weaker signal seen in the regional surveys in September, and we expect this to continue in October. This suggests that the ISM manufacturing index would be down -1.4 ppts, putting the overall index below 50 for the first time. The services indexes did not fare much better, with NY (-4.8 ppts) and Richmond (-4.2 ppts) seeing a particularly large decline on an ISM-adjusted basis. As a result, we think the ISM services index will fall about 1 ppt, though stay well above 50.

 

  • The US economy returned to growth in 3Q, and we also expect this to translate to a less bad quarter for productivity. After entering a significant productivity recession in 1H, with strong employment growth amid negative output, we think productivity is likely to be up modestly 3Q (+0.5% q/q saar). Nevertheless still robust aggregate income growth during the quarter will keep unit labor cost growth elevated (+4.5% q/q saar). Note that this is will be first productivity and costs report to incorporate recent benchmark revisions, which lowered household income estimates to reduce the discrepancy between GDP and GDI. The combination of the revisions will moderate reported UCI, but it is still likely to be uncomfortably high for Fed officials – we estimate it will be running at 5.7% on an annual average basis in 3Q, down from the 7.1% (unrevised) pace in 2Q.

 

  • We think that the US economy continued to add jobs at a solid pace in October. We’re expecting nonfarm payroll gains around 250k – a significant deceleration from the 500k+ pace seen in July – but still above trend and in line with the pace from last month. High frequency data generally moved sideways through the month – jobless claims have been resilient, while openings and PMIs are deteriorating. Though there was some noise in the jobless claims data around Hurricane Ian, we think the timing and magnitude of the rise in Florida jobless claims suggest it won’t materially impact the overall report (Florida initial claims peaked up about 11k w/w). The impact of retail hiring could also cause some noise in this report, with seasonal hiring likely to be lower but also earlier than last year. We similarly think that average hourly earnings will rise 0.3% m/m (risk of rounding up), again bringing a better pace but still too firm wage inflation for the Fed. Looking ahead, we are increasingly concerned about a non-linear path for the labor market slowdown. 3Q earnings releases so far as well as the decline in job openings suggest hiring momentum is slowing, but are not yet pointing to widespread layoffs. We continue to think there is very wide uncertainty on when this slowdown will actually become apparent in the BLS data, given how poorly high frequency indicators have worked for forecasting payrolls this year.

 

Recent developments:            

  • The US economy returned to growth as expected in 3Q. Real GDP rose 2.6% q/q saar (vs. 2.5% expected) and details were also right in line with our tracking. Faltering final domestic demand highlighted the softening of the US economy amid tighter financial conditions and high inflation, while noisy trade and inventories contributed strongly (after dragging GDP down in 1H). Despite this slowdown in final domestic demand, we still think the worst is still ahead for the US economy. The typical lags between what has now been a larger tightening in FCI than the 2008 episode and growth still suggest to us that the economy will contract in 4Q and into 1H 2023. We’re looking for real growth to be negative for the full year 2023 (-0.5% q4/q4), similar to our tracking for 2022 (-0.5% q4/q4).

 

  • Despite a softening in commissions, ECI reported wage inflation remains firm across industries and occupations – private wages and salaries, excluding commissions remained at 5.6% on a y/y basis – while core PCE inflation was also firm, ticking back up to 5.1% y/y. Though there were no major surprises in either report, we think the details of the ECI report are still far too strong to be consistent with the Fed’s objective. Meanwhile, monthly real spending was also firm, and the monthly sequential path set up for a slightly stronger trajectory into 4Q. Nevertheless 4Q real GDP growth still appears poised to once again contract. We are looking for real GDP to fall -0.5% q/q saar in 4Q, on a small rise in consumption, which is offset by increasingly negative fixed investment.

 

  • Credit card data is starting to show the impact from Amazon’s early holiday shopping period, and likely some effects from California beginning to distribute tax rebate checks. Nonstore retail spending ticked higher in the weekly credit card data the BEA publishes, and the credit card data we follow showing a notable improvement in spending at Amazon and in California. Overall we think this is setting up for a mixed and volatile batch of economic reports in the coming months. Retail sales are likely to be solid in October, as the seasonal factors fail to account for Amazon and other retailers pulling the holiday shopping season earlier yet again, only for this to reverse when spending is slower than usual later in the shopping period.

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