Earnings, labor, shutdown risk—the week’s market drivers explained.
KEY TAKEAWAYS
Inflation remains sticky, driven by services like housing and healthcare
Tariff-based inflation STILL hasn’t shown up yet in consumer prices
Earnings season looms with high expectations, led by JPMorgan on Oct. 14
Labor market data this week will guide Fed policy
Markets are shrugging off the looming government shutdown
MY HOT TAKES
Sticky inflation is old news, not a reason for restrictive Fed policy
Tariffs are being used as a scapegoat for inflation that isn’t materializing
Earnings season is about expectations management more than growth
The labor market is the real catalyst for Fed decisions right now
Markets may underestimate shutdown risk as just political theater
You can quote me: “Tariff inflation is the Fed’s favorite excuse, but it’s nowhere to be found.”
No news is good news. There is always news to report, although, many times there is nothing new or noteworthy in the content. This week’s news cycle includes the possibility of a government shutdown in the days ahead, the labor market with a bevy of important numbers due this week, upcoming earnings season, and inflation.
Let’s tackle those in reverse. Last Friday we got the Fed’s favorite inflation gauge, the PCE Price Index. The headline number came in at 2.7% as expected, a slight increase over July’s 2.6% print. “Sticky inflation” is the headline that seems to remain sticky. Check out the chart then keep reading.
This Bloomberg ECAN tells you everything you need to know about the current state of inflation in the US. The white line is headline PCE (Personal Consumption Expenditures) inflation, while the blue line is Core PCE Inflation which excludes food and energy. The stacked bars below the lines represent the inputs into the numbers.
We are obsessed with inflation for two reasons. One, because we are all feeling the pinch at the cash register, and two, because the arch nemesis of economic growth these days–the Fed–is using it to justify its persistent application of the economic brakes. On the latter, if you quickly eyeball the chart, you will clearly note that it has remained steadily sideways since late 2023. Any progress made in 2022 and 2023 has seemed to stop, leaving us with the “sticky” moniker.
Those rust-colored bars are services inflation. Within the services aggregate, housing still dominates. It expanded into late 2022 and then receded really, really… really slowly to where it is currently, which is still high by historical standards. That should be old news by now. Healthcare is another major component of that sticky inflation category. It is not quite as egregious as housing, but it remains troublesome. This is also old news. New news on the inflation front started earlier this year with the launch of the administration's aggressive tariff policy.
Tariffs are known to be inflationary, and the Fed has been using it to justify inaction for the better part of last month. Most recently the Fed resumed its “normalization” of rates with a 25 basis-point cut, but still cautioned about inflation–meaning, no guarantees for further cuts. What has been interesting for me is that tariff-based inflation would only really impact Durable Goods (purple bars) and Nondurable Goods (yellow bars). Looking at the chart 🙃, you should notice that durables went from negative (deflationary) to ever slightly positive since last summer, and nondurables are barely noticeable. So where is that big inflation from tariffs? Still not present! End of story.
It is true that importers have been faced with increased costs resulting from tariffs, but it appears that those costs have not been passed onto consumers just yet. The reason? Because consumers may not tolerate them given the current levels of prices. Companies appear to be absorbing those costs. That really leaves services inflation as the key agitant, which is OLD news. I won’t get into my argument of how lower rates will actually help services inflation today but suffice it to say that tariffs are not a good excuse for keeping rates restrictive at the moment. Oh, and about that 2% target that we hear about ALL THE TIME. I just downloaded PCE inflation going back to 1959, and do you know what the average is? It is 3.29%! So, a 2.7% PCE, while above the Fed’s target, is below average since the 1960s.
Earnings season is rapidly approaching, and it will be ushered in by the Financials, and leading that group is superlative JPMorgan Chase, which will announce its Q3 earnings on October 14th, just around 2 weeks from now. After last quarter's surprisingly positive growth, the sector’s year over year quarterly growth is expected to decline slightly. Despite this, the sector has been performing quite nicely as investors pile into it, in anticipation of more rate cuts and a further yield curve steepening. Will there be disappointments? The bar is high, so slight misses could cause… well, some indigestion, and as financials are the first to report, they tend to set the tone for the broader earnings season.
Speaking of the broader earnings season, earnings for S&P 500 are expected to show a much muted almost 0% change over earnings a year ago. Similarly to financials, the S&P 500 has been doing… well, alright, up nearly 13% year to date and just below all-time highs. This represents strong conviction for growth by investors. But caution is the prescription here, because a great deal of the S&P’s success year to date is attributed to a small group of stocks. The message here is to pay close attention to sector, industry, and sub-industry results rather than the broader, index-level view. It should go without saying that each company is different. So, with expectations so high, earnings will be the ultimate arbiter over which direction stocks will head next. Expect tension to build further as we get to October 14 as analysts will begin prognosticating and positioning for earnings.
If you agreed with me earlier about inflation, you would be quite keen to learn about the current state of the labor market, which will be the catalyst for the Fed’s next few moves, and this week ahead will fill that thirst. We will get JOLTS job openings earlier in the week, ADP Employment Change mid-week, weekly employment numbers on Thursday, and the grand finale monthly employment numbers on Friday. All the numbers point to a continuation of softening labor conditions. This was the justification for the Fed’s most recent interest rate cut, and this week’s numbers will give us a clue about which way the bankers will lean in their next policy meeting–exactly 1 month from now.
Lastly, we have to touch on the looming Federal Government shutdown. There is no question that a prolonged shutdown will have economic implications. But what about market implications? Well, so far, markets appear to be shrugging off the high possibility of a shutdown, including the recent tough rhetoric from the President. We could look to the last government shutdown for answers. That happened during Trump’s first presidency, but there were other factors in play which distort the story. It was the longest in US history, but stocks had been trounced just prior, caused mostly by Fed tightening and tough talk. A last-minute Fed change of heart and “pivot” sent stocks flying with a 10.3% gain throughout the shutdown. Now we are trading at all-time highs, and the Fed doesn’t seem to be predisposed to any concessions. Still stocks appear to be betting that an agreement will be reached in short order with minimal disruption.
So, this is the news. Inflation is not news at all, based on last Friday’s number. Tariff-based inflation is nowhere to be found yet. Earnings season is coming up quickly, and the bar is super-high, but alas, it always is. Labor market numbers have been striking out recently, and the Fed has recognized the importance of dealing with the problems. This week’s numbers will certainly inform next steps in Fed policy. The looming government shutdown seems like a lock, but markets are viewing it as political theater–for now. Is there anything new about this news? Stay tuned.
FRIDAY’S MARKETS
Stocks traded higher on Friday as inflation numbers came in as expected. Strong consumption persisted and University of Michigan Sentiment revised downward slightly. Bond yields were unchanged, and the US Dollar is softening on the looming shutdown.
NEXT UP
Pending Home Sales (August) may have been flat after slipping by -0.4% in July.
Dallas Fed Manufacturing Index (August) is expected to have improved slightly to -1.6 from -1.8.
Fed speakers today include Waller, Lane, Musalem, and Bostic.
Later this week, we will get more housing numbers, JOLTS Job Openings, Consumer Confidence, ISM PMIs, Factory Orders, and monthly labor report from BLS. Download the attached calendar so you can be first in line when the news hits the tape.