Markets are convinced that the Fed will deliver an early holiday gift – a rate cut – next week. Odds of a December cut have hung near 90% ever since shifting up in late November, following support for more easing from Fed Presidents Williams (NY) and Daly (San Fran.). Economic data out this week, while mixed, did not perturb that balance. Equities managed to trek modestly higher, with S&P 500 up 1.1% from last week’s close.

September’s personal income and spending report  provided a snapshot of spending and inflation trends before the government shutdown. Spending was flat in real terms in September, ending the third quarter on a soft note. Consumption for the quarter was up 2.7% (q/q annualized) – below expectations but still an improvement from 2.5% in the second quarter. September provides a soft handoff to the fourth quarter, which coupled with the government shutdown, slowing job growth, and weak consumer confidence, suggests spending will slow further at the end of the year. Early data from Thanksgiving weekend suggests holiday shopping was healthy but likely grew at a pace slightly below that of last year. Online sales continued to lead the way, with Cyber Week spending up nearly 8% year-over-year (y/y) according to Adobe. In-store gains were softer, with closely watched indicators pointing to growth in the low single-digits. AI tools helped boost retail site traffic, while a growing Buy-Now-Pay-Later (BNPL) trend also played an important role in propping up spending.

Core PCE inflation rose 0.2% month-over-month (m/m) in September, and 2.8% in y/y terms – a modest easing from 2.9% in the prior two months. The ISM services price index recorded a notable pullback in November – marking a modest positive post-shutdown signal with respect to inflationary pressures. Nonetheless, Cleveland Fed Inflation Nowcasting puts core PCE at 0.23% (m/m) for both October and November, 2.8% and 2.9% in y/y terms respectively – still well above target. 

Employment data was mixed. Initial jobless claims dropped to a three-year low of 191k at November’s end. The Thanksgiving holiday may have distorted the data. But even prior to that last week, initial claims were still trending lower. Conversely, the ADP report showed private payrolls fell by 32k in November. Its three-month average, which is more closely aligned with the BLS equivalent, turned slightly negative too (Chart 1). Job cut announcements, meanwhile, also pointed to continued challenges. Layoff announcements in November were cut in half from their October tally, coming in at 71k. But even when looking past the weakness in the government sector, the trend in layoff announcements remains elevated (Chart 2). Overall, markets seemingly expect the Fed to focus on signs of labor market softness and maintain a cautious policy stance. 

Our reading is that the Fed won’t disappoint market expectations next week. But in the New Year, the bar for additional cuts may be higher. Having delivered some insurance cuts, the Fed will likely take time to digest delayed economic reports and carefully assess post-shutdown data to form a clearer picture of the economy’s health.