The situation on Wall Street is, well, unpleasant, and it in turn is creating considerable uncertainty about the outlook for monetary policy in 2019. The Fed is now caught in an uncomfortable place. Powell & Co. ditched forward guidance in favor of a managing expectations via data-dependence relative to a medium-term outlook. That outlook is fundamentally hawkish as it describes policy as continuing to tighten even as growth decelerates. Moreover, incoming data remains supportive of that outlook.

This isn’t really a problem for rate hikes next year; the data could cut either way by March. It is a bit of a challenge for next week’s meeting as the Fed is loath to appear reactive to markets alone.

What can we say about the data? It’s not bad. Not bad at all. Some of it, such as the ISM surveys, are holding up better than I would expect given the likelihood that economic growth is transitioning to a slower pace of activity as 2019 approaches. The non-manufacturing ISM survey copied its sibling with a solid read in November:

The employment report for November was solid. Nonfarm payrolls grew a touch less than expected:

The three-month average is a bit softer at 170.3k, perhaps indicative of a softening of job growth. Or just an inability of easily finding workers when the unemployment rate dips below 4%. But, most importantly, given the high level of variance in this report, I don’t know that can really say much has changed in the labor market.

The same holds true for wage growth, which was a bit softer, but not inconsistent with normal variance:

On the good side, the strong labor market continues to deliver new workers, holding up labor force growth while preventing the unemployment rate from slipping:

The most forward looking indicator of the report, temporary employment, continues to signal a bright future:

Certainty a number that looking much more worrisome in 2016 than now. Likewise, while I see continued angst over the initial claims numbers, the rise is fairly minimal, occurs during a difficult time to seasonally adjust, and remains not very widely dispersed across the nation:

JOLTS report through October remained strong as well:

The data then remains consistent with a Fed rate hike in December. That said, market participants are picking up on something not in the data. Maybe it’s not anyone thing, but a combination of whole bunch of things. As a primary backdrop, I think the current economic situation places market participants in a very difficult uncomfortable situation. Growth is transitioning down, and we don’t know where it will stop. 2.5% or 1.5%? The latter is slow enough to take the Fed off the table. The former not so much.

Moreover, it seems likely that margins are under intense pressures at this stage in the cycle. Firms are caught between two rocks and a hard place: Tight labor markets, tariffs, and low inflation that prevents them from offsetting the first two factors. And if growth is slowing while labor markets remain firm, then productivity is not rising enough to provide a way out.

Finally, we have geopolitical risk just about everywhere. President Trump’s “bull in china shop” strategy with all of our trading partners leaves the US isolated when we could have pursued a unified approach to addressing issues with China. At home, Trump looks increasingly vulnerable and his response will likely be to create additional chaos. Brexit has devolved into a hot mess of a disaster.

What does the Fed do next month in response? Given the incoming data and the resistance of the Fed to be seen as reacting to market downturns, the baseline case remains that the Fed hikes in December and increases the uncertainty about the path of policy in 2019. The markets will interpret this dovishly, although I suspect the Fed was likely to want to create greater uncertainty about next year in any event.

The risk of course is that the Fed takes a pass next week. For many FOMC participants, I think that would be a bitter pill to swallow with the data lining up as it is, which is why it is difficult to make this the base case. That said, the January meeting will only be six weeks later; they could always come back for another bite at the apple at that time. There is reason to believe this is the correct strategy, but my suspicion is that the Fed will chose the data over the markets. To be sure though, given the fluidity of the situation, financial markets could take an even more severe turn for the worse by next week and scuttle any Fed rate hike plans.

Bottom Line: The data flow clears the way for the Fed to hike next week. The Fed doesn’t need to make any decisions on March yet, so they won’t commit to anything in 2019. That will be interpreted dovishly in this environment. If the data stumbles between now and March, the Fed will take itself off the table, assuming inflation remains quiescent. So far, market volatility by itself is likely not enough to derail next week’s rate hike. The Fed typically wants more to justify a policy change.