A week after the most recent rate decision by the Federal Open Market Committee (FOMC), Chairman Jerome Powell was in Washington, D.C., on Wednesday and Thursday to provide testimony to Congress as part of the semiannual monetary policy report. If anyone was hoping for dovish commentary or even less-hawkish commentary, for that matter, this was not the testimony they were looking for.
As a quick reminder, the primary tool at the Federal Reserve’s disposal to combat inflation is increasing interest rates. This process slows the economy by inducing tighter financial conditions, such as higher borrowing costs, lower stock prices, and a stronger dollar. The Fed took a hiatus from raising rates last month, a move Powell defended, describing the move as “prudent” given “how far and how fast” the Fed raised rates over the previous year, which will provide them some time to review additional data. Powell cautioned that the “full effects of monetary restraint” would take time to be realized, and the decision to pause rate increases allows officials to better assess how much further they need to raise borrowing costs to manage stubbornly high inflation. This more moderate approach comes in the face of more persistent inflation and surprisingly strong economic activity.
However, this “moderation” appears like it could be short-lived, as Powell justified the need for further tightening, stating that “inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.” Inflation and economic activity have decelerated less than many experts anticipated, casting more doubt over how high they might lift rates later this year. Most Fed officials are projecting two more increases this year, which would take the federal funds rate to a 22-year high. On Wednesday, Powell termed these expectations “a pretty good guess of what will happen if the economy performs as expected.”
One counter to the need for additional rate hikes comes from the banking sector, where instability in the Spring led to deposit concerns and tighter credit conditions. This situation calls for a delicate balance as the Fed has to quell inflation with higher rates while avoiding squeezing the banking system with higher capital costs. If there is any additional turmoil in the banking sector, it would very likely spell the end of the hiking cycle. In other bank news from the testimony, Powell assured Congressional leaders that enhanced capital regulations would target banks possessing assets of $100B or more as authorities aim to strengthen the banking system after this year’s failures.
And while futures markets are pricing in a 75% chance of a rate increase in July, we know predictions about future actions of the Federal Reserve are fraught with uncertainty. With differing viewpoints among officials, the current strategy appears to be “wait-and-see.” However, the upcoming months will provide more data on inflation, offering a more precise direction. Meanwhile, market participants should be on the lookout for further rate hikes (albeit at a slower pace) while keeping a glancing eye on developments in the banking sector.
Economy
- U.S. equity markets took a breather for the week ending June 23rd, with the S&P 500 down -1.4%, the Nasdaq down -1.4%, and the small-cap Russell 2000 down -2.9%. It was a very light news week, even as Jerome Powell testified before Congress.
- In an unexpected turn, U.S. housing starts surged 21.7% MoM to reach a seasonally adjusted annualized rate of 1.63M in May. This is the highest level since April 2022 and significantly outperformed forecasts of 1.4M. The data suggest a stabilizing housing market following a slowdown that began early last year due to increased mortgage rates, high property prices, and stricter lending practices.
- The week ending June 17th saw 264K Americans filing for unemployment benefits, which exceeded market expectations and matched the previous week’s upwardly revised value. This represents the highest level since October 2021. The numbers align with recent data indicating a slight weakening in the U.S. labor market following a long period of sustained tightness.
- At its June meeting, the Bank of England unexpectedly raised its policy interest rate by 50 basis points to 5.0%, representing the 13th consecutive increase. Contrary to market expectations of a more modest 25 basis point hike, this decision pushed borrowing costs to their highest level since the 2008 financial crisis. This measure was taken to combat persistent inflation as policymakers have committed to implementing further rate increases should inflationary pressures continue. The most recent data indicated that U.K. inflation unexpectedly remained steady at 8.7% in May.
Stocks
- U.S. equities were in negative territory. Real Estate and Energy led the decline, while Healthcare and Consumer Discretionary outperformed. Growth stocks led value stocks and large caps beat small caps.
- International equities closed lower for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield decreased three basis points to 3.73% during the week.
- Global bond markets were in positive territory this week.
- Government bonds led for the week, followed by corporate bonds and high-yield bonds.
