This week’s FOMC meeting was both uneventful and revealing in a way that did not provide clear guidance for investors. With the 25 basis point hike, Chair Powell refused to commit to either further hikes or to hitting the terminal rate; everything from here out is data dependent, and he cited the two jobs reports, two CPI reports, and the Employment Cost Index (ECI) report due before the next FOMC meeting as the drivers of how the FOMC acts in their next policy decision.
Nevertheless, a consistent theme emerged throughout his press conference: he argued “reducing inflation is likely to require a period of below trend growth and some softening of labor market conditions” and that “stronger growth could lead to higher inflation.” In both cases, they broke a direct link between a strong economy/strong labor markets and indefinite FOMC rate hikes. Said differently, the FOMC is laser-focused on inflation. Hence, continued disinflation could deter further rate hikes even if the labor market remains strong.
There are probably some bounds on that dynamic; for instance, Powell noted that while wages “weren’t an important cause of inflation” initially, they “are probably an important issue going forward.” But in general, the Fed’s reaction process is simple: further disinflation similar to the pace we’ve seen over the last few reports means no further rate hikes, while a re-acceleration in inflation could cause the terminal rate to increase. Either way, Powell argues rate cuts “won’t be this year, I don’t think” because “policy has not been restrictive enough, for long enough, to push growth down. We think the process still probably has a long way to go.”
That leaves investors to watch the data, which will hopefully mean clear disinflation continues to justify rates on hold for the rest of 2023 with possible cuts early next year. A less clear-cut outcome would be firmer inflation figures alongside robust wage growth, as indicated by either the ECI or jobs reports. This time, the market reaction was broadly muted, suggesting that the markets had already anticipated a relatively uneventful Fed meeting and had factored in the news.
On the inflation front, we received some encouraging news from the Bureau of Economic Analysis (BEA) from the release of Q2 GDP. Not only did real GDP come in at 2.4% for Q2, a far cry from a recessionary print, but perhaps more significantly, the GDP price index dropped to 2.2%, slightly below the average since 1990. Moreover, Core PCE data was also released, showing prices up only 0.2% MoM, which was lower than economists expected. These are very encouraging signs that, if they continue, would be more data points that suggest we are nearing the end of this rate-hiking cycle.
Economy
- U.S. equity markets were higher, with the S&P 500 up +1.0%, the Nasdaq up +2.0%, and the small-cap Russell 2000 up +1.1%. It was an up-and-down week, but Friday was strong due to lower PCE inflation and lower wage gains.
- The Federal Reserve raised the target range for the federal funds rate by 25 BPS to 5.5%, in line with market expectations, bringing borrowing costs to the highest level since January 2001.
- Core PCE prices in the U.S., the Federal Reserve’s preferred gauge to measure inflation, went up by 0.2% MoM in June, easing from a 0.3% increase in the previous month and below market expectations. The annual rate rose by 4.1%, the lowest since September 2021 and less than market expectations of 4.2%.
- The S&P Global U.S. Manufacturing PMI increased to 49 in July from a six-month low of 46.3 in June, beating forecasts of 46.2, flash estimates showed. The reading signaled the slowest deterioration in operating conditions in the manufacturing sector in the current three-month sequence of declines.
- The S&P Global U.S. Services PMI dropped to 52.4 in July, down from 54.4 the previous month and below market expectations of 54.0, according to a preliminary estimate. The latest reading pointed to the weakest pace of expansion in the sector since February, as new sales growth slowed amid constraints on client spending, including higher interest rates.
Stocks
- U.S. equities were in positive territory. Communication Services and Energy were the top performers, while Utilities and Real Estate lagged. Value stocks led growth stocks, and large caps beat small caps.
- International equities closed higher for the week. Emerging markets fared better than developed markets.
Bonds
- The 10-year Treasury bond yield increased 13 basis points to 3.97% during the week.
- Global bond markets were in negative territory this week.
- High-yield bonds led for the week, followed by corporate bonds and government bonds.
