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Weekly Update 7/28/2023: Fed Lifts Rates as Inflation Continues to Moderate & Earnings Season Rolls On

  • Domestic Economic News
  • Interest Rate Insights & The Fed
  • Impactful International News

Domestic Economic News

US business activity expanded in early July at the slowest pace in five months as services growth moderated. The S&P Global flash US composite purchasing managers index fell 1.2 points to 52 in July, the group reported Monday. Readings above 50 indicate growth. A gauge of future activity also declined, slipping to its weakest level this year as service-provider optimism waned. “The darkening picture adds downside risks to output growth in the coming months which, alongside the slowing in the pace of expansion in July, will keep alive fear that the US economy may yet succumb to another downturn before the year is out,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement. “The stickiness of price pressures meanwhile remains a major concern,” he said. The composite gauge of prices charged ticked up in early July, indicating the stubbornness of inflationary pressures. Manufacturers’ input prices increased for the first time in three months. Service providers reported higher operating expenses, with wages being the primary driver as companies continue to have difficulty retaining workers. The index of employment at service providers slid to a six-month low. The group’s overall services gauge dropped 2 points to a five-month low of 52.4. The manufacturing index continued to show contraction, though at a slower rate. Factories pared inventories of materials and finished goods as domestic and global demand remained soft, the report showed. Manufacturers expect a brighter future, though, bolstered by hopes of a greater ability to hire and cooling input costs.

On a positive note, US consumer confidence advanced in July to a two-year high, bolstered by a strong job market and easing inflation. The Conference Board’s index rose to 117 this month from 110.1 in June, data out Tuesday showed. That exceeded the median estimate of 112 in a Bloomberg survey of economists. The group’s gauge of current conditions improved to the strongest level since March 2020. A measure of expectations — which reflects consumers’ six-month outlook — advanced to the highest since the start of last year. A gauge of expected inflation ticked down. “Greater confidence was evident across all age groups, and among both consumers earning incomes less than $50,000 and those making more than $100,000,” Dana Peterson, chief economist at the Conference Board, said in a statement. Recent economic data have reinforced hopes the US can avert recession, with the job market holding firm even while key inflation gauges show encouraging signs of progress. Wages are also finally keeping pace with inflation, providing many households the wherewithal to keep spending. The share of consumers saying recession is “somewhat” or “very likely” to occur did tick up. “Still, recession expectations remained below their recent peak, suggesting fears of a recession have eased relative to earlier this year,” Peterson said. More consumers said jobs were “plentiful” in July. The share of respondents reporting that jobs were hard to get fell to one of the lowest readings on record, and their expectations for the labor market six months from now improved. The difference between the current “plentiful” and “hard-to-get” measures — a metric watched closely by economists as a gauge of labor-market strength — was the largest since February. Buying plans were mixed. Larger shares of respondents plan to buy cars and homes, while fewer expect to purchase major appliances like refrigerators and washing machines.

Home prices in the US climbed for a fourth month as demand coupled with tight inventory to push values higher. A national gauge of prices rose 0.7% in May from April, according to seasonally adjusted data from S&P CoreLogic Case-Shiller. Buyers have been competing for a shortage of listings, generating bidding wars in some areas of the country. In the four weeks through July 16, the total number of homes listed for sale was down 16% from a year earlier, according to data from Redfin Corp. “Home prices in the U.S. began to fall after June 2022, and May’s data bolster the case that the final month of the decline was January 2023,” Craig Lazzara, managing director at S&P Dow Jones Indices, said in the statement Tuesday. “The breadth and strength of May’s report are consistent with an optimistic view of future months.” The housing market cooled over the past year as a surge in borrowing costs kept some buyers on the sidelines. On a year-over-year basis, prices nationally were down 0.5%, compared with a 0.1% drop in April. The top cities for price gains have shifted in recent months from warmer climates to cities further north. Chicago, Cleveland and New York posted some of the biggest price increases in a measure of 20 cities, the first time in five years that a cold-weather city held the top spot. Tight supply may continue to make it fairly expensive for some buyers. “Limited inventory relative to buyer demand will likely keep prices somewhat afloat,” said Hannah Jones, an economic research analyst at Realtor.com. “However, these trends vary greatly market to market.”

US economic growth unexpectedly picked up steam in the second quarter thanks to resilience among consumers and businesses in the face of high interest rates. Gross domestic product rose at a 2.4% annualized rate after a 2% pace in the previous three months, the Commerce Department’s initial estimate showed Thursday. Consumer spending increased at a 1.6% pace, more than forecast, after surging at the start of the year. The Federal Reserve’s preferred underlying inflation metric advanced at a slower-than-expected 3.8% pace. The US economy is in better shape than economists had expected it would be just a few months ago. While forecasters are split on the odds of a recession, a strong labor market, sturdy consumer spending and now easing inflation have fueled hopes that the US will avoid a downturn. The Fed staff is no longer forecasting a recession, Chair Jerome Powell said Wednesday after the central bank raised interest rates by a quarter percentage point. Powell also said that it’s his own expectation that the Fed can cool inflation without a big increase in unemployment. “Growth is outpacing expectations even as the monetary policy stance has become restrictive,” Rubeela Farooqi, chief US economist at High Frequency Economics, said in a note. “A strong household sector that continues to benefit from positive job growth and rising real incomes should keep growth on a positive trajectory this year.” Still, headwinds persist with the Fed’s benchmark interest rate at a 22-year high and some signs of consumer strain bubbling.

In additional good news, the personal consumption expenditures price index grew at an 2.6% annualized pace in the April to June period, the smallest advance since the closing months of 2020. Excluding food and energy, the index rose at the slowest pace in more than two years. The persistent strength of the jobs market remains a key source of support for the economy. Separate data out Thursday showed applications for unemployment benefits retreated to the lowest level since late February. Continuing claims, which can offer insight into how quickly out-of-work Americans are able to find a new job, declined to the lowest since January. The figure came in for the week ending July 22 at 221,000, which was down 7,000 from the prior week and below the estimate for 235,000.

Key measures of US inflation and labor costs cooled significantly in recent months, adding to growing optimism that the economy may be able to avoid a recession. The employment cost index, a broad gauge of wages and benefits, increased 1% in the second quarter, marking the slowest advance since 2021, according to Bureau of Labor Statistics figures released Friday. A separate report showed the Fed’s preferred inflation gauge, the personal consumption expenditures price index, rose 3% from a year earlier in June, the smallest increase in more than two years. Core prices — which exclude food and energy and are regarded as a more reliable signal of underlying inflation — advanced by a less-than-expected 4.1%, also the least since 2021. The PCE report also indicated consumer spending, adjusted for inflation, rose in June by the most since the start of the year, bolstering the message from data on Thursday that showed the US economy expanded at a solid pace in the second quarter. Taken together, the figures add to hopes that the Federal Reserve can achieve a so-called soft landing: moderating inflation without big job losses, despite the steepest interest-rate hikes in a generation. S&P 500 stock index futures rose following the release of the data, and Treasuries pared gains. Here’s what Bloomberg Economics Says: “The moderation in second-quarter ECI offers the most encouraging sign yet of disinflation, suggesting that the stickiest component of inflation is coming down. It also shows that recent wage disinflation is not a fluke, and has legs.” — Anna Wong, economist. We could not have said it better ourselves! J

Interest Rate Insight and the Fed

The Federal Reserve raised interest rates to the highest level in 22 years and Chair Jerome Powell said additional increases will depend on incoming data as officials fine-tune their effort to further quell inflation. The quarter percentage-point hike, a unanimous decision, lifted the target range for the Fed’s benchmark federal funds rate to 5.25% to 5.5%, the highest level since 2001. It marked the 11th increase since March 2022, when the rate was near zero. “Looking ahead, we will continue to take a data-dependent approach in determining the extent of additional policy firming that may be appropriate,” Powell said at a post-meeting press conference. That echoed what the central bank’s Federal Open Market Committee said in a statement published Wednesday in Washington, which overall was almost identical to its previous statement in June. “The committee will continue to assess additional information and its implications for monetary policy,” policymakers said. “In determining the extent of additional policy firming that may be appropriate to return inflation to 2% over time, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

Powell said the data could justify either holding rates steady or raising them again at the Fed’s next meeting in September. He said policymakers haven’t made any decisions about future moves, including whether they are now inclined to raise rates at every other meeting. “We’re going to be going meeting-by-meeting,” he said, adding that officials will be looking for moderate growth, improving inflation and supply and demand coming into better balance, particularly in the labor market. As Powell spoke, stocks advanced while Treasury yields and the dollar fell. Swaps traders held fairly steady the probability they see of the Fed hiking rates by an additional quarter point before year’s end. The pricing implies just slightly over 50% chance of another bump higher before the Fed tightening cycle ends. The Fed has since early last year engaged in the most aggressive tightening campaign since the 1980s in an effort to curb inflation, which in 2022 hit a 40-year high. While policymakers paused rate hikes last month to assess the impact of previous moves, they also signaled at the time that two more increases would probably be appropriate by the end of the year. The latest hike was widely anticipated after recent reports showed a resilient economy that has largely withstood higher interest rates so far. But ahead of Wednesday’s decision, investors saw a second increase as less certain, in part because of data on consumer prices showing inflation receded sharply last month. Powell pointed to encouraging signs that the Fed’s efforts to curb inflation are working, but “what our eyes are telling us is policy has not been restrictive enough for long enough to have its full desired effects.” “We intend again to keep policy restrictive until we’re confident that inflation is coming down sustainably to our 2% target, and we’re prepared to further tighten if that is appropriate,” he said. “And we think the process still probably has a long way to go.”

Impactful International News

China’s top leaders signaled more support for the troubled real estate sector alongside pledges to boost consumption and resolve local government debt, though fell short of announcing large-scale stimulus to support the slowing economic recovery. The ruling Communist Party’s 24-member Politburo — its top decision-making body led by President Xi Jinping — promised “counter-cyclical” policy, according to a readout published Monday by the official Xinhua News Agency. That suggested more economic support as well as an “adjustment” of restrictions in the property sector. Real estate has been slumping for two years, partly due to a government clampdown on corporate and household leverage. The meeting — during which leaders set the rest of the year’s economic policy agenda — did not include language indicating major fiscal or monetary loosening. “Overall, the Politburo fell short of so-called ‘bazooka stimulus,’” said Kiyong Seong, lead Asia macro strategist at Societe Generale SA. “I don’t expect a sustained impact on the market unless there is a series of strong concrete steps.” Financial markets showed limited enthusiasm for the measures. Futures on the Hang Seng China Enterprises Index climbed as much as 0.6% after the statement was released before paring those gains. The offshore yuan trimmed losses, it remained weaker on the day. Investors have been waiting for support after official data showed the rebound’s momentum slowing in the second quarter. Economists have pointed to the property crunch and weak private sector confidence as the main challenges to China’s official economic growth target of about 5% this year.

European Central Bank President Christine Lagarde said officials have an “open mind” on what to do next after lifting interest rates by another quarter-point on Thursday. A ninth straight increase since last July brought the deposit rate to 3.75% — as economists expected. Officials have flagged that their unprecedented hiking campaign is nearing its end as inflation abates, while still exceeding the 2% target. “We have an open mind as to what the decisions will be in September and in subsequent meetings,” Lagarde told reporters in Frankfurt. “So we might hike, and we might hold.” If the ECB does pause, Lagarde said it “would not necessarily be for an extended period.” As she spoke, the futures contract for September rates barely moved, suggesting traders see the odds of both options as essentially 50/50. The ECB also set the remuneration of minimum reserves at 0% — a step it said would improve the efficiency of monetary policy. “Future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary,” it said in a statement. “The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction.” Like in the US, where the Federal Reserve hiked rates on Wednesday, analysts and investors reckon the ECB is now at — or one step away from — a peak in borrowing costs. Officials in Frankfurt, though, must tread delicately as their tightening to date is increasingly felt. Growth in the euro-zone economy is precarious, while demand for bank loans has plunged.

While it usually takes 12-18 months for monetary-policy shifts to fully hit home, evidence is mounting that the effect of ECB’s yearlong bout of hikes is reaching firms and households. Alongside the steepest-ever drop in demand for corporate credit in the euro area, the bloc’s top economy — Germany — is struggling to exit a recession. The continent’s services sector, meanwhile, is starting to wobble, following persistent weakness in manufacturing. “The near-term economic outlook for the euro area has deteriorated owing largely to weaker domestic demand,” Lagarde said. “Over time, falling inflation, rising incomes, and improving supply conditions should support the recovery.” She described the outlook for consumer-price gains as “too high for too long.” The hope is that slower economic expansion will damp inflation sufficiently — a so-called soft landing. But price pressures remain. Core inflation, a closely watched metric that excludes energy and food, quickened last month to match the 5.5% headline reading.


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