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In this edition, we'll dive into the ongoing tug-of-war between the market and the Federal Reserve over inflation, analyze the latest GDP data, and explore the Bank of Japan's policy shift.
The Market vs. Fed Fight Rages On - Here's why Inflation Divides Them.
The battle between the stock market and the Federal Reserve over inflation has been intense throughout the year, and it shows no signs of stopping. The central bank recently raised interest rates, but Chairman Jerome Powell remains cautious about future moves.
The market, on the other hand, seems optimistic that the inflation fight is nearly won and that the tightening cycle is coming to an end, although i wouldn’t be too sure of that as it currently stands.
Both sides have had their fair share of forecasting missteps this year, leading to general misunderstanding and a gap between the fed and forecasters’ views. The market feels it can challenge or even disregard the Fed's view due to the central bank's data-dependent approach, where forward guidance is lacking. Crucial metrics like the personal consumption expenditures (PCE) price index and the employment cost index (ECI) hold the key to bridging the gap between the market and the Fed, but it remains to be seen whether they will do so.
Key metrics have continuously positively surprised the markets and the Fed. Yet other metrics have remained continuously stubborn, creating a dissonance between the Fed’s expectations and results. This can result in a longer than hoped interest rate hike cycle all the while investor optimism continues to rise, this can ultimately create a minor to major investor bust.
It's evident that the Fed's battle against inflation is far from over, and the market's struggle against the central bank continues for the time being.
Fed Chairman Jerome Powell Wouldn’t Rule Out Another Rate Hike
After the Federal Reserve's recent rate hike, Chairman Jerome Powell left the door open for further increases, emphasizing the necessity of taming inflation to reach the target of 2%. While some believe that the July rate hike might be the last of this cycle, Powell emphasized that failing to tame inflation would be detrimental to everyone. This was conveyed not only in his literal words but as per usual also in his tone and his choice of words.
The Federal Open Market Committee foresees a moderate rate of economic growth, indicating slight strength compared to the past weeks. Powell discarded some recent slowdowns in price growth as the reversal of pandemic-specific factors, acknowledging the continued strength in consumer demand and rising confidence.
The Fed's fight against inflation is becoming more challenging, especially in the non-housing core services sector. Addressing inflation may require further actions, potentially leading to additional rate adjustments.
To elaborate, increased demand and consumer confidence amidst rising inflation creates dissonance. Inflation and interest hikes should theoretically put a halt or a slowdown on consumer spending and decrease consumer confidence, although what we are currently seeing in practice is continued confidence despite the interest rate hikes.
GDP Rose Faster Than Expected, But Consumers Feel Pinched
Admittedly, the US economy exhibited strong performance in the second quarter, with GDP growing at a 2.4% annual rate, surpassing expectations of 1.5%. However, the growth in consumer spending has slowed, leading to concerns among food and beverage companies, which have witnessed weakening sales.
So despite the strong performance and outpacing of expectations, it remains crucial to consider that consumer spending's deceleration may temper the overall economic performance. Commercial real estate and equipment spending rose significantly during the same period.
Companies like McDonald's are experiencing the effects of minor changing consumer spending habits.With lower-income customers opting for discounted menu options, the fast-food giant may face challenges in raising prices as it has done previously. Despite these uncertainties, McDonald's remains optimistic, raising its projection for 2023 operating margins, once more showcasing the disregard for potential market demand downswings.
Bank of Japan Holds Rates, But Makes Policy Shift
In a surprising move, the Bank of Japan held its short-term interest rate target at -0.1% but introduced "greater flexibility" to its yield-curve control. The central bank is no longer treating the upper and lower bounds of the range as rigid limits, signaling potential tighter monetary policy ahead.
This policy shift is significant for global markets, as Japan has been known for maintaining ultra-loose monetary policies for an extended period. The adjustment may lead Japanese investors to view domestic bonds as more attractive, possibly impacting their positions in US fixed-income assets.
Overall, the financial landscape remains uncertain, with inflation, monetary policies, and tech giants' performance all influencing the market's trajectory.
