Market Week: July 24, 2023

The week in review

  • Retail sales was up 0.2% m/m
  • Housing starts fell to 1,434k
  • Industrial production was down 0.5% m/m

The week ahead

  • FOMC meeting
  • Svcs. and mfg. PMIs
  • Real GDP
  • Consumer confidence & sentiment

Thought of the week

In recent weeks, markets absorbed a lot of news pertaining to both sides of the Fed’s mandate, full employment and inflation. In June, payroll job growth declined, the unemployment rate ticked down from 3.7% to 3.6% and wage growth remained at 4.4% y/y, neither adding to, nor diminishing, fears of wage inflation. Meanwhile, June retail sales data added to a picture of a resilient economy, which we expect to be confirmed by this week’s second quarter GDP release. The other part of the Fed’s mandate, inflation, continues to decelerate, with June headline and core CPI at 3.0% and 4.8% y/y, respectively. Similarly, Powell’s preferred measure, super-core inflation, fell to its lowest level since September 2021. While both parts of the Fed’s mandate continue to trend in the right direction, we expect the Fed to hike another 25bps on Wednesday. The market clearly agrees and is pricing in a 96% probability of a hike.

Regardless, the end of the Fed hiking cycle looks closer than it did earlier this year, with this week’s chart showing the market expects no further hikes for the remainder of the year assuming we get a hike Wednesday. However, the market appears too pessimistic in its outlook for rate cuts with only one full cut expected in 1Q24 and a cumulative 125bps for the year. The Fed often raises rates on an escalator, before being forced to take an elevator down, with rates falling on average 275bps within the first year of cuts.

As rates move lower, the investment climate becomes more appealing for all long-term asset classes. Investors may want to extend fixed income duration as expectations for policy rates in 2024 and 2025 may be too high given a oftening in growth momentum and rapid decline in inflation.

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