Sep 14, 2023|Market Insights- 3 min
At the last meeting of the Federal Open Market Committee in July, interest rates inched up again to 5.25-5.5%, after a temporary pause following the previous session in June.
The markets are aware that the U.S. economy is nearing the end of a lengthy process of monetary tightening. Thoughts are naturally moving to when that end will come, and at what point the Federal Reserve (“the Fed”) will decide to begin lowering rates to less restrictive levels.
In this article, we take stock of the most recent commentary and events, and draw conclusions for individual investors.
Jackson Hole
The annual meeting of economists and central bankers at Jackson Hole, Wyoming, included a speech by Fed Chairman Jerome Powell that analysts and commentators were scrutinizing for clues as to planned next steps.[1]
The speech contained some cautious ambiguity that will be familiar to followers of Powell’s previous statements. “We are navigating by the stars under cloudy skies…We will keep at it until the job is done.” However, Powell did reiterate the key point that despite progress, inflation (at that time 4.3% - twice the target rate) is still too high.
He continued by dissecting the key components of Core PCE*, the Fed’s preferred gauge of inflation. The analysis concluded that improvements in global supply chains have done much to alleviate inflationary pressures. However, further measures may still be needed to address components less directly dependent on international events - for example, in non-housing services such as medicine and transportation.
In summary, Powell has once again refused to ‘declare victory’ and implied that the Fed intends to hold its current stance until conclusive evidence appears to the contrary. This leaves the door open to at least one further rate hike, and minutes from the previous meetings indicate some members are in favor of another increase this year.[2]
Perhaps a more helpful analogy than sailing under cloudy skies is Powell’s remark in June, which compared the current interest rate trajectory to a car that drives more and more slowly as it approaches its final destination.[3] While the end may not be here yet, it does appear to be in sight.
The latest data
Macroeconomic data support the cautious stance of the Fed Chairman. GDP has remained strong this year, exceeding expectations.[4]
In terms of inflation itself, after declining for some months, the latest Core PCE figures showed a slight uptick for July (from 4.1% to 4.2%), thanks to robust summer spending by consumers.[5] The latest CPI inflation data also came in slightly above expectations (3.7% vs 3.6%) owing to energy and shelter costs.[6].
The latest jobs data, meanwhile, showed a nuanced picture: employers are continuing to hire, but at a slowing rate, while unemployment is creeping up again. Wage growth is slowing, but increasing in real terms as inflation declines.[7]
The jobs figures could be interpreted as signs that the labor market is rebalancing - a positive development. At the same time, it could be pointed out that the market is still somewhat off balance, meaning that inflation could re-ignite if a cycle of higher wages leading to higher prices begins.
As for the markets, the CME FedWatch Tool reflects an overwhelming majority of opinion (97%) that there will be no rate change at the next meeting, although around 40% predict a rate rise before the end of the year.[8]
All in all, the sentiment expressed in the Jackson Hole speech appears apt: it is too soon to celebrate.
Conclusions for investors
There is a famous saying that if all the world’s economists were laid end to end, they would not reach a conclusion. While endless debate is possible for economists, where does all this leave investors?
We always recommend that investors look beyond the unpredictable short-term (the “noise”) and focus on the larger-scale implications of events (the “signal”).
At the Jackson Hole Symposium, the head of the European Central Bank, Christine Lagarde, offered a thoughtful analysis of the fundamental changes occurring globally in society and the economy.[7] The main message of the speech reflected a growing trend in economic thinking - that we need to update what we consider ‘normal’.
Climate change, geopolitical fragmentation, historic levels of government debt, and technological step-changes all create a backdrop against which former economic rules may no longer apply. Hence, the key to success is an open mind, and a willingness both to challenge and be challenged.
In such an environment, it better not to go it alone
(*) Personal Consumption Price Index
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