Will September Be a Live Fed Meeting? July 26, 2023

Federal Reserve Chairman Jerome Powell is largely expected to raise the fed funds rate this afternoon, but the increasingly important question is the outlook for future Fed meetings. While backing off from hawkish rhetoric can be costly in the inflation battle, investors would most certainly cheer commentary in support of a “one and done” position today. In past meetings though, when Powell has tilted dovish, financial conditions loosened further, causing inflation to bounce back, signaling the need for additional tightening. Market players, furthermore, won’t be smiling at the end of the day if Powell keeps a September hike on the table. Stocks and yields are down at the moment as spectators impatiently await Powell.

Drivers of Stubborn Inflation

The impacts of tighter monetary policy typically hit interest rate sensitive sectors initially, such as automobile purchases, real estate, factory equipment and other big-ticket items that are typically purchased with financing, before spreading to the non-rate sensitive sectors. The current inflationary cycle, however, is different, with huge amounts of pandemic monetary and fiscal stimulus shoring up corporate and consumer balance sheets. Corporations have continued hiring after experiencing labor shortages in an effort to maintain proper staffing levels at the expense of margins. Consumers have enjoyed lofty gains to their investment portfolios and real estate relative to pre-pandemic levels while also having a plethora of job opportunities to choose from alongside strong wage gains, propelling household spending despite a drastic reversal in interest rates.

Fed Meets After a Series of Mixed Data

As the Fed meets today, it will look at data from last week that sent mixed messages regarding the potential for the Fed to remain hawkish without sending the economy into recession. Encouragingly, labor market strength has persisted, implying that additional rate hikes may not wreak havoc on employment. In the past few weeks, unemployment claims and job openings have been supportive of jobs growing in excess of 200,000 per month. Residential real estate is also encouraging. Just yesterday, the S&P CoreLogic Case-Shiller home price index recorded its fourth-consecutive month of price gains on a national basis, defying the headwinds of high interest rates and low affordability. New home sales reported today are still moving at a strong clip and representing an increasing share of real estate transactions. The services sector is losing momentum, however, with July’s services PMI and Redbook Retail Sales falling to their lowest levels in months. Manufacturing remains in the tombs, as the strong Chinese recovery has yet to manifest amidst depressed consumer demand due in part to previous pandemic demand surges and slowing business investment.

At this very moment, inflation is picking up in commodities, remaining steady with services and going the other way in the goods sector. 

While strong labor demand may give the Fed room to raise rates without causing an upheaval in the job market, the Fed will have to assess the potential for inflation to continue and how other areas of the economy will fare if additional rate hikes are required. At this very moment, inflation is picking up in commodities, remaining steady with services and going the other way in the goods sector. 

Cloud Computing Grows as Digital Advertising Weakens

The secular growth trend of cloud computing appears to be growing but digital advertising is limping along as corporations cut back on marketing in anticipation of weak economic growth in the near future.

While Microsoft yesterday reported weak results for its cloud-computing service, Alphabet said its cloud service revenues climbed 28% year-over-year as businesses increasingly turn to off-premises computing. The company also said its advertising revenue grew only in the single digits, marking the fourth-consecutive quarter of disappointing results.

Markets Brace for Fed Comments

Ultimately, the Fed will assess data showing that parts of the economy are contracting while the job market remains strong. The central bank is in a tricky spot. If it eases off its tightening too quickly, inflation may once again increase but being too heavy handed with tightening could push the country into recession. Powell’s comments today are likely to be pivotal in the outlook for markets and the economy, especially with a lack of clarity regarding if the Fed will decide to further tighten policy or pause its rate hiking when it meets in September. Overall, the soft landing depends on the lags of monetary policy slowing down inflation without disturbing consumer spending. So far so good, but momentum is slowing sharply in the short-term, narrowing the path for the Powell Fed.

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