(Expansion) – On the occasion of the last meeting of the Federal Open Market Committee (FOMC) last July, the United States Federal Reserve (Fed) marked a clear change in its position by announcing that, since the interest rate reference is now very close to neutral territory, your policy direction will become “data dependent” from now on. This very slight change in the tone of the Fed has allowed the markets to prolong their rally.
It is true that several of the colleagues accompanying Fed Chairman Jerome Powell on the governing board were quick to deny any hint of moderation in the Fed’s position and reaffirmed their willingness to bring inflation down to the target set, as well as the urgent need to continue applying significant rate hikes to achieve that goal.
While there is little doubt that the Fed will raise rates at its next meeting in September, the market is divided on the magnitude of that increase, will it be 50 or 75 basis points (bps), as inflation is peaking and begins to surprise on the downside.
What factor could then push the data-dependent Fed to halt its rate hike trajectory? Data pointing to a decline in inflation could move in this direction and there are signs that prices should change course, essentially because economic momentum is slowing.
The macroeconomic data, meanwhile, continue to disappoint on the downside. Much of this weakness stems from the real estate sector, where rising prices and rising mortgage rates are negatively affecting both construction activity and demand itself.
And while investment intentions are at record highs, they are moderating, and both leading manufacturing indicators and trade surveys reveal growing pessimism, which is also reflected in major surveys of consumer expectations.
On the other hand, the labor market continues to show signs of exceptional strength, which reduces the possibility of the economy entering a recession. While economic indicators are tilting slightly lower, both financial conditions and risk appetite took a sharp turn last month.
The rally that occurred in the equity markets, causing the S&P 500 to rise 17.4% from its June low, and the tightening of credit spreads are factors that contributed to partially alleviate the liquidity shortage that was affecting the markets.
However, ahead of the central bank symposium in Jackson Hole later this week, the market appears to be expecting Fed officials to deliver a rather harsh message, as the momentum of the rally has slowed, lowering Large-cap stocks are down 4.1% from their August high. Consequently, risk appetite has collapsed.
Creo expects the Fed to stick to its data-driven message and limit rate hikes to just 50 bps, given the balance of economic indicators.
That said, investors should keep in mind that the Fed’s rate hikes have not fully passed through to the real economy so far this year. The lagged effect of monetary policy will add to a highly negative fiscal impulse, causing the federal budget deficit to shrink rapidly.
Editor’s note : Yves Bonzon is Group Chief Investment Officer at Julius Baer. Follow him on . The opinions published in this column belong exclusively to the author.
