Late summer heat appears to be a problem for the U.S. economy as well, and it’s making some investors – and therefore the markets – a little uneasy. But as with the weather, in the current economic heat, it’s best to remain optimistic because the slowdown is just around the corner.
This heat refers to above-trend growth, reflected in the Atlanta Fed’s Q3 GDP tracking estimate, which is still at 5.6%, and the risk that the economy accelerated again. This week should remind us that inflation and the Fed are still too high for comfort. The Bloomberg consensus expects the consumer price index for August to rise to 3.6% year-on-year and 0.6% month-on-month. In June, those numbers fell to 3% and 0.2%, respectively, data that helped investors accept a soft landing. August CPI data will not suddenly reverse this view. Core inflation is expected to continue to fall and the likely increase in the consumer price index is well known and is due to certain factors such as: B. higher oil prices, which do not indicate a renewed acceleration in inflation. But the steady path of disinflation is encountering some turbulence.
So, is the economy running too hot, creating a “good news is bad news” dynamic for the markets, and conversely, bad news is good? Recent price movements suggest this. Last Thursday, the ISM services index surprised positively and initial jobless claims fell to their lowest level since February, adding to concerns about a renewed acceleration. The S&P 500 (lower) and Treasury yields (higher) responded accordingly on the day. Earlier Friday, the S&P was higher after the August jobs report included a week of data that suggested a slowdown in the labor market – meaning “bad” data was good for stocks. Admittedly, Treasury yields also rose that day, meaning the data wasn’t all that bad.
Of course, this price movement is not about the strength of the economy per se, but about the Fed’s policy expectations. Good data should be positive for risk assets, but only up to a point. Beyond this level, the hot economy is likely to lead to more restrictive monetary policy, increasing future downside risk to growth. Current data flirts with this area.
The flip side of this dynamic is more interesting for the market outlook, especially if, like us, you believe that growth will slow rather than accelerate from current levels. It’s easy to see why stocks would rise on weaker data if it does anything but ensure that the Fed can handle the rate hike. Even better for risk assets is the prospect of interest rate cuts. This may not happen until well into 2024, but once the Fed is done raising rates, the market will likely advance the timing of cuts due to any weak growth data. In other words, the market could behave as if the Fed put is back, justified or not.
The time to keep an eye on this development is the FOMC meeting on November 2nd. A rate hike at the September 20 FOMC meeting is very unlikely – the market chance is less than 10%, and Fed officials gave no indication that a rate hike is imminent before the lock-in period. Market prices for a final increase in November are around 50%. Then, if economic conditions don’t justify another rate hike, it will be hard to believe that the Fed isn’t done raising rates yet, or at least that’s how markets will see it. If you want to make the case for a year-end rally, this scenario is a pretty good place to start.
The conclusion: We expect the economy to cool down by the end of the year after this final summer heat. Until this is sufficiently clear, investors will likely continue to vacillate between interpreting the data as “good is bad” and “bad is good,” resulting in volatile, fluctuating prices across all asset classes. The prospect of the economy cooling enough for the Fed to end its rate-hiking cycle by November raises the possibility that markets could heat up as the weather turns colder.
Lead author: Jason Draho, Head of Asset Allocation, CIO Americas
Original Blog – Heat wave September 11, 2023.
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