Fed’s Powell leaves investors with a cloud of uncertainty. Why the US stock market has a tough week ahead.

By Isabel Wang

What’s the next crucial test for the US stock market after Jackson Hole is over?

The US stock market bounced back from a three-week losing streak this week, although the release of Nvidia earnings and a speech by Federal Reserve Chair Jerome Powell at the Jackson Hole economic symposium caused some volatility, but the boom in artificial intelligence did offset rising bond yields.

Next week, the July Personal Consumption Spending Index, the Fed’s preferred measure of inflation, and the latest monthly jobs report will pose another challenge for markets as investors assess whether stocks will scale up their recent gains amid the “overcast skies” of uncertainty about the US can defend economic outlook.

On Friday, Fed Chair Powell said the central bank was ready to raise interest rates further until policymakers were confident inflation was on a convincing path toward the Fed’s 2 percent target, but acknowledged that they remain unsure whether further rate hikes are needed The economy may not yet have felt the full impact of the monetary tightening of the last year and a half.

“Powell is in a position where he’s trying to climb one of the Grand Tetons, and he’s not doing it without pausing and catching his breath,” said Johan Grahn, senior ETF market strategist at Allianz Investment Management. Grahn believes the Federal Reserve Open Market Committee is debating whether it has reached the “top,” or one of the “peaks,” or is on a “false peak” in its efforts to contain inflation by raising interest rates and curbing demand.

“Powell needs those ‘data clouds’ to give him a signal so they know the job is done, and I don’t think he’ll know until September,” Grahn said.

Powell’s much-anticipated speech at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, came just days after Nvidia (NVDA), the chipmaker at the forefront of an industry-wide AI frenzy, posted record earnings that beat Wall Street estimates surpassed, largely due to a boom in generative AI revenue. However, both events were broadly in line with expectations, sparking yawns on Wall Street during a sleepy August, market analysts said.

According to Dow Jones Market Data, US stocks ended the week mostly higher, with the Dow Jones Industrial Average DJIA down 0.5%, while the S&P 500 SPX gained 0.8% and the Nasdaq Composite COMP was up on the week up 2.3%.

See: Hot US economy drives real yields to about 15-year highs after Powell’s Jackson Hole speech

However, the biggest event for markets is always the next one.

As the second quarter earnings season draws to a close, key economic data in the coming days will provide clues to the resilience of the US economy and whether the Fed will hike rates further at its September 19-20 monetary policy meeting .

“There is a lack of corporate news that will really move markets, meaning traders and investors will turn their attention to the macroeconomic components,” said Anthony Saglimbene, chief market strategist at Ameriprise Financial.

Next week, markets will get the latest reports on the jobs market, including the July Job Openings and Labor Turnover Survey (JOLTS) due on Tuesday, followed by the ADP National Employment Report for August on Wednesday. On Friday, the focus will be on the Labor Department’s August report on non-farm payrolls.

The US economy is expected to add 175,000 jobs in August, up from 187,000 the previous month, according to a survey by Dow Jones economists. The percentage of unemployed Americans looking for work is expected to remain unchanged at 3.5% from the previous month. According to the quarterly summary of economic forecasts, the central bank forecast in June that unemployment would rise to 4.1% by the end of 2023, compared to 4.5% in March

Meanwhile, the Bureau of Economic Analysis will release its index of personal consumption expenditure (PCE) — the Fed’s preferred indicator of inflation — for July on Thursday.

US annual inflation is expected to rise to 3.3% yoy in July from 3% the previous month, while consumer prices are expected to rise a modest 0.2% over the month. According to Wall Street analysts polled by Dow Jones, so-called “core” PCE is also expected to edge up to 4.2%, up from 4.1% in June. The core interest rate does not take into account volatile food and energy costs and is considered by the Fed to be a better indicator of future inflation trends.

Powell pointed out during his Jackson Hole speech that the PCE core is his primary focus. “The lower monthly readings for June and July for core inflation were welcome, but two months of good data is just the beginning of what it takes to build confidence that inflation is moving sustainably toward our target,” Powell said.

Investors need the “Goldilocks scenario,” in which economic growth slows but doesn’t crash off a cliff, which would suggest the Fed is closer to raising interest rates, Saglimbene said in a phone interview with MarketWatch on Friday. “Any stronger than expected economic data, such as an unexpectedly hotter than expected PCE inflation and jobs report, could be taken as negative by the market.”

While the July PCE report will be the “linchpin” for the September policy meeting, the data would need to deviate significantly from expectations for policymakers to “take another step up that proverbial mountain,” Grahn said .

However, assessing the precise extent of monetary policy dovishness is complicated by uncertainty over the length of the lags that monetary tightening is having on economic activity and inflation, Powell said on Friday, noting that “the wide range of “Estimates” of these delays suggest there could be “significant further delays” in the pipeline.

“The lagging effect, in my opinion, overshadows concerns that two months of good inflation readings are not trending,” Grahn told MarketWatch by phone on Friday. “The lag effect is starting to have an impact on the economy, but it is not reasonable to think that it will have its full impact in the next four weeks, so I expect a meeting in September with a decision not to say anything.”

Overall, the US stock market has fallen this month as August once again lives up to its bad reputation for equities. The S&P 500 is down nearly 4% so far this month, on course for its biggest monthly loss of 2023, while the Dow Jones Industrial Average is down 3.4% and the Nasdaq Composite is down 5.3% month-to-date, according to the Dow. Jones market data has fallen.

Those pullbacks are seen as a sharp contrast to the AI-driven rally earlier this year, when the Nasdaq Composite posted its best first-half performance since 1983, as investors hoped the Fed might wind down its inflation fight faster than markets expected.

However, recent strong economic data has raised concerns that the Fed will keep interest rates higher for longer than expected, causing longer-dated government bond yields to rise.

According to Dow Jones Market Data, the 10-year government bond yield BX:TMUBMUSD10Y rose to its highest level since November 2007 on Monday uncertainty about Beijing’s political support is also contributing to general unrest in US financial markets.

See: Global investors expect massive economic stimulus from China. Because of this, it may never come to pass

August is historically not the best month for the US stock market. Investors kicked off August 2023 with five straight months of gains for the S&P 500 index and the Nasdaq Composite, giving investors an “excuse” to lock in profits at megacap technology companies trading at “high valuations,” he said Saglimbene.

The weekly AAII Investor Sentiment survey shows that bullish sentiment has eased and is below average for the second straight week in the seven days ended Wednesday. In the most recent poll, just 32.3% of respondents had a positive outlook for the stock market, down from the historical average of 37.5%.

However, historical data shows that September may not look much better than August as September is traditionally the weakest month for US equities. According to Dow Jones Market Data, the S&P 500 and Dow Industrials have each fallen an average of 1.1% in September since 1928 and 1896, respectively.

See: Here are the chances that the stock market will crash

In addition, concerns remain that the Fed could hike rates again and slow the economy more than expected, ultimately leading to a recession in 2024, Saglimbene said.

“I don’t think traders are ready to enter the market and buy based on these declines, but I think if we see more pressure in September while macro conditions hold, more investors will step in and get started with the purchase, and that might be more supportive [for stocks] in the second half of this year when seasonal trends improve.”

– Isabel Wang

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(ENDS) Dow Jones Newswires

8/27/23 1220ET

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