The US Federal Reserve’s July meeting begins today and tomorrow it will announce the rate hike decision, followed by the speech of Chair Jerome Powell.
This week is quite crucial for markets and apart from the US Fed, the European Central Bank and the Bank of Japan will announce their policy changes. We also have earnings from Big Tech companies including Amazon (AMZN) and Meta Platforms (META). The latter has more than doubled this year and might need to impress markets with its earnings to sustain the rally
US stocks fell after the Fed’s June meeting even as the central bank paused its rate hikes after 10 consecutive increases which catapulted the rates to between 5.00%-5.25% - the highest since 2007.
Fed rate hikes were among the reasons US stocks crashed in 2022. Stocks have nonetheless rebounded in 2023 and the Nasdaq-100 (QQQ) rose 32% in the first half of the year to have its best first-half performance in four decades.
As the Fed’s July meeting outcome looms, stocks are on an 11-day run higher. Will Powell play once again play the role of party pooper for bulls, as he has been for the most part since the rate hike cycle began in March 2022?
Traders expect Fed to raise rates by 25 basis points in July
According to the CME FedWatch tool, almost 99% of traders predict that the Fed will raise by 25 basis points in July. The dot plot after the Fed’s June meeting called for another 50-basis point rate hike in 2023. Speaking at the central banker panel hosted by the European Central Bank in Sintra, Portugal, last month, Powell said that he won’t rule out rate hikes at consecutive meetings.
“If you look at the data over the last quarter, what you see is stronger than expected growth, a tighter than expected labor market and higher than expected inflation,” said Powell. The remarks were more hawkish than expected, even as Powell has previously blamed the tight US job market for fueling inflation on multiple occasions.
Powell has sounded hawkish about rate hikes
The minutes of the June meeting also showed that most Fed members continue to have a more moderately hawkish stance toward rate hikes. The minutes said, “Many [Fed officials] also noted that, after rapidly tightening the stance of monetary policy last year, the Committee had slowed the pace of tightening and that a further moderation in the pace of policy firming was appropriate in order to provide additional time to observe the effects of cumulative tightening and assess their implications for policy."
The minutes also added that “participants expected that a period of below-trend growth in real GDP and some softening in labor market conditions would be needed to bring aggregate supply and aggregate demand into better balance and reduce inflationary pressures sufficiently to return inflation to 2 percent over time.”
US treasury yields, which fell during the regional banking crisis, have since recovered and are back to levels where they traded at the beginning of the year. As bond yields have whipsawed, so have Treasury ETFs whose price action is inversely correlated to yields.
US inflation has moderated and job growth has slowed down
Meanwhile, since the Fed’s June meeting, several economic indicators point to a slowdown in growth and a continued decline in inflation. The June consumer price index (CPI) came in at 3%, which is not only 6.1 percentage points lower than the corresponding month in 2022 but also the lowest since March 2021.
Also, the June nonfarm payroll (NFP) data showed that the US economy added 209,000 jobs in the month, which was the lowest for the year and below the 225,000 that analysts expected.
Could US stock markets continue to rally in the second half of 2023?
US stocks were quite strong in the first half of the year and have recouped much of their 2022 losses. I believe the Fed’s policy actions will drive the markets in the second half of the year and beyond. US Treasury yields might also react to Fed's rate hike decision.
Most traders are of the view that the July rate hike will be the last one in this tightening cycle. According to the CME FedWatch tool, over 63% of the traders believe that the Fed will pause after a 25-basis point hike this month. Apart from the interest rate decision, Powell’s tone could drive stocks. Markets will especially weigh his stance given the steep fall in US inflation and the recent moderation in the US labor market.
In the past, Powell has ruled out rate cuts. Now with interest rates gradually falling towards the Fed’s target of 2%, Powell might yet again spell out his stance about a “pivot” – or a progression to rate cuts.
Powell might also comment on the possibility of the so-called “soft landing” for the US economy which many believe is now looking like a much more realistic economic outcome than it did over the last few months.
Overall, Powell’s comments on the future trajectory of interest rates are what the markets will be more interested in. However, many believe that the US central bank might not take a too dovish stance.
Steve Englander, head of global G10 FX research and North America macro strategy at Standard Chartered said, “In our view the FOMC is like a weather forecaster who sees a 30% chance of rain, but skews the forecast to rain because the fallout from an incorrect sunny forecast is seen as greater than from an incorrect rain forecast.”
Given that the Fed burnt its fingers once by believing inflation to be “transitory,” it might not want to pivot to rate cuts in a hurry. That said, markets will still look for some insights into the Fed’s thought process on a possible pivot in the future, and a more hawkish than expected commentary from Powell might jeopardize the impressive rally in US stocks.
On the date of publication, Mohit Oberoi had a position in: QQQ , META , AMZN . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
