In August, the 2023 stock market rise paused as investors debated whether the most recent economic statistics would force the Federal Reserve to raise interest rates at least one more before the year’s end.
The S&P 500 experienced a 1.4% decline in August, bringing its gains for the year to 18.8%. Investors were put off by remarks made by Federal Reserve Chair Jerome Powell at the Jackson Hole Economic Symposium that suggested additional tightening of monetary policy may be on the way.
While everything is going on, second-quarter earnings figures have been inconsistent as businesses continue to battle with cost increases and the prospect of a U.S. economic slowdown.
Are Interest Rates Going Up?
September’s Wall Street headlines are anticipated to continue to be dominated by inflation, interest rates, and the labor situation.
The consumer price index increased by 3.2% year over year in July, less below economists’ expectations of a 3.3% increase and down from June 2022’s 9.1% peak inflation rate. For the second month in a row, the headline CPI measurement increased by just 0.2% on a monthly basis.
Powell stated that inflation is still “too high” in his yearly address to the Jackson Hole audience in August, and he cautioned investors that “we are prepared to raise rates further.” Powell added that the Fed will be able to “proceed carefully” at upcoming meetings due to the combination of decelerating inflation and a strong economy.
The Federal Open Market Committee (FOMC) hiked interest rates by another 25 basis points (bps) at its most recent meeting in July, bringing their target range to its highest level in 22 years: between 5.25% and 5.5%. The FOMC’s upcoming meeting, which concludes on September 20, is anticipated to result in the FOMC keeping interest rates at their current levels.
Every month that inflation comes in below forecasts, according to Chris Zaccarelli, chief investment officer at Independent Advisor Alliance, the probability that this is the Fed’s final rate hike for the current cycle rises.
The probability that the FOMC will increase rates by at least another 25 basis points by November is 44.4%, according to the bond market. The odds that the FOMC will reduce interest rates from their current levels by May 2024 are similarly priced into the market at 59.5%.
American Recession Watch
In its efforts to steer a “soft landing” for the American economy, the Fed received conflicting information in August. In addition to CPI inflation coming in lower than anticipated, the personal consumption expenditures (PCE) price index increased from 3% to 3.3% year-over-year in July. The Fed’s preferred inflation measure, core PCE inflation, which excludes volatile food and energy costs, increased by 4.2% in July, in line with analyst expectations and remaining much above the FOMC’s 2% long-term target.
The hot U.S. labor market is also beginning to cool off as prices increase further. In July, the U.S. economy added 187,000 jobs, less than the 200,000 predicted by economists, according to the Labor Department. Since the COVID-19 pandemic lockdowns in March and April of 2020, the U.S. has not recorded back-to-back months adding fewer than 200,000 employment. June and July mark that first instance.
In July, the unemployment rate in the United States reached 0.7, the highest level since September 2021. But the unemployment rate in the United States is still only 3.5%. Powell stated in his Jackson Hole address that “some softening in labor market conditions” will probably be needed to bring inflation back down to 2%.
The FOMC may find it challenging to defend delaying interest rate increases until the labor market cools even more. The likelihood of economic repercussions in the future increases the higher interest rates must be raised by the Fed to manage inflation.
The New York Fed’s U.S. recession probability index, which continues to forecast a 66% chance of a recession within the next 12 months, reflects this risk.
Although FOMC members no longer predict a recession, the most recent economic estimates released by the Federal Reserve in June indicate a substantial decline in U.S. GDP growth in the second half of 2023 and into 2024.
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