Stocks ahead of the week: the market has misread the Federal Reserve

“We have front-end loaded these large rate hikes and are now getting closer to where we need to be,” Fed Chairman Jerome Powell told reporters.

Of course, Powell said, another “unusually large” raise could also be on the table. But Wall Street has looked further.

What happened after: Investors cheered Powell’s apparent pivot. The S&P 500 rose, marking its best month since November 2020, and financial conditions eased. Mortgage rates fell below 5% for the first time since mid-April.

Now, Fed officials are trying to set the record straight. Not wanting the markets to turn too abruptly, reversing the effects of their hard work so far, they spoke harshly again.

“[We’re] hardly ever did, ”San Francisco Fed Chair Mary Daly said in a LinkedIn interview last week.
Loretta Mester, head of the Federal Reserve Bank of Cleveland, told the Washington Post that “it would be inappropriate … to shout victory too soon” and risk high inflation taking root.

“We have to see really compelling evidence that inflation is going down, and my guess is that we haven’t seen that yet,” Mester said.

As the Fed tries to bring demand back down so it can stop colliding with tight supply – raising prices – it is closely watching the job market, which has remained strong.

While job openings fell in June, the US economy continues to create jobs at a healthy pace. An explosive July report released on Friday showed a gain of 528,000 positions last month. The unemployment rate fell to 3.5%.

The news poured cold water on the theory that the Fed would radically change its approach in the short term. The central bank actually wants to see some weakening in the labor market. When there are too many open roles, wages rise rapidly, which can further worsen inflation across the economy.

“This is not the news the Fed wanted to hear, and that will likely make rates rise faster,” said Robert Frick, business economist with the Navy Federal Credit Union.

Investors have turned back: the stock market on Friday predicted a 66% chance of a three-quarter point rate hike in September, according to CME’s FedWatch tool. On Thursday, the market had only priced a 34% chance of such a high rise.

Arriving: The next big data release is the Consumer Price Index, which is used to track US inflation. Economists interviewed by Refinitiv expect to learn that prices rose 8.7% in the year through July, down slightly from June. But barring the volatility of food and energy prices, inflation could have risen slightly.

The strong US dollar is hurting everyone else

The US dollar has been in tears this year. This is good news for American tourists traveling around Europe, but bad news for almost every other country in the world.

The latest: the greenback rose more than 10% in 2022 against other major currencies, close to the highest level of the last two decades, as investors worried about a global recession rushed to raise dollars, which are considered a safe haven in turbulent times.

Adding to the dollar’s appeal is the Federal Reserve’s aggressive interest rate hike campaign to tackle high inflation for decades. This has made American investments more attractive, as they now offer higher returns.

US travelers can rejoice that a night out in Rome that once cost $ 100 now costs about $ 80, but it’s a more complicated picture for multinationals and foreign governments.

See here: About half of international trade is billed in dollars, invoicing to manufacturers and small businesses that rely on imported goods. Governments that have to repay their debts in dollars may also have problems, especially if their reserves run out.

The dollar gain is already hurting some vulnerable economies.

The dollar shortage in Sri Lanka contributed to the worst economic crisis in the country’s history, eventually forcing the country’s president to leave office last month. The Pakistani rupee plunged to an all-time low against the dollar at the end of July, pushing it to the brink of default. And Egypt, hit by rising food prices, is facing a depleted dollar reserve and an exodus of foreign investment. All three countries had to ask for help from the International Monetary Fund.

“It has been a difficult environment,” William Jackson, chief emerging market economist at Capital Economics, told me.

Next next

Monday: Earnings from BioNTech, Palantir, Tyson Foods, Novavax, News Corp., Take-Two Interactive and SmileDirectClub

Tuesday: Earnings from Dine Brands, Hyatt, Spirit Airlines, Coinbase, Roblox and Wynn Resorts

Wednesday: US Consumer Price Index for July; Earnings from Disney, Fox Corporation, Wendy’s and Bumble

Thursday: OPEC monthly report; US Producer Price Index for July; Earnings from Utz Brands, Warby Parker and Wheels Up

Friday: UK GDP; University of Michigan Consumer Sentiment Survey

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