July 2023 Quarterly InsightsCategory

Upside for Rates Likely Capped as Economic Data Softens in the Fall

By Economics & Strategy Team
2 min read

US Economist Tom Simons slightly raised his terminal rate forecast to 5.375% in the wake of the June FOMC meeting. There were a few key elements of Chairman Powell's post-meeting comments that gave Tom the impression that one more rate hike is coming, but not two. First, Powell explained that the decision not to raise rates in June was part of a process of moderating the speed of rate hikes. Second, Powell, echoing many others, referenced the idea that moderating the pace of hikes while inflation remains unacceptably high is justified by the uncertainty surrounding policy lags. By the time of the late-July meeting, Tom does not believe there will be enough evidence of slowing growth and inflation to stop the Fed from hiking. Assuming a hike in July, he thinks the Fed will "skip" again in September, which means that the next opportunity to hike would be in October. However, by that point, Tom expects the data to have softened to the point that another rate hike will not be necessary. He anticipates significant declines in headline inflation, the rolling over of labor market data and increased pressure on consumption spurred by the likely September or October resumption of student loan payments.  

Chief Market Strategist David Zervos believes the major takeaway from the FOMC dot plot at the June meeting was that the current economic situation just isn’t that bad. The unemployment rate, which had been forecast to rise to 4.5% by year end, is now expected to be 4.1%. Headline PCE inflation is now projected to come down even faster, to 3.2%. Core inflation was the only negative update in the new projections, and is now seen ending the year at 3.9% instead of 3.6%, which is no doubt the primary reason why 50bps of additional hikes have now been put into the Fed’s SEP. Ultimately, Zervos believes that if core inflation gets back onto a path that looks set to hit 3.6% by year end, then the Fed skip will turn into a full-fledged pause. If, however, core inflation continues to be sticky and trend toward the new forecast of 3.9%, additional hikes are headed our way.

Global Head of Equity Strategy Christopher Wood highlighted several important trends. First, there is growing confidence that AI will provide the next productivity-enhancing growth narrative for the coming decade. He doesn’t believe that necessarily means the Big Tech stocks will be the dominant thematic for the duration, as he believes the picks and shovels theme remains the most compelling for now. Second, the fact that global investors still do not want to invest in Chinese stocks provides an explanation for interest in Japanese stocks. Third, the YTD weakness in oil has been due to a combination of concerns including Russia cheating the global sanctions regime, slowing demand in the West, the lack of a more vigorous recovery in China and further drawdowns of the US SPR. As a result, if OPEC supply remains constrained, the demand outlook is likely to remain the key variable for prices.