There's a lot for markets to react to this week. It’s been a busy week for economic data. To recap:
But there were really just four key events:
- Fed rate hike on Wednesday
- Q2 GDP on Thursday
- PCE inflation on Friday
- Wage growth on Friday
Those data were the best of both worlds for the Fed. The GDP report showed the economy remains resilient, while inflation and wage growth slowed a bit more than expected, helping position the Fed for the “soft landing” that looks increasingly possible.
Add earnings news on top of this week’s deluge of data and it’s no wonder markets have been up and down. For the week, the major equity indices are up 1%-2% (blue line).
Possibly and more importantly, 10-year Treasury rates are now around 4% (green line). In case you missed it, 10 days ago they were 3.75%.
1. Fed hikes 25bps as expected, leaves door open to hike or pause going forward
As expected, the Fed hiked 25bps to 5.5%, a 22-year high.
But the positive for markets was that the Federal Reserve Chair Jerome Powell emphasized data dependency going forward, so it’s possible this was the last hike this cycle – as markets have priced (light red line) – if inflation eases as the Fed wants.
And we can add the Fed staff to the growing list of economists no longer forecasting recession.
2. Q2 GDP growth picks up speed on broad-based gains, signaling no recession
Yesterday’s Q2 GDP data also helps the “no recession” camp.
Q2 real GDP came in stronger than expected, seeing 2.4% annualized growth, up from 2% in Q1.
And the gains were broad-based. Consumer spending remained the biggest contributor, as people continue to spend, especially on services. Government spending also helped. The big surprise was that businesses boosted investment, despite higher rates and tight credit conditions, which had depressed investment in recent quarters.
3. Broad disinflation – including key core services – sends PCE inflation lower
This morning had more positive economic news, with the release of the PCE inflation data.
Headline PCE inflation is the gauge the Fed prefers. It fell to 3.0% YoY from 3.8% (orange line), and core PCE inflation slowed to 4.1% YoY from 4.6% (blue line).
This pretty much mirrors the CPI data we got earlier this month (see our recap here). Energy is the biggest drag on inflation, but we’re now seeing disinflation across the board – from food to core goods and now even the sticky housing and wage-driven core services components.
4. Wage growth is also slowing, partly helping PCE inflation fall
Finally, we got further confirmation today that wage growth is slowing with the Fed’s preferred wage metric (the Employment Cost Index) rising at a 4.1% annualized rate (black line) – its smallest increase in two years. Based on forward-looking small business compensation plans (blue line), it looks like it should keep slowing.
Lots for the Fed and markets to like
GDP shows the economy remains resilient and even saw a rebound in business investment, so it’s not just consumers driving the economy. PCE inflation, including core, is falling toward the Fed’s 2% target. And that’s helped by slower wage growth, which augurs well for a continued fall in inflation.
From here, the Fed will get two more jobs reports and two more CPI reports before its September meeting. If we continue to see solid, but not blowout, jobs numbers and further easing in inflation – especially core – the Fed should be able to hold off on further rate hikes, as markets expect.
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