June meeting: the aftermath
The Federal Reserve last met on June 11-12 when, as was widely expected, they opted to hold rates steady pending more conclusive data that inflation was under control. The Fed also published its updated economic projections, which showed that it only expected to make one rate cut this year (a reduction from three expected cuts in the previous release).[1]
The published materials included an updated version of the ‘dot plot’ - a graph that shows the variation in views in the committee - with some members predicting no cuts and others predicting as many as two before year end.[2] The subsequent statements by individuals on the committee reflected this divide, with some indicating they felt the momentum was positive, while one member retained the possibility of raising rates even higher.[3]
The CPI inflation surprise
The end-June release of the Personal Consumption Expenditures Price Index (PCE) inflation data showed both the core and headline numbers trending downwards, which was welcome news.[4]
The real stir, however, was caused by the latest Consumer Price Index (CPI) inflation figures published on July 11. These not only came in lower than expected, cooling for the 3rd month in a row, but also saw prices actually fall month-on-month by the largest amount since 2020.
This means that inflation has for the moment been replaced by deflation - a psychologically significant moment.
Source: St. Louis Federal Reserve
The detail beneath the headline figures shows that while many prices - such as food, rent, and healthcare - are still at a higher level than before the onset of COVID-19, rental and home-related costs are rising at the lowest rate in 3 years. As rental is normally the last category to slow down, this has been taken by some as a sign that the tide is finally turning.[5]
The word from the Fed
On July 10, Federal Reserve Chairman Jerome Powell delivered his semiannual testimony to the U.S. Congress. He made several remarks in his formal statement and the following Q&A that seemed to confirm not only a change in sentiment at the Fed, but also in focus.
In asserting that the economy is ‘more or less back’ to its pre-pandemic levels, Chairman Powell came closer than ever to declaring the battle against inflation won. However, he went on to say that the central bank should also be keeping an eye on its other mandate to maintain employment levels. In other words, holding rates too high for too long could damage the economy for no good reason.[6]
Comments by other members have underscored that the mood is changing to how quickly, rather than whether, to cut rates.[7] Meanwhile, the markets are confident that the September meeting will see the first of a series of cuts that many appear to believe will continue well into next year.[8]
Conclusion
Zooming out, we can see that even before the positive CPI figures sparked a new wave of optimism, broader concerns were already pointing to lower rates.
Powell’s comments on 60 Minutes earlier in July highlighted the challenge posed by the U.S. national debt, which is growing faster than the U.S. economy. Higher interest rates contribute in no small part to making this problem worse.[9]
As investors, it is these broader issues that should concern us. It is tempting to get caught up in the exuberant gyrations of a market that may believe that the ‘good old days’ of ultra-low interest rates are returning.
Instead, it could be wiser to take a more balanced view that assesses the new challenges that could arise as a result of lower rates in a world that has fundamentally shifted since the pre-pandemic era (see our white paper Shifting Balance for an example of this thinking).
In a market as interconnected as today’s world, there is no such thing as completely ‘good’ news, but there is such a thing as good analysis.