Quarterly Market Outlook: A Delicate Balance

Is the Federal Reserve finished? There are economic signs to support and to oppose the proposition that the Fed's rate-hike cycle has done its job—slowing the economy enough to cool inflation—and can be ended. Whether the central bank still sees the need for another increase is a key question as we head into the final months of the year. We tend to think it won't, but there has been enough uncertainty about it to cause volatility in both stock and bond markets.

For context, recall that the Fed has raised the federal funds rate target1 to 5.25% to 5.5% from near zero in a little more than a year's time. The impact of that policy tightening is showing up in economic data and lower inflation. Notably, the labor market, which is a key factor for the Fed in setting policy, is showing softness. Job openings have declined, hiring has slowed, wage growth is trending lower and the unemployment rate has ticked higher. The monthly pace of hiring has fallen to 150,000 on a rolling three-month basis, compared with more than 300,000 earlier this year. Wage growth is also slowing down, and the unemployment rate rose in August to 3.8%, the highest level since February 2022.

job growth slowed

Moreover, inflation is slowing. The Fed's preferred inflation gauge, the "core" Personal Consumption Expenditures (PCE) Price Index2 (core means it excludes volatile food and energy prices) rose by just 0.2% in July. On a three-month annualized basis, core PCE was up 2.9% year-over-year in July—closer to, but still above the Fed's 2% inflation target.