The summer has kicked off with some excitement about central banks starting their cutting cycles, but the Federal Reserve is not among them. While other advanced economies can justify easier policy on the basis of slower inflation and growth worries, the resilience of the U.S. economy is holding rates higher for longer. Hiring continues while layoffs have been limited, and wage gains are outpacing inflation. Consumption and investment are settling into steady, sustainable paces. The Fed’s ability to be patient is a luxury afforded by a positive economic context.
If benign inflation reports multiply, we believe the Fed will be on track for a first cut in September. However, the margin for error has eroded; another surprise from the data could push easing further off into the future. We, and the Fed’s decision makers, are taking the data one month at a time, with hope for the soft landing still intact.
Following are our thoughts on recent data and developments.
KEY ECONOMIC INDICATORS
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- At its June meeting, the Federal Open Market Committee did not change policy, in line with expectations. The quarterly Summary of Economic Projections showed opinions on the committee vary from zero to two cuts by the end of the year, with conservative expectations for core inflation to merely hold steady through December.
As of June, the Fed’s taper of balance sheet reductions is underway, with declines in U.S. Treasury holdings now capped at $25 billion per month. In the first two years of quantitative tightening, the Fed’s securities portfolio value has run down by over $1.6 trillion, without consequence; slowing the pace of the process after a rapid decline is an appropriately cautious adjustment.
- The Fed’s efforts to cool the economy through tighter financial conditions have not borne fruit. The risk rally that started last fall has not abated, with equity indices continuing to climb to all-time highs. Volatility has shifted to fixed income markets, with the yield on the 10-year Treasury more likely to reflect immediate market sentiment. Spreads on corporate bonds are holding at very narrow levels. Spreads on new mortgages are contracting slightly but remain historically elevated amid rate volatility. However, higher mortgage rates are not depressing home values amid constrained supply.
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