Markets revised higher the implied probability of a further hike at or before the November meeting by 10 basis points to 48%, with a stronger-than-expected services sector survey contributing to the shift. Investors are also expecting rates to stay higher for longer, with 18 basis points less easing priced for rate cuts in 2024 over the course of the week.
This week will produce more evidence on the pace at which inflation is cooling and how well consumers are holding up. These releases will shape market sentiment heading into the Fed’s next policy decision on 20 September.
But, despite the strength of services activity, we still expect a softish landing for the US economy.
The moderation of inflation looks on track. The release on Wednesday of the consumer price index (CPI) will help set the tone for markets ahead of the Fed meeting. Economists are expecting the headline rate of inflation to accelerate for August, led by a rise in gasoline prices, with the consensus forecast for a 3.6% year-over-year rate, up from 3.2% in July.
Even if headline inflation accelerates, we expect the focus to be on the core rate, which excludes food and energy, and should confirm that underlying price pressures are moderating. Here, the consensus is for the rate to hold steady at 0.2% for a third consecutive month, while the year-over-year rate should slow to 4.3% in August—down from 4.7% in July.
The following day, the focus will shift to the producer price index, which includes several elements that feed into the Fed’s favorite measure of inflation, the core personal consumption expenditure index. While we believe the low-hanging fruit on inflation has already been plucked, leading to a greater potential for disappointments, the declining trend appears intact.
The labor market is cooling, but not too abruptly. August payrolls also pointed toward a "goldilocks" scenario in which growth is neither too hot, nor too cold. The economy created 187,000 new jobs over the month, only a little higher than the consensus forecast for 170,000—with a downward revision of a cumulative 110,000 for the prior two months. Monthly wage growth was also slower, and unemployment rose to 3.8%, versus expectations that it would remain steady near multi-decade lows of 3.5%. That was the final major jobs release ahead of the Fed’s decision and would be consistent with an end to rate rises, in our view.
Consumer spending appears on track to slow, with the downside being limited by strong household balance sheets. Investors will be looking for an update on the state of American consumers with August retail sales data, which followed an unexpectedly strong 0.7% monthly rise in July. The consensus forecast is for a moderation. Overall, we expect consumer spending to weaken, since much of the excess savings accumulated during the pandemic have been spent by lower income households and savings rates remain well below historic norms and look likely to rise. With real wage growth still low, despite moderating inflation, the capacity of households to increase spending looks limited.
However, we still expect strong balance sheets among wealthier Americans to underpin spending to some degree. Fed data on Friday showed household net worth rising to a record high of USD 154 trillion for the second quarter, reflecting gains for homeowners and those with equity investments.
So, we still see the US economy headed for a period of moderate growth, avoiding a recession over the coming 12 months. That will support equities. However, uncertainty is likely to keep broad equity markets choppy and rangebound. Against that backdrop we favor equity laggards, including more defensive sectors and emerging market stocks.
Main contributors - Solita Marcelli, Mark Haefele, Jason Draho, Brian Rose, Christopher Swann, Vincent Heaney, Jon Gordon
Original report - US still looks on course for softish landing, 11 September 2023.