The July minutes showed “most” policymakers saw significant upside risks to inflation that could require further tightening. Worries over the possibility of an additional rate hike were further increased by more robust economic data from the US on Wednesday, with strong showings from both July industrial production and US housing starts.
In the wake of these developments, markets raised the implied probability of a September Fed hike to 45%. Elsewhere, waning confidence in China’s economic recovery is continuing to weigh on risk sentiment.
The next major signal on Fed policy is likely to come at Jackson Hole, where Fed Chair Jerome Powell is expected to speak on 25 August. With the July Fed minutes behind us and Jackson Hole ahead, we make two observations:
The minutes didn’t actually deviate much from the script. While markets may not have been positioned for a hawkish tilt to the commentary, we see few actual surprises when weighed against consensus economist expectations or the Fed’s own Summary of Economic Projections (SEP). The minutes largely echoed Chair Jerome Powell’s post-FOMC press conference commentary, focusing on labor market strength. The minutes showed two participants advocated pausing rates in July, and “some” raised downside risks to both economic activity and labor data.
A data-dependent Fed means data-sensitive markets. In the minutes, policymakers emphasized the need to clearly communicate the Fed's continued “data-dependent approach to policy” in the coming months. Participants also cited tentative signs of price pressures easing, a view that predates the positive Consumer Price Index release earlier this month, which pointed to moderating headline and core inflation. There is also the potential for further reassuring indications from the August inflation and jobs reports, both of which will be released prior to the Fed's next policy meeting on 19–20 September.
While our base case is for no additional Fed hikes this year, the risk of further tightening remains if US data continue to beat expectations. Against this backdrop, we advise investors to:
Look for equity laggards: We see particular opportunities in parts of the equity market that have lagged. The MSCI Emerging Markets index has trailed the MSCI All Country World index by nine percentage points this year, returning just 2% as of 17 August. In addition, growth stocks have returned around 21% this year in the global index, leaving value behind at 4%. We expect these laggards to play catchup in the months ahead.
Buy quality bonds. With central bank policy rates near a peak, reinvestment risk will likely rise for investors holding excess cash or fixed deposits. We favor locking in attractive yields, with a tilt to more defensive, higher-quality segments of fixed income. We expect high grade (government), investment grade, and sustainable debt to deliver good returns over the balance of the year, and we prefer five- to 10-year maturities.
Dollar upside should be limited. The dollar is again rising as markets continue to reflect the risk of further Fed tightening. But we see limited upside from here, and retain a least preferred view on the currency. We are most preferred on the euro, as we think recent economic disappointments are already priced into the currency’s valuation.
Main contributors - Solita Marcelli, Mark Haefele, Jon Gordon, Christopher Swann
Original report - Seeking clarity from the Fed, 17 August 2023.