Thought of the day

The S&P 500 rose 1% on Wednesday, hitting its 37th record high this year, as investors awaited today’s consumer price index (CPI) release for June. Topping 5,600 for the first time on Wednesday, the benchmark has risen for seven consecutive days, the longest winning streak since November last year. The index is now up 18.1% year-to-date. The yield on the 10-year US Treasury stood at 4.28% at the time of writing, 20 basis points lower from the start of this month.

Investors are hoping that the CPI data will confirm the continuation of the disinflation trend, following encouraging data for both April and May. The consensus is for the core measure, which excludes volatile food and energy costs, to rise by 0.2% for the second straight month. A figure that is in line with or below expectations would likely reinforce confidence among investors that inflation is falling to the Federal Reserve’s target, and that the central bank will soon start cutting rates.

But falling inflation is not the only factor that will decide the Fed’s next policy move. Recent economic data and Fed Chair Jerome Powell’s Congressional testimony this week showed that the case for cuts is becoming stronger.

The US labor market has cooled. Data released at the end of last week showed job creation slowed in June, while employment growth for April and May was also revised lower. In addition, the release pointed to moderating wage growth, and the unemployment rate edged up to the highest level in more than two and a half years. Earlier in the week, the Job Openings and Labor Turnover Survey (JOLTS) showed the quits rate remained at pre-pandemic lows, suggesting workers have become less able to leave their employer for a better-paid position elsewhere. Powell this week told the Senate Banking Committee that “the labor market appears to be fully back in balance,” and that unexpected weakness in the labor market could prompt a cut. As inflation returns to the Fed's target, it should become easier for it to focus on the second part of its mandate—promoting maximum employment.

Economic growth has moderated and is on track for a soft landing. Both the manufacturing and services sectors of the US economy contracted in June, with weaker-than-expected ISM purchasing managers' index readings. Retail sales growth has also downshifted in recent months, with real consumption growth for the latest quarter likely running at a modest rate of around 1.5%. While the latest Atlanta Fed’s GDPNow tracker for the second quarter was revised up from 1.5% to 2% on 10 June, this remains much lower than the 4% growth during the second half of last year. We maintain our view that the US economy is headed for a soft landing.

The Fed looks set to start policy easing in the coming months. Over his two days of commentary before Congress, Powell largely stuck to the Fed’s current stance of wanting to gain greater confidence that inflation is headed back to the central bank’s 2% target before cutting rates. But there are signs that indicated such a move is getting closer. Powell stressed the two-sided risks the Fed now faces, adding that “more good data would strengthen” the case for looser monetary policy. He also suggested he has “some confidence” that the bar to cutting rates had been cleared, although he was “not ready to say that yet.”

So, we continue to expect the Fed to join the global rate-cutting cycle in September, with 50 basis points of easing this year. This would create a favorable backdrop for both quality bonds and quality stocks.