Volatility in US equity markets somewhat subsided this week, as investors appeared to have found some direction. The broader narrative – despite a positive job report on Friday – is that decreasing inflation – likely the result of lower growth projections – could lead to a less hawkish Federal Reserve. As we wrote last week, slower growth “should not necessarily be seen as bad news. An economic slowdown, if correctly managed, can help tame demand-driven inflation, and keep long-term rates under control.”
That said, markets appeared to have also been reassured by the Fed’s determination to continue fighting high inflation, as it transpired from the June meeting’s minutes published on Wednesday.
There are still likely to be dislocations in global markets due to the speed of the shift in expectations – from high inflation to economic slowdown – and, going forward, as liquidity decreases in the summer months. But at least in the US, equity markets appeared to have found a bottom, and 10-year Treasury rates to have peaked.
There’s little doubt in our view that June CPI data, to be released on Wednesday, is going to be a big determinant of market moves this coming week. Investors have started to price out large upward moves in the Fed Funds, even as most analysts still believe the Fed will hike 75 basis points in July. Post that, all bets are on.
Other relevant data scheduled for publication next week include the Fed’s Beige Book on Wednesday, June retail sales and University of Michigan July preliminary consumer sentiment – on Friday – which will likely confirm shakier consumer confidence, and industrial production, also due Friday.
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The news that positively shook markets this past Thursday came out of China, with the government’s decision to allow local administrations to issue over $200 billion in new debt to finance infrastructure spending. However, stimulating demand in the absence of adequate supply can generate inflationary pressures – as the US has experienced in the past six months.
In the meantime, Europe is teetering on the edge of a recession, for which odds are 40% this year according to Goldman Sachs. That assessment, however, may not be fully taking into account the sharp decline of Russian gas flows into Europe, with the potential for more disruptions come fall – rather than the previously projected normalization. Unlike in the US, which is energy independent, Europe’s energy crisis threatens growth without offering any inflation respite, which makes monetary policy decisions harder, and the potential for stagflation higher.
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