Inflation, the Fed, and the Markets

Posted by Jacob Radke

This is going to be a big week. Tomorrow, Tuesday, we get CPI inflation numbers, Wednesday we get the largely anticipated Fed decision (accompanied by their summary of economic projections), and retail sales on Thursday. All very important indicators for inflation, interest rates, and the economy. And last week we got the jobs report, which showed that employed persons are accelerating instead of decelerating.

Company earnings outperformed analyst expectations in the second quarter, which boosted the outlook on the S&P 500 index, and the economy. The Bank of Montreal now expects the S&P 500 to close at $4,350 in 2023, just one of many to be raising their year end price targets.

Technically the bear market is over, as the index has climbed 20%+ since it’s October bottom. Although that is a powerful statement, this is what is known as a cyclical bull market not a secular bull market meaning it may be short lived and we’ll have not much in way of knowing if we are actually in a secular bull market which could last for years.

What’s Next for Inflation?

Inflation, but by the time you read this we will know, is expected to come in at 4.1%, a broad deceleration from 4.93% in April. More significantly this would push fed funds real interest rates into positive territory of greater than 1%. If this inflation trend continues we may see 2% inflation by the end of the year and greater real rates of return.

What’s Next for the Fed?

The Fed is largely projected to pause rate hikes and maintain the 5%-5.25% target for the foreseeable future. Holding real rates and restrictive policy until inflation is back down at target.

The Fed is going to release their summary of economic projections on Wednesday which should outline what they intend to accomplish over the coming 12 months.

Ultimately it is unknowable the actuality of their future actions, but it gives good guidance for what they anticipate.

As far as for the economy, policy in restrictive territory for too long should bring down growth. However, raising rates as fast and as much as they did should have also brought down economic growth.

What’s Next for the Market?

So then that brings us to the markets. The markets are looking forward, always. If you predict for tomorrow you may miss on the prediction in 10 years. The markets today are looking past inflation and looking past the Fed. I don’t believe there is that much that the Fed and inflation can do to materially damage what has positively happened in the market.

What can affect it is a great hit to economic and business growth.

Market participants are looking to 2024 to be the year where the economy, if it enters a recession, will begin it’s ascent again. The market is almost ignoring the fact that today and possibly still this year we could be entering into a recession. And that is not that surprising because the market is routinely doing that in the first place.

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