News in Charts: Time for a Fed pivot?

Easing US recession fears and increasing expectations of a Fed ‘pause’ have contributed to a new, positive mood in US markets, aided by technological optimism about the possible benefits from AI. The S&P 500 was more than 20% off its cyclical lows during trading earlier this week, although whether this is a bear market rally or a new bull market, it is too early to tell. The outlook for inflation and all its associated implications for Federal Reserve policy will continue to prove critical, as they have done for several quarters now. The US labour market report for May surprised to the upside, marking the 13th time out of 14 that the initial print has been higher than the median expectation among economists polled by Reuters. It adds to a range of coincident data suggesting that the US economy continues to shrug off rate hikes and banking turmoil to avoid recession. Of course, investors must consider the risks that good news ends up being bad news if strong output data continue to keep price pressures elevated.

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Despite the headline employment figure in May’s payrolls print beating expectations, there were signs of cooling elsewhere in the report and in other recently released data. These include:

• The unemployment rate increased by 0.3 percentage points, the largest monthly increase since April 2020
• On a three-month annualised basis, wage growth was 4%, down from more than 6% in early 2022
• The quit rate, which tends to correspond well to wage growth, has softened to 2.4% in April, off cyclical highs of 3%

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A key question will be the extent to which this softening continues, and whether that will be enough to bring inflation back to its 2% target. It should be noted that, if prices continue to increase at their average rate so far this year, headline inflation will fall below 4% in June for the first time in more than two years, thanks to favourable base effects. With that figure due for release on 12 July before an FOMC meeting in the same month, it should give the rate-setters until their September meeting to calibrate their next move.

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The recent, weak ISM non-manufacturing report for May has probably solidified the likelihood of a Fed ‘pause’ that was already in prospect. After a rapid hiking cycle, the real fed funds rate is now in positive territory, whether you annualise the outturns in actual inflation or use expectations as judged by investors. Many policymakers have pointed to uncertain lags in monetary policy as a reason to take a breather on further rate hikes. Those in favour of such a move appear to be in the ascendancy, but the outlook for US policy rates over the next year remains highly uncertain, with big risks in both directions.

Fathom will be discussing these issues (and others) in greater depth in its Global Outlook, Summer 2023. Details will be available to Refinitiv subscribers on Chartbook in due course. For more information, please contact enquiries@fathom-consulting.com.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.