Equity Week Ahead: The Market Misread the Federal Reserve

“We loaded up these very large rate increases, and now we’re getting closer to where we need to be,” Fed Chairman Jerome Powell told reporters.

Of course, Powell said, another “unusually large” raise could also be on the table. But Wall Street looked beyond that.

What came next: Investors applauded Powell’s apparent pivot. The S&P 500 rallied, posting its best month since November 2020, and financial conditions eased. Mortgage rates fell below 5% for the first time since mid-April.

Now Fed officials are trying to set the record straight. Not wanting the markets to change course too abruptly, reversing the effects of their hard work so far, they spoke tough again.

“[We’re] far from nearly done,” San Francisco Fed President Mary Daly said in a LinkedIn interview last week.
Loretta Mester, head of the Federal Reserve Bank of Cleveland, told the Washington Post that it “would be inappropriate…to declare victory too soon” and risk letting high inflation take root.

“We need to see some really compelling evidence that inflation is coming down, and I think we haven’t seen that yet,” Mester said.

As the Fed tries to lower demand so that it stops running into limited supply – driving up prices – it is closely watching the labor market, which has remained strong.

While job offers fell in June, the US economy continues to create jobs at a steady pace. An explosive July report released on Friday showed a gain of 528,000 jobs last month. The unemployment rate fell to 3.5%.

The news threw cold water on the theory that the Fed would drastically change its approach anytime soon. The central bank actually wants to see a weakening in the labor market. When there are too many vacancies, wages rise rapidly, which can add to economy-wide inflation.

“This is not the news the Fed wanted to hear, and it will likely cause it to push rates higher, faster,” said Robert Frick, business economist at Navy Federal Credit Union.

Investors are back: The stock market on Friday predicted a 66% chance of a three-quarter point rate hike in September, according to CME’s FedWatch tool. On Thursday, the market had assessed the chances of such a high rise at only 34%.

Coming : The next big data release is the Consumer Price Index, which is used to track inflation in the United States. Economists polled by Refinitiv expect to learn that prices rose 8.7% on the year to July, down slightly from June. But excluding volatile food and energy prices, inflation may have picked up slightly.

The strong US dollar hurts everyone

The US dollar is in freefall this year. That’s good news for American tourists wandering around Europe, but bad news for just about every other country in the world.

The latest: The greenback has risen more than 10% in 2022 against other major currencies — near its highest level in two decades — as investors worried about a global recession rush to pick up cash dollars, which are considered a safe haven in turbulent times.

Adding to the appeal of the dollar is the Federal Reserve’s aggressive interest rate hike campaign to tackle decades-high inflation. This has made US investments more attractive, as they now offer higher returns.

American travelers can rejoice that an evening in Rome that once cost $100 now costs around $80, but that’s a more complicated picture for multinational corporations and foreign governments.

See here: About half of international trade is invoiced in dollars, driving up bills for manufacturers and small businesses that rely on imported goods. Governments that must repay their debts in dollars could also face difficulties, especially if reserves run out.

The dollar’s gain is already hurting some vulnerable economies.

A shortage of dollars in Sri Lanka contributed to the worst economic crisis in the country’s history, eventually forcing the country’s president to resign last month. The Pakistani rupee plunged to a record low against the dollar in late July, pushing it to the brink of default. And Egypt – battered by rising food prices – faces a depleted supply of dollars and an exodus of foreign investment. All three countries had to turn to the International Monetary Fund for help.

“It’s been a tough environment,” William Jackson, chief emerging markets economist at Capital Economics, told me.

Next

Monday: Revenues from BioNTech, Palantir, Tyson Foods, Novavax, News Corp., Take-Two Interactive and SmileDirectClub

Tuesday: Gains from Dine Brands, Hyatt, Spirit Airlines, Coinbase, Roblox and Wynn Resorts

Wednesday: US consumer price index for July; Earnings from Disney, Fox Corporation, Wendy’s and Bumble

Thursday: OPEC monthly report; US Producer Price Index for July; Earnings from Utz Brands, Warby Parker and Wheels Up

Friday: UK GDP; University of Michigan Consumer Sentiment Survey

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