Economic Update: Fed Funds Rate Increase

During last week’s Federal Open Market Committee (FOMC) meeting, monetary policymakers voted to raise the fed funds rate by another 75 basis points, lifting the target range to 2.25-2.50 percent.

That matched the 75 bps hike in June, which was already the largest single-meeting rate increase in over a quarter of a century, and essentially solidified the message the committee has communicated recently that historic levels of inflation require a historic response. Moreover, all 12 voting members of the committee supported the decision to hike rates by 75 bps, and in the official statement released by the FOMC it stressed that it is “strongly committed to returning inflation to its 2 percent objective.” However, with the core PCE price index, the Fed’s preferred measure of household inflation, increasing at an annual rate of 4.8 percent in June (most recent data release), it’s clear the committee still has a long way to go in terms of reaching that 2 percent objective.

Motivation for the committee to get inflation under control is in large part related to the consumer, the main driver of U.S. gross domestic product (GDP) growth. Indeed, many Americans are having to dig deep in the face of the highest inflation in over 40 years to find the means to maintain their rate of spending from the first half of 2022. Moreover, personal income on trend is not keeping pace with price increases, so in order to keep consuming at the same rate many households have resorted to putting off saving. In fact, the personal saving rate at 5.1 percent is now lower than it was during the worst part of the financial crisis in 2009. Put another way, consumers are dealing with both inflation eroding their purchasing power, and wage growth not providing as much of a boost to income as it did a year ago.

As for the stock market’s response to the FOMC decision, the initial reaction was very positive, and major equity indices added roughly another 5 percent in gains during the final three days of July. Stocks have actually been on a tear all last month, with the S&P 500 rallying by 9.11 percent, making it the 3rd best July ever recorded. Seasonality, albeit not guaranteed, is favorable going forward, with August and September tending to perform well following a July gain of at least 5 percent. Further, when July is an up month for stocks during a midterm election year (like this one), the gains continued into August and September 77 percent and 69 percent of the time, respectively, with average returns of 1.00 percent and 1.28 percent. However, it is important to remember that the S&P was also down 20.6 percent in the first half of 2022, the worst start to a year for the index since 1962, so much of the recent bounce could just be a (temporary) relief rally.

There is the possibility as well that an anticipation of the Fed pivoting to a less hawkish stance down the road has driven the recent upsurge in stock prices, with the end-of-month push being exacerbated by short covering. This actually puts both the markets and the Fed in a unique “dance” where stocks are rallying due to expectations of a dovish Fed pivot, but at the same time higher equity valuations are a form of easing financial conditions, the exact opposite of what the Fed wants when trying to get inflation under control. So altogether the market rally itself could actually be getting in the way of the perceived dovish (or at least less hawkish) Fed shift that has driven stock prices higher recently.

What To Watch Next Week

Monday

  • Nothing significant

Tuesday

  • NFIB Small Business Optimism Index 6:00 AM ET
  • Productivity and Costs 8:30 AM ET
  • 3-Yr Note Auction 1:00 PM ET

Wednesday

  • MBA Mortgage Applications 7:00 AM ET
  • CPI 8:30 AM ET
  • Atlanta Fed Business Inflation Expectations 10:00 AM ET
  • Wholesale Inventories (Preliminary) 10:00 AM ET
  • EIA Petroleum Status Report 10:30 AM ET
  • Charles Evans Speaks 11:00 AM ET
  • 10-Yr Note Auction 1:00 PM ET

Thursday

  • Jobless Claims 8:30 AM ET
  • PPI-Final Demand 8:30 AM ET
  • EIA Natural Gas Report 10:30 AM ET
  • 20-Yr Bond Announcement 11:00 AM ET
  • 30-Yr TIPS Announcement 11:00 AM ET
  • 30-Yr Bond Auction 1:00 PM ET
  • Fed Balance Sheet 4:30 PM ET

Friday

  • Import and Export Prices 8:30 AM ET
  • Consumer Sentiment 10:00 AM ET
  • Baker Hughes Rig Count 1:00 PM ET
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