Investors still face fog of uncertainty on economy, Fed
Summary
Markets remain vulnerable to swings in monetary policy expectations.
Investors’ nerves have been soothed recently by reassuring economic data. But the outlook for the economy and for monetary policy both remain unusually uncertain, meaning more volatility could be in store.
The prospects for a soft landing got a boost this week, as data showed consumer-price inflation continuing to slow, in line with expectations, even as retail sales saw a surprising surge in July.
Yet Thursday’s retail sales report wasn’t quite as good as it looked. The headline figure jumped 1% from a month earlier, Commerce Department figures showed, crushing economist estimates of a 0.3% gain. But that was largely because of a rebound in auto sales, which took a hit in June from a widespread cyberattack on dealerships. Excluding motor vehicles and parts, retail sales rose just 0.4% in July.
Meanwhile, industrial production figures from the Federal Reserve, also released on Thursday, came in weak, showing a 0.6% decline in July from June. The Federal Reserve, which publishes that report, said disruptions from Hurricane Beryl dragged on that figure by around 0.3 percentage points. Even stripping that out, though, the decline was worse than expectations for a 0.1% fall. June’s reading was also revised down.
The truth is that, while a hard landing isn’t at all imminent, the extent to which economic momentum is actually slowing remains unclear at the moment. This makes the market’s apparent high degree of confidence in the Federal Reserve look odd.
Everyone now seems to agree that a rate cut is coming in September. But there remains active debate about how much the Fed will do at that meeting, and how quickly it will proceed thereafter to keep bringing rates down. Markets are currently pricing in a 27.5% chance of a half-point cut, which would be bigger than the usual quarter-point move, according to the CME FedWatch tool. But a week ago markets were implying a 55% chance of a half-point cut.
The uncertainty naturally grows the further out one tries to forecast Fed actions. Since the central bank is effectively in transition between policy stances, it hasn’t given Fed-watchers much to go on in terms of how it will proceed. No one can say with any degree of confidence where rates will be a year from now, except that they will likely be lower.
This means that markets could be prone to more disruptions like the one they have just been through. Recent experience shows just how sharp those disruptions can be: It was hawkish rhetoric from the Bank of Japan that prompted a surge in the yen, an unwind in the carry trade and the most volatile week for stocks in years. That is a reminder of how changes in monetary-policy expectations can have huge ripple effects.
It also means the updated “dot plot," which shows Fed policymakers’ consensus forecasts for the economy and rates, will be under even more scrutiny than usual in September.
On Thursday, the S&P 500 was on track for its sixth straight day of gains and was only around 3% shy of the all-time high it reached in mid July. Investors should brace for a bit more turbulence.
Write to Aaron Back at aaron.back@wsj.com
