On August 10, statistics released by the U.S. Department of Labor showed that the U.S. consumer price index (CPI) rose 8.5% year-on-year in July, lower than market expectations of 8.7%. In addition, it is also lower than the 9.1% inflation level in June. This change has made the market's expectations for U.S. inflation to "peak" significantly stronger. In fact, there are early signs of a fall in U.S. inflation data in July. As the biggest driver of this round of inflation in the country, global energy and food prices have fallen significantly since July. Oil prices have fallen to pre-Ukraine war levels amid fears of a recession in the U.S. and the global economy. The fall in inflation levels means less pressure on the Federal Reserve's monetary policy, and the pace of its rate hikes will become more moderate.
Market analysts generally weakened expectations for further sharp interest rate hikes by the Fed, leading to stronger U.S. stocks. As of the close of trading on August 10, the three major U.S. stock indexes collectively rose by more than 1%. The Dow Jones rose 1.63%; the S&P 500 13%; and the Nasdaq 2.89%. It is worth mentioning that at the closing point, the Nasdaq rebounded by more than 20% from the low point in June, entering a technical bull market. It is reported that after the release of the statistics, the swap market's expectations for the Fed's rate hike in September fell to 58 basis points. In addition, U.S. Treasury yields fell across the board, and the dollar fell sharply. Notably, the U.S. economic outlook and the performance of the capital market are in contradiction, and the market performance does not reflect the economic fundamentals. As a matter of fact, it moved closer to the policy expectations. A catchphrase among Wall Street professionals is “bad news for the economy is good news for the stock market, and vice versa”. From this point of view, this is not good news for the U.S. economy.
For researchers at ANBOUND, the fall in inflation is good news, and the pace of future Fed rate hikes is expected to ease, which is beneficial to avoid a "hard landing" of the economy. That being said, for the Fed, the real challenge has just begun. On the one hand, inflation remains at a high level, which will push the Fed to continue raising interest rates and shrinking its balance sheet. This, in turn, will restrain the economy more and more. On the other hand, a fall in inflation actually means a slowdown in economic demand, reflecting the effect of the "aggressive" tightening of monetary policy on the economy. While inflation is falling, the Fed will be under increasing pressure from the economic slowdown.
The current American CPI data has shown some decline, yet it is still at a relatively high level. Although some short-term factors have been digested, structural factors affecting inflation such as energy issues and supply chain distortions still exist, which means that it is difficult for inflation to fall back quickly. Meanwhile, U.S. core inflation, excluding food and energy, reached 5.9% in July, unchanged from June, indicating that inflation is becoming deeply rooted. The U.S. government is currently passing an inflation-fighting fiscal bill to expedite supply-side resolution. However, fiscal expansion will offset the Fed's monetary tightening, meaning the desire for lower inflation will not materialize quickly. It remains unlikely that the Fed will achieve the expected rapid inflation pullback in a "soft landing".
In the case of the Fed continuing to raise interest rates, high financing costs will cause the re-emergence of debt risk in the U.S. At present, the market expects that the Fed will raise the policy interest rate to more than 3% at the end of the year, which will make American residents, enterprises, and even governments at all levels, who have long been accustomed to low-interest rates, have to face high debt interest payments. Indeed, the U.S. housing market has shown signs of slowing down, and if interest rates continue to rise, the situation in 2008 may be repeated. Rising financing costs will erode corporate profits, while tight liquidity means the sustainability of future corporate liabilities will be at risk. These will also have an impact on the U.S. capital market and burst the bloating market bubble.
As far as the outlook for U.S. inflation and economic growth is concerned, ANBOUND has previously expressed the expectation that inflation and the economy will fall in tandem. The longer inflation drags on, the longer the Fed will continue to raise interest rates, the stronger its inhibitory effect on the economy, and the greater the possibility that the U.S. economy will fall into recession. This shows that the Fed has slowed down the pace of interest rate hikes as expected, which is "good news among bad news". One cannot, however, rule out the long-term negative impact of the policy itself on the economy. Since the beginning of this year, the U.S. economic growth rate has experienced negative month-on-month growth for two consecutive quarters. While the U.S. employment performance is still strong, the economy has continued to slow down, indicating that the demand side has shown signs of slowing down. The prospects, therefore, are still not exactly optimistic and the U.S. is likely to experience stagnation or recession as the Fed gradually raises rates.
Final analysis conclusion:
There are a lot of debates in the market about whether the U.S. economy is in recession. In the view of the Federal Reserve, for the U.S. economy to achieve a "soft landing", the inflation level will need to fall back quickly before the pace of the economic slowdown. This is also the reason for its consideration in the intense interest rate hike. However, as inflation becomes increasingly entrenched and the economic pressure increases, the U.S. monetary space continues to shrink with interest rate hikes. As things stand, the Fed needs to reconsider the trade-off and balance between inflation and growth.
