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Market Update

Fed doubles down on continuing rate hikes; U.S. recession “not the most likely” outcome, according to Powell

July 3, 2023


Last week, Federal Reserve Chair Jerome Powell offered encouraging comments as he believes a “soft-landing” scenario is now the most likely outcome for the U.S. economy. Core PCE metrics delivered additional evidence that the economy continues to cool, while employment metrics remain strong. In Europe, however, inflation remains stubbornly high as the ECB warns markets against pricing in near-term rate cuts.

Powell delivers an optimistic message on the “resilient and growing” U.S. economy

Last week, Chair Powell offered remarks at a conference organized by the European Central Bank that the U.S. economy continues to perform strongly despite rates remaining steadfast at multi-year highs and a central bank committed to executing on an “any means necessary” approach to quelling domestic inflation.

“The U.S. economy has actually been quite resilient,” Powell said during a speech in Portugal on Wednesday. Notably, he suggested that while an American recession is “certainly possible,” ultimately, he believes that such a result is “not the most likely case,” as the economy continues to be “resilient and still growing.”

The comments are notable on the heels of the June FOMC meeting where the central bank ended its streak of 10 consecutive interest rate hikes by electing to hold its key federal funds rate between 5.00 and 5.25%. Fed officials have been deliberate in signaling to markets that two additional rate hikes are anticipated before year-end even as inflation cools across the U.S. On Friday, personal consumption expenditure (PCE) price index data, the Fed’s preferred inflation measuring stick, showed continued signs of relief. Consumer spending slowed considerably in May with prices increasing only 0.3% for the month, when excluding volatile food and energy components, and 4.6% from one year ago.

Core inflation in Europe increases in June; Germany’s CPI jumps to 6.4%

The euro weakened last week to $1.08 as markets took inventory of mixed inflation data from across the Eurozone. Headline data eased to 5.5% from 6.1% in May. Core inflation, however, increased by 10bps to 5.4% for the month, suggesting that despite the European Central Bank’s efforts to quell price pressures through restrictive monetary policy, inflation remains stubborn.

Notably, at the national level, inflation metrics varied across the continent as the data present varying narratives across different countries. Prices in Italy and France cooled in June, data shows, and Spain became the first country in the Eurozone to reach the ECB’s 2% target. CPI data from Germany, the largest economy in Europe, presented a different story as price pressures accelerated up to 6.4%, up from a 14-month low recorded in May.

Critically, mixed data likely means the ECB, which has consistently signaled that it will continue to raise rates until prices begin to consistently cool across the continent. With markets now pricing in cuts in the U.S. beginning in early 2024, U.S. companies with European operations may see signs of diverging central bank policies, which could lead to prolonged, significant interest rate differentials prompting heightened euro-dollar volatility.

The week ahead

U.S. markets will experience a holiday-shortened week. On Wednesday, investors will look closely at the June FOMC minutes which are set to release. On Friday, key U.S. non-farm payroll and unemployment data will provide insight into whether Fed rate increases will have a sustained impact on the domestic economy.

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