Markets elongate the Fed's outlook and economic trouble abroad

Retail sales rise, inflation expectations soften

Economic data releases continue to show the strength of the U.S. economy, but the potential for inflation to remain stubbornly high lingers. Last Tuesday, U.S. retail sales reported a 0.7% rise in July, beating expectations (+0.4%) and rising at the fastest pace since the start of the year. Consumers took advantage of easing prices in July, spending more at bars and restaurants as well as back-to-school categories. Overall consumer confidence remains relatively strong as consumers enjoy the effects of lower inflation and a strong labor market.

In line with relative consumer optimism, consumer inflation expectations are softening closer to the Fed’s 2% target. Consumer inflation expectations over the next year fell to 3.5% in July, down 0.3% from June, marking the lowest reading since April 2021. While the data provides an optimistic outlook on the economy, too much consumer strength could force the Fed to pursue a more aggressive policy should inflationary pressures prove sticky.

The Fed's interest rate debate: How long?

Last Wednesday, FOMC minutes from July’s meeting revealed that high inflation is still at the forefront of “most” policymakers' minds. The minutes read, “Most participants continue to see significant upside risks to inflation, which could require further tightening of monetary policy.” Minneapolis Federal Reserve President Neel Kashkari finds that inflation is “still too high,” and he’s “not ready to say that we’re done” in the battle over high inflation. While the market is not pricing in any more hikes in the future, in response to the FOMC minutes, the market now expects the Fed to hold rates for longer than previously expected. According to the CME FedWatch Tool, markets are not pricing in a rate cut until May 2024. Ten-year Treasury yields touched 4.30% on Wednesday, their highest level since 2008 in response to policymakers' concerns over inflation.

Continued economic woes in China

China remains in the limelight as its post-pandemic economic data continues to be lackluster: missing expectations and displaying signs of slowing. Last week, industrial production and retail sales displayed home sales slowing, and unemployment numbers growing even higher — all signs pointing China toward deflationary territory. On Tuesday, China’s central bank lowered its two key lending rates to try and reverse the course of its slowdown. Economists expect China to continue lowering its interest rates in the coming months but remain skeptical of its ability to fizzle deflationary pressures. In response to the unsettling data, on Wednesday, China’s 10-year yields hit record lows at 2.6% — their lowest levels since the COVID-19 pandemic in 2020. The onshore yuan also fell on Wednesday, reaching 7.2981 yuan to a dollar — a 16-year low.

When major world economies, like China, slow down, global economic growth also slows down. This may actually be a net positive for the global economy as it can broadly reduce inflationary pressures. However, a slowdown in China risks many other global challenges beyond inflation.

Ruble hits code red territory

Last Tuesday, Russia’s central-bank chair Elvira Nabiullina announced an emergency rate hike to 12% from 8.5% in response to a sharp selloff in ruble on Monday in which the ruble dropped to trading 100 USD — its weakest level since just weeks after Russia invaded Ukraine. This emergency rate hike decision comes after the central bank’s announcement to raise rates higher than expected in July. Russia continues to deal with fast-rising inflation and the need to borrow and spend money to keep up with the war efforts in Ukraine. The ruble has been one of the world’s most feeble currencies since the onset of the Russia-Ukraine war, and it has only weakened since the Wagner mutiny in June, reflecting an imbalance in the Russian economy and political instability due to the war. The weaker ruble will only make imports more expensive, and the prolonged Western sanctions, specifically on Russia’s oil and gas industry, mean Russia’s international supply chains will remain disrupted, adding further pressure on prices.

Notably, at the onset of the Russia-Ukraine war, many commentators discussed how the Russian economy and ruble were holding up relatively well. The current state of the Russian economy and currency is a reminder not to project short-term actions into the long term.

Looking ahead

This week is relatively quiet for major economic data releases. Starting on Tuesday, existing home sales in July will be released, followed by flash S&P U.S. services and manufacturing PMI on Wednesday. On Thursday, durable goods orders will be released and consumer sentiment for August will close out the week on Friday.