How high will they go?
Just as the market anticipated, the Federal Reserve Open Market Committee (FOMC) chose not to raise interest rates last week. However, Fed officials made it clear another rate increase might be necessary before the end of 2023 as continued economic strength, higher energy prices, robust consumer spending, and rising wages in a strong labor market have kept upward pressure on inflation.
FOMC economic projections indicate the Fed anticipates the effective federal funds rate will remain higher for longer than many hoped. The median projected rates were:
Fed Chair Jerome Powell indicated that an economic soft landing – a slowdown in economic growth that results in lower inflation without a recession – remains a possibility, reported Howard Schneider and Michael S. Derby of Reuters.
Former Treasury Secretary Lawrence Summers warned that any expectation for a soft landing might be too optimistic as significant risks remain, including upward pressure on wages, slowing consumer spending, and higher borrowing costs, reported Chris Anstey of Bloomberg. As a result, it’s possible the Fed could be surprised by weaker economic growth or higher inflation.
After the FOMC meeting, yields on bonds moved higher. The yield on a one-year United States Treasury bill finished Wednesday at 5.47 percent, and the yield on the benchmark 10-year Treasury note closed at 4.35 percent.
U.S. stock markets moved lower as investors considered the potential effects of high interest rates for longer. Rising interest rates (and tightening bank lending standards) make borrowing more difficult, lifting the cost of capital and lowering profits. When company profits drop, share price valuations tend to move lower, reported Mary Hall in Investopedia.
As investors mulled the Fed’s outlook, the possibility of a government shutdown, and other factors, major U.S. stock indices finished the week lower, according to Barron’s. Yields on U.S. Treasuries generally moved higher over the week.
Adding new ingredients to the economic blender.
The performance of United States economy in 2023 has been as unexpected as a lentil-avocado-cinnamon smoothie – a tasty surprise. Last week, economic data suggested the Federal Reserve may need to do more to slow the economy. The consumer price index showed inflation edging higher, wholesale inflation was higher than expected (largely due to higher energy prices), and retail sales were healthy.
Stronger-than-expected economic data inspired market optimism that the Federal Reserve will bring inflation down without a recession. However, new ingredients are being added to the economic mix that could prove less palatable. These include:
It's possible these events will result in increased market volatility in coming weeks.
Last week, major U.S. stock indices moved lower, according to Barron’s, and yields on longer maturities of Treasuries.
All the work, work, work.
2023 has been a remarkable year so far. It has, “confounded economists, humbled forecasters, and rewarded investors. Despite a rapid rise in interest rates, the U.S. economy continues to grow. Inflation has fallen – if not quite to desired levels – and stocks have entered a bull market, with the S&P 500 gaining 17% year to date and the Nasdaq Composite up more than 30%,” reported Nicholas Jasinski of Barron’s.
One of the biggest surprises has been the strength of the labor market. Over the 12-month period through August 31, 2023, employers added about 271,000 new jobs each month, on average, according to the U.S. Bureau of Labor Statistics. (In August, 187,000 new jobs were created, suggesting some labor market softening.)
So far this year, we’ve seen:
4-of-5 prime-age workers working. Last summer, the employment-to-population ratio, which compares the number of people employed to the civilian population of a city, state or country, reached a 20-year high for 25- to 54-year-olds. In June, July and August, the ratio was 80.9 percent, according to the St. Louis Federal Reserve (SLFR).
“This ratio is a good barometer of the overall health of the labor market because it excludes younger people who are more likely to be in and out of school as well as older people who may be retired,” reported Stephanie Hughes of Marketplace.
The employment-to-population ratio for women hit a record high. In the second quarter, the employment-to-population ratio for women reached 75 percent – a new record. Three-of-4 women, ages 25 to 54, were employed, according to the SLFR.
“Women are crushing it in the labor market right now – their return to work from the pandemic has been faster than men’s…A big part of this is the rise of remote and flexible work, which has enabled a record number of women with young children to enter or remain in the workforce,” reported Emily Peck of Axios Markets.
The labor force participation rate increase. The labor force participation rate – the number of people who are employed or are seeking employment – remained stubbornly low even after the U.S. economy reopened following pandemic closures. In August, the labor force participation rate increased to the highest level since the pandemic.
“The labor market continues to rebalance in a healthy direction. The U.S. economy is still adding jobs…And, for employers, there are now more workers available per open positions, and wage pressures are abating,” reported Jasinski of Barron’s.
Last week, major U.S. stock indices moved lower when economic data raised concerns the Fed may need to raise rates again, according to Barron’s. In the Treasury market, the yield on the 30-year U.S. Treasury bond finished the week at 4.3 percent.
If you’ve ever waited in traffic while the center section of a bridge lifts to allow ships and sailboats to pass underneath, you may have noticed the enormous counterweight that lowers as the bridge moves higher. When the boats have passed, the counterweight rises, and the bridge lowers back into place.
The Federal Reserve (Fed) often acts as a counterweight to the economy; raising and lowering interest rates to achieve its goals. Recently, the Fed has been raising rates to bring inflation down. Higher rates make borrowing more expensive, slowing economic growth and reducing demand for goods.
Over the past 18 months, the Fed has raised the effective federal funds rate from near zero to 5.33 percent. Last week, data suggested its efforts were working. The Personal Consumption Expenditures Price Index showed that headline inflation has dropped from a peak of 6.8 percent in June of 2022 to 3.3 percent in July 2023.
In addition, last week’s employment report showed jobs growth slowed in August. In an interesting twist, despite more jobs being created, the unemployment rate rose from 3.5 percent to 3.8 percent. It rose because the labor force participation rate increased as more people returned to the workforce and looked for jobs.
“This was a more complicated report than recent months’ with lots of cross-currents. Overall, it supports the soft-landing thesis for the economy, as the labor market is easing without major layoffs and wage dips…This seems like an ideal report for the Federal Reserve. Wage gains are coming down and payrolls are rising but at a much slower pace,” reported Katia Dmitrieva of Bloomberg.
Last week’s data left many believing the Fed will leave rates unchanged in September; however, there was disagreement about whether the Fed will remain on pause, resume rate hikes, or lower rates in the months ahead.
Markets embraced the idea of a Fed pause in September, and major U.S. stock indices moved higher last week, according to Barron’s. In addition, the yield on the one-year U.S. Treasury bill finished the week at 5.4 percent.