The CIO’s Take:
Focus on messaging at July FOMC
As we’ve remarked many times in recent weeks, there was no serious hope of a cut at July’s FOMC, which wrapped up last Wednesday. Instead, attention was squarely on whether Powell—whose Fed has been known for its desire not to surprise markets—would use last week’s meeting as an opportunity to sow the seeds for easing in September. Although the Fed’s official statement seemed surprisingly conservative, considering data on a cooling economy since June, Powell’s post-meeting press conference didn’t disappoint.
Policy statement a little hawkish
First, we should dig into that policy statement. With respect to the two-sided risks the Fed is managing, labor markets have gone from “remained strong” in June to “moderated” in the July statement, while inflation is now “somewhat elevated” versus “elevated” in June, and the word “modest” was deleted in describing progress on taming inflation. On the other hand, there was no change in language that “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence”—a surprise, no doubt, to dovish readers.
Powell’s remarks tip September cut
While the official policy statement didn’t scream ‘September cuts’, Powell’s press conference gave a stronger indication that easing is nigh. There were mentions of the Committee’s “confidence” throughout Powell’s remarks, with the Fed chair noting that the group’s confidence was building. Perhaps the clearest indication of a move at the next FOMC was Powell’s comment that the time for rate cuts is “approaching and if we do get the data that we hope we get, then a reduction in our policy rate could be on the table at the September meeting.”
Big downside surprise in July jobs
Of course, markets had already been firmly pricing in a rate cut in September, so there was little movement in Fed funds futures after the FOMC, though bigger reductions were projected at the margin further down the road (see below). Traders reacted much more on Friday, when nonfarm payrolls for July came in much softer than expected, showing 114K jobs added in July, less than the consensus forecast of 175K new jobs and June’s 179K figure. The unemployment rate jumped from 4.1% in June to 4.3% in July—perhaps more than the “moderation” Fed officials have described.
Indeed, Friday’s jobs report led markets to forecast up to five cuts by year-end—despite just three FOMC meetings remaining. That third observation of rate cut odds for the September FOMC—closer to two cuts than one—suggests traders are now pricing in a strong likelihood the Fed chooses to ease by 50 bps at its next meeting. Our read is that policymakers don’t really see themselves as behind the curve, and this is very unlikely. Powell himself, when asked at last week’s presser about the appropriateness of an outsized cut in September, firmly rejected the notion.
Watch data going into September
Part of the Fed’s reluctance to more strongly message aggressive easing beginning in September must certainly hinge on how much data remains before the next FOMC. Friday’s shocking labor market data would certainly seem to validate the Fed’s reluctance to commit to a policy path—and there’s still one more monthly jobs report to go, along with two more inflation prints, before the Committee’s September meeting. Count us among those eagerly awaiting Powell’s next big opportunity to tip his hand: the Fed’s Jackson Hole conference in late August.
US stock investors seeing red
US stocks rose in the immediate wake of the FOMC decision and Powell’s press conference, though anyone watching equity indices over the last few weeks will know the trend has been anything but bullish. One of the first indications the current bull market might be heading into rough waters came on July 24th, when the S&P 500 Index lost more than 2% for the first time in 17 months. Since then, we’ve noted a surge in equity volatility, and the selloff intensified last week: bad enough that it put NASDAQ stocks in correction territory, down 10% since hitting an all-time high in early July.
Tech leads the selloff
It wasn’t just the NASDAQ trading lower last week, the Dow and S&P 500 are also in the midst of drawdowns, though tech has certainly borne the brunt of the losses, with stocks within the AI theme hit particular hard since markets entered this rough patch, proxied for by the Bloomberg Artificial Intelligence Index, which closed Friday more than 13% of its recent highs. Of course, equity investors can’t complain too much: each of these categories of stocks is still solidly positive year-to-date, even after the selloff (see below).
Expectations were a bit too rosy
To understand what’s happening here, it’s important to remember that whether stocks go up or down is not about the news, per se, but how surprising it is. Powell’s FOMC press conference, essentially telegraphing a September cut, was certainly positive for stocks—but markets already expected it. The real shock was Friday’s weaker-than-anticipated jobs report, which led investors to question the ‘soft landing’ narrative they had previously priced into stocks. As investors shifted more weight to the hard landing scenario, stocks naturally sold off. A surprise hike by the BoJ (more on that later) only made matters worse, as investors in the popular yen carry trade saw their funding costs increase, leading them to liquidate positions in other markets, where they were deploying their borrowed yen.
Q2 earnings a hard dose of reality
Along those lines, it’s actually second-quarter earnings that have been the bigger negative surprise keeping downside pressure on global stocks in recent weeks. Q2 numbers and management guidance from companies the likes of McDonalds and Starbucks suggest US consumers are slowing down, adding to concerns the Fed might have already fallen too far behind the curve. Big tech companies’ results have been even more of a mixed bag—and that’s not surprising given something we’ve been talking about consistently: how high expectations for the sector have gotten.
Are investors finally over AI hype?
Amazon, Alphabet, and Microsoft, for example, three members of the Magnificent 7, have disappointed the market with their second quarter results. It’s not because the numbers themselves are even that bad; Microsoft, for example, beat on the top and bottom line and still declined. The issue is that investors have staked such high hopes—and, consequently, such rich multiples—on the promise of AI, but now come to realize the massive capital outlay required to build up AI capabilities will be incurred long before uncertain benefits to the AI revolution show up in earnings.
Stock pickers had chances to win
Not all stocks, even among big tech, have been losers this earnings season, and some have bucked a trend toward greater skepticism with respect to AI. Apple reported last week, for instance, beating on EPS and touting its strategic overhaul, focusing attention on an AI ramp-up. Meta was another outperformer, seeing a 7% pop in its shares afterhours, post its Wednesday report, in part because better-than-expected earnings and revenues resulted from past investment in AI, which CEO Mark Zuckerberg cited as a factor in better ad targeting and content recommendations.
Not all banks ‘on hold’ last week
The Fed wasn’t the only central bank meeting on rates last week, with decisions by the Bank of England (BoE) and Bank of Japan (BoJ) rounding out major monetary policy actions last week. The BoE’s Monetary Policy Committee, meeting on Thursday, beat the Fed in the race to cuts, dropping its policy rate by a quarter-point, the bank’s first reduction since March 2020. The BoJ, by contrast, increased its benchmark rate by a quarter-point.
BoE barely manages quarter-point cut
The BoE’s decision was fairly straightforward, coming as bank governor Andrew Bailey noted that “Inflationary pressures have eased enough”—though the decision was a close one, coming in a 5-4 vote, with even those voting in favor being described as “finely balanced” in their decision. Committee members remained concerned about resurgent inflation, expected to rise to 2.75% this year before declining to the bank’s 2% target in 2025. Bailey emphasized the need “not to cut interest rates too quickly or by too much”, and we don’t expect easing to happen quickly from here.
BoJ shocks markets with earlier hike
A day before the UK policymakers moved, the BoJ had its own meeting and gave the markets a bigger surprise, boosting its short-term policy rate target to 0.25%, from a range of 0% to 0.1%, while also committing to reduce its bond buying activity over the next two years. While most observers expected further tightening in 2024 as the BoJ becomes more comfortable in a return to growth and inflation, consensus forecasts—including our own expectations—called for those hikes to come later this year.
Weak yen may be mostly to blame
So why the unexpectedly sudden move up in rates? Our sense is that while the BoJ would have preferred—much like the Fed—to take in more data on the state of Japan’s economy before making its next move, weakness in the yen complicated matters. In early July, the yen reached new 38-year lows against the dollar at around ¥162, leading to speculation that the bank would face political pressure to raise rates in defense of the currency, with progress toward reducing the gap between US and Japanese rates helping to ease pressure against the yen.
Indeed, with expectations of imminent Fed cuts rising over recent weeks, the yen had already made some progress off its early-July lows. By the end of last week, after the BoJ hike, the yen had strengthened from around ¥152 to ¥147 against the dollar.
We’re not worried about Japanese stocks
There was also big movement in Japanese stocks last week, with the Nikkei 225 Index closing 2.5% lower on Thursday and dropping another 5.8% on Friday—its biggest one-day decline since March 2020. While a softening US economy isn’t good for Japanese exports, neither would be a massive appreciation in the yen, and these factors seem to account for last week’s Nikkei selloff. We’re less concerned in the medium term, as we imagine the yen can strengthen a bit more still from multi-decade weakness before it really hurts, while the real focus should be on Japan’s resurgent growth.
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