Stocks and bonds bounced back sharply after a tough first half, ending July in the green for U.S. markets. U.S. equities posted their best month since November 2020, with the S&P 500 gaining 9.1%, while the Dow finished up 6.7%. The Nasdaq Index finished 12.4% higher.
In this report, we’ll take a look at the July Fed meeting results, recession talk, and the strong dollar’s impact on earnings.
The Federal Reserve showed its resolve in the fight against inflation by hiking interest rates by 0.75% in June and July, the most aggressive two-month hikes since the Fed began using overnight rates as the primary policy tool in the early 1990s. Inflation data in June continued to support the aggressive approach, as the consumer price index reached heights not seen in nearly 41 years. Since March, the Fed has lifted its target interest rate from near zero to a level between 2.25% and 2.50%.
We are starting to see signs of slowing inflation, starting with gasoline, used-vehicle prices, and other inflation drivers like crops and industrial metals. The S&P GSCI agriculture index, which offers insight into food price inflation, has fallen by a quarter since peaking in May. Similarly, the industrial-metals index has dropped by a third.
A cool down in prices provides consumers with a welcome respite from rising prices while signaling to the Fed that the inflation fight is working.
Following the July Fed meeting, Chair Jerome Powell reiterated that the central bank’s focus is on restoring price stability as soon as possible. While achieving a soft landing remains a goal, the actual path ahead is a bit more uncertain. The Fed has said it would not flinch in the focus on moderating inflation even if it results in a “sustained period” of economic weakness and a slower job market.
While this may seem negative for the economy, keep in mind that the Fed needs to maintain credibility in delivering price stability. If markets trust that the Fed can tame inflation, then the Fed won’t have to work so hard to achieve that goal because inflation expectations will start coming down, which has a follow-on effect on actual inflation.
The Fed still believes that “modestly restrictive” monetary policy is necessary under current economic conditions, suggesting that another outsized rate hike may await at the September policy meeting.
Signs of economic weakness have already appeared, as the Bureau of Economic Analysis reported a second consecutive quarter of negative gross domestic product (GDP) growth, with a decline of 0.9% for the period. GDP measures overall economic output, and two straight quarters of GDP contraction could satisfy a widely accepted rule of thumb for recession. Ultimately, the National Bureau of Economic Research (NBER) declares recessions, but they may not make a determination for several months.
Treasury Secretary Janet Yellen said she would be amazed if NBER calls this a recession because of the state of the jobs market. She said, “When you’re creating almost 400,000 jobs a month, that is not a recession.”
As Blackrock notes, the policy response to the pandemic allowed companies to build up cash buffers and even if a recession hits, they do not expect a very deep recession. However, with the current macro environment, we may be looking at shorter economic cycles.
Finally, the Fed’s interest rate hikes have boosted the strength of the dollar to its highest levels in two decades. Increased demand for the dollar has been notable, especially compared to the European Euro and Japanese Yen, where central banks have been slower to react with tighter monetary policy. In fact, the dollar reached parity with the euro—a one-to-one exchange rate—for the first time since 2002.
While a strengthened dollar means that American tourists can travel abroad more cheaply, goods sold by U.S. businesses also become more expensive overseas and thus less attractive. Similarly, when foreign sales are converted back to dollars, they appear weaker.
As a result, the strong dollar has wiped billions of dollars off second-quarter sales of U.S. companies. S&P 500 companies made about 29% of their revenues abroad in 2021, with tech companies more exposed. That said, second quarter earnings have still grown overall, with the expectation that they will increase 10% over last year.
Markets bounced back in July, and while U.S. economic growth went into negative territory for two quarters the job market is still strong. A strong dollar could put some headwinds on corporate earnings, though so far they remain robust. We’ll be looking ahead to the Fed’s September meeting for an indication of what might come next in terms of monetary policy.
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The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The Nasdaq Composite is a market-capitalization-weighted index consisting of all Nasdaq Stock Exchange listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds or debenture securities. The Bloomberg Barclays U.S. Aggregate Bond Index measures the investment-grade U.S. dollar-denominated, fixed-rate taxable bond market and includes Treasury securities, government-related securities, corporate securities, residential and commercial mortgage-backed securities, and asset-backed securities.
The S&P GSCI Agriculture Index is a benchmark for investment performance in the agricultural commodity markets, including wheat, corn, soybeans, coffee, sugar, cocoa and cotton, and is a sub-index of the S&P GSCI, a broad-based and production weighted investable commodity index that includes the most liquid commodity futures, which is designed to represent the global commodity market beta.
The S&P GSCI Industrial Metals Index is a benchmark for investment performance in the industrial metals markets, including aluminum, copper, lead, nickel and zinc, and is a sub-index of the S&P GSCI, a broad-based and production weighted investable commodity index that includes the most liquid commodity futures, which is designed to represent the global commodity market beta.
The S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally considered representative of the broad U.S. stock market. The MSCI All Country World Index (ACWI) is designed to represent the performance of large- and mid-cap stocks across 23 developed and 26 emerging markets and represents approximately 85% of the free float-adjusted market capitalization of each market. The MSCI Europe Index captures large- and mid-cap representation across 15 developed market countries in Europe and covers approximately 85% of the free float-adjusted market capitalization across the European developed market equity universe. The MSCI Emerging Markets Index captures large- and mid-cap representation across 26 emerging market countries and covers approximately 85% of the free float-adjusted market capitalization in each country.