The US economy is experiencing above-trend growth, with the Atlanta Fed 3Q GDP tracking estimate still at 5.6%. There is a risk that the economy could re-accelerate, which has some investors feeling uncomfortable. However, it is important to remain optimistic as there is cooling on the horizon.
Inflation remains a concern, with the Bloomberg consensus suggesting that August headline CPI will rise to 3.6% year on year and 0.6% month on month. While these numbers are higher than June’s figures of 3% and 0.2%, respectively, they are not expected to drastically change the view of a soft landing for investors. Core inflation is expected to continue to decline, and the increase in headline CPI can be attributed to specific factors such as higher oil prices, rather than a broader inflationary trend.
There is speculation about whether the economy is running too hot, leading to a dynamic where good news is seen as bad news for the markets, and vice versa for bad news being seen as good. Recent price action suggests this may be the case, with positive economic data causing the S&P 500 to fall and Treasury yields to rise. Conversely, negative data, such as a cooling labor market, has resulted in the S&P 500 rising.
This price action is driven by expectations of Federal Reserve policy. Good data is generally positive for risk assets, but beyond a certain point, a hot economy may lead to more restrictive monetary policy, which could increase downside risk to growth. However, if growth is expected to slow rather than re-accelerate, the market may rally on soft data, as it would suggest that the Federal Reserve is done hiking rates and may even consider rate cuts in the future.
The next Federal Open Market Committee (FOMC) meeting on November 2nd will be an important event to watch for further insights into the market outlook. A hike at the September 20th FOMC meeting is highly unlikely, and if economic conditions do not justify another hike in November, it will be hard to believe that the Federal Reserve will continue hiking rates. This scenario could set the stage for a year-end rally in the markets.
Overall, it is expected that the economy will cool down as we approach the end of the year. Until there is clarity on this cooling trend, investors are likely to interpret data in a way that toggles between “good is bad” and “bad is good,” resulting in choppy and range-bound prices across asset classes. However, the possibility of the Federal Reserve ending its hiking cycle by November could lead to increased market activity as the weather turns colder.