As Jerome Powell recalled at a conference organized by the Wall Street Journal, the fight against inflation remains the Fed's top priority. The American institution will therefore continue to increase its rates as much as necessary, in an approach which is "data dependent", until inflation falls in a "clear and convincing manner". While the negative impact on growth of such a tightening is beyond doubt, the Fed Chairman continues to believe that a soft landing remains possible. Indeed, Jerome Powell considers that the American economy is particularly resilient with a low unemployment rate, solid consumption and healthy balance sheets and that it is therefore able to cope with a more restrictive monetary policy without rough landing.
However, while still maintaining a hawkish discourse, a less aggressive tone from some FOMC members is beginning to emerge. Thus, after two 50 bps hikes in the course of the next two meetings, which would bring key rates back to the range of 1.75% to 2%, the Fed could return to "a sequence of measured rate increases" according to Philadelphia Fed President Patrick Harker. This approach had been validated the day before by Charles Evans, President of the Chicago Fed, in order to better understand the consequences on growth of the approach towards the "neutral" rate (estimated at 2.4% by the members of the FOMC), or even beyond in the contraction phase.
While Fed and market expectations have long been off the charts over the past year, with investors viewing the central bank as far too behind in its fight against inflation, that seems to have changed. Thus, with inflation which should begin to decline thanks, at the very least to base effects (see our last meeting on Monday) and rate hike expectations now well anchored and in line with the discourse of members of the FOMC, the “inflationary” theme could become less topical for the markets, replaced by fears about growth, one theme chasing another.
While it is true that macroeconomic data still shows signs of resilience (retail sales and industrial production up for the month of April), fears about growth came from the microeconomic side. Publications deemed disappointing by retail giants (Target, Walmart), impacted by inflation which is compressing their margins, and the cautious discourse of their leaders have fueled fears about the solidity of American growth, which has strongly correct the financial markets, the S&P 500 narrowly avoiding closing the week in the bear market.
IIn these turbulent markets, we will nevertheless note that long rates seem to have regained their value as a safe haven asset and a form of correlation in the event of a fall in the equity markets, proof, perhaps, that the hardest part of the movement in rates is behind us.
To remain constructive, note that the Chinese Central Bank (which denotes in the general movement of monetary tightening to deal with inflation) has, for the second time this year, lowered a reference rate for mortgage loans (the LPR to 5 years) with a view to supporting the economy and in particular the real estate sector. The subject in China, impacting all global supply chains, nevertheless remains the long-awaited lull on the “zero-Covid” policy front (one can legitimately doubt whether the Chinese Panda accepts the recent proposal of delivery of vaccines by the American Eagle…).
Without speaking at this stage of a real recession, a global weakening of growth (see our previous publications) must be taken into account. However, in a scenario of low growth and lower inflation and as long as a recession is avoided, equities can do relatively well (see the chart of the week). While commodities and defensive stocks have rallied nicely since the start of the year, more growth-oriented sectors should fare better if the inflation rate slows. We have therefore decided to “monitor” our overweighting in the energy sector to gradually return to sectors that had hitherto been less weighted.