Following last week's strong employment report, investors shifted their focus to the latest inflation data. In May, U.S. consumers saw a reprieve from rising prices, with the Consumer Price Index (CPI) remaining unchanged month-over-month, the calmest reading since mid-2022. Essentials like groceries, gasoline, and car insurance saw reductions. Gasoline prices fell by 3.6%, the most significant drop since November, and motor vehicle insurance costs decreased for the first time since 2021. Energy costs moderated, with steady electricity prices and declining natural gas costs. The core CPI, excluding volatile food and energy prices, rose by just 0.2% month-over-month, less than expected. Producer prices followed suit, with the Producer Price Index (PPI) declining by 0.2% in May, the largest decrease in seven months. The PPI for final demand increased by 2.2% year-over-year, indicating a broad cooling in inflationary pressures. Several components of the PPI used to calculate the Fed's preferred inflation measure, the personal consumption expenditures (PCE) price index, softened in May, suggesting a similar trend in the PCE report to be released later this month.
Despite these promising signs, the Federal Reserve remains cautious. At the conclusion of its meeting this week, the Federal Open Market Committee (FOMC) decided to keep the federal funds rate steady at 5.25%-5.50% for the seventh consecutive meeting, emphasizing the need to see sustained evidence of easing inflation before considering any rate cuts. The FOMC's latest projections now suggest only one interest rate cut in 2024, with four more cuts expected in 2025. The Committee reiterated that it would not reduce the federal funds target range until inflation moves sustainably toward its 2% goal. Additionally, the Fed continues to reduce its holdings of U.S. Treasury securities and agency mortgage-backed securities as per its predefined schedule of $25 billion and $35 billion per month.
Financial markets reacted positively to the economic releases and the Fed's current policy stance. As of this morning, Treasury yields declined, with the two-year yield dipping to 4.70% and the 10-year yield to 4.22%. Stocks also rose, with the S&P 500 increasing by 1.28%. Cooling inflation could support higher stock valuations as cost pressures ease, though the Fed's reluctance to cut rates soon might temper short-term bullish sentiment. For bonds, lower inflation and stable interest rates have resulted in consistent returns, making them more attractive to investors seeking stability and income. Overall, the market's reaction suggests cautious optimism as investors balance current conditions with future expectations.
While recent data suggests cooling inflation, the Federal Reserve remains vigilant, maintaining its current policy until it is confident inflation is on a sustainable trajectory. This measured approach seeks to balance economic growth with price stability, influencing both stock and bond markets as investors recalibrate their strategies. We anticipate the Fed aims for a soft landing for the U.S. economy, characterized by slower yet positive growth in Gross Domestic Product (GDP) and a marginally higher unemployment rate. This objective aligns with our view of a moderate reduction in the Federal Funds rate in the coming months, assuming no major disruptions in economic activity.
Next Week:
Empire Manufacturing, Retail Sales, Industrial Production, Capacity Utilization, Business Inventories, Initial/Continuing Jobless Claims, Housing Starts, Building Permits, Philadelphia Fed, S&P Global US Manufacturing/ Services Purchasing Managers Index (PMI), Leading Index (LEI), Existing Home Sales
© 2024 Chandler Asset Management, Inc. An Independent Registered Investment Adviser. All rights reserved. Data source: Bloomberg, Federal Reserve, and the US Department of Labor. This report is provided for informational purposes only and should not be construed as specific investment or legal advice. The information contained herein was obtained from sources believed to be reliable as of the date of publication, but may become outdated or superseded at any time without notice. Any opinions or views expressed are based on current market conditions and are subject to change. This report may contain forecasts and forward-looking statements which are inherently limited and should not be relied upon as an indicator of future results. Past performance is not indicative of future results. This report is not intended to constitute an offer, solicitation, recommendation, or advice regarding any securities or investment strategy and should not be regarded by recipients as a substitute for the exercise of their own judgment. Fixed income investments are subject to interest rate, credit, and market risk. Interest rate risk: The value of fixed income investments will decline as interest rates rise. Credit risk: the possibility that the borrower may not be able to repay interest and principal. Low-rated bonds generally have to pay higher interest rates to attract investors willing to take on greater risk. Market risk: the bond market, in general, could decline due to economic conditions, especially during periods of rising interest rates.