Easing inflation, cooling labor markets, and the economic slowdown
Summary
With inflation easing, the labor market cooling, and a general economic slowdown anticipated, rate cuts are becoming a central focus for many on Wall Street. However, the uncertainty surrounding the timing of these cuts and the approaching U.S. elections could lead to increased market volatility over the next six to twelve months. This volatility, coupled with future election outcomes, could dramatically shift market expectations for future rate cuts. As a result, organizations may consider converting additional floating-rate debt to fixed through interest rate swaps or other derivative instruments to shield themselves from potential market fluctuations.
The Fed
Last Monday, July 15, Federal Reserve Chair Jerome Powell addressed the Economic Club of Washington, DC, highlighting that cutting rates after inflation hits 2.00% would be too late. Powell stated that to move towards the 2.00% target sustainably, rate-cut decisions need to be supported by good inflation data, and fortunately, the last PCE and CPI numbers firmly indicated a slowdown. Combined with the most recent unemployment figures, both inflation and the labor market (two significant factors influencing rate-cut decisions) showed signs of cooling. As of today, the market is now pricing in a 93.60% probability of a September Fed rate cut.
Source: CME FedWatch Tool - Conditional Meeting Probabilities
Economic resilience
Retail sales for June 2024 were unchanged at 0.00% despite initial expectations of a -0.40% decrease, with revisions for May 2024 retail sales of +0.10% to +0.30%. Despite some hotter-than-expected numbers, these releases are not expected to significantly impact rate decisions. In fact, the stronger retail sales release seemed to ease fears of a sharp economic decline discussed a few weeks ago when the unemployment release came close to triggering the Sahm Rule. The rule states that a recession is near when the three-month average unemployment rate rises by at least 0.50% from its low in the past year. All things considered, the economy remains resilient.
Leading economic index
The Conference Board Leading Economic Index decreased by -0.20% for June 2024, higher than originally forecasted at -0.30%, followed by May’s revised reading of -0.40%. Justyna Zabinska-La Monica, Senior Manager of the Conference Board said, “Taken together, June's data suggest that economic activity is likely to continue to lose momentum in the months ahead. We currently forecast that cooling consumer spending will push U.S. GDP growth down to around 1.00% (annualized) in Q3 of this year."
Treasury
Last week, treasury yields rose in what seemed to be a response to former President Donald Trump’s assassination attempt and what some have speculated as the increased probability of a Republican win. Some speculate that the economy may experience higher deficits and sustained inflation under Trump's policy agenda, leading to the potential for higher short- and long-term rates. Yesterday, however, President Joe Biden announced he will step down as the 2024 Democratic presidential nominee, bringing new uncertainty into the markets. While the economy certainly appears to be slowing down, it remains unpredictable, and organizations should continue to monitor and manage their financial risk.
The week ahead
Next week’s economic releases will highlight the advance GDP estimates for the second quarter, coming out on July 25. Additionally, PCE numbers are scheduled to be released on July 26, as markets anxiously await more good inflation data, pending potential rate cuts for September.
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About the author
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Amol Dhargalkar
Managing Partner, Chairman
Kennett Square
Amol Dhargalkar is a Managing Partner and Chairman for Chatham’s Board of Directors. He brings over 20 years of experience in derivatives capital markets expertise.
Disclaimers
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
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