July 2023 Market Lookback

In a month where growth data came in strong & inflation data came in cool, the Federal Reserve decided to hike rates and reiterated that future decisions will depend on the totality of the data. Treasury yields rose and fell as economic data rolled in, while U.S. stock indices rose for the 5th straight month. Commodities saw prices rise the most since March 2022, which alongside a weaker US dollar helped boost emerging market stocks. Volatility in both stocks & bonds remained relatively muted for a second straight month.

Macro

•   The Federal Reserve raised the fed funds rate target range to 5.25%-5.50% on Jul 26, leaving open the possibility of further rate hikes.

•   209k jobs were added in June, the first downside surprise in 15 months, while the prior two months were revised 110k.

•   July CPI came in below expectations on both a headline (0.2% m/m & 3.0% y/y) and core (0.2% m/m & 4.8% y/y) basis.

•   Q2 GDP rose by 2.4% q/q and the Atlanta Fed GDP Nowcast initiated Q3 tracking at +3.5%, which would be the most since Q4 2021.

•   Consumer confidence rose in July according to both the University of Michigan & Conference Board, notably surpassing expectations.

•   Oil prices rose by $11 (+15.8%) in July, the largest m/m increase since Jan 2022.

Equities

•   Bottom-up 2023 EPS estimates for the S&P 500 fell from $219 to $218 in July, while top-down strategist estimates rose from $214 to $216.

•   All S&P 500 sectors had positive returns in July, the second such month in a row.

•   The S&P 500 forward 12m P/E surpassed 19.8x at the end of July, the highest level since early April 2022.

•   Emerging markets outperformed developed markets for the first time since Nov 2022, buoyed by a rebound in oil & commodities, as well as a weaker US dollar.

Fixed Income

•   2Y & 10Y Treasury yields swung by as much as 46bps & 34bps, respectively, as bond traders reacted to data pointing to strong growth and softer inflation.

•   HY bonds outperformed Treasurys & IG bonds for the fourth month in a row, the longest such streak in over two years.

Crypto

•   A district court judge ruled that Ripple’s XRP token was not a security when purchased through exchanges, but that it was a security when sold to institutional investors.

The Last Mile is the Hardest

What a difference a year can make. In July 2022, headline CPI had just come in at 9.1% y/y, equity markets were 15-20% off their highs, and the Fed was in the early stages of its most aggressive tightening cycle in over four decades. Now? Annual inflation fell to a smidge below 3%, stocks are up 30-40% off the lows of last year, and markets expect that the Fed just hiked for the last time this cycle.

All clear? Maybe not. It’s often said that the last mile in a marathon is the hardest. A runner’s energy levels are depleted, and time seems to move agonizingly slower as the finish line gets closer. In many ways, investors & the economy find themselves in that position.

Inflation swap pricing indicates that investors expect y/y inflation to move higher over the next three months, largely due to base effects. Additionally, core inflation, which the Fed believes is a better gauge for judging underlying inflation, has remained elevated due to slower-moving shelter & services components. This is important because the Fed has an inflation target of 2%, not “2% is ideal but 3% is okay”. While inflation has fallen a meaningful amount over the first half of the year, the last leg won’t likely come so easily.

Will the Fed Complete the Marathon?

Chair Powell begins every post-FOMC statement press conference reiterating the Fed’s commitment to restoring price stability. The Fed often notes that while there is risk of doing too much (i.e. hiking too far and causing more economic pain than necessary), the greater risk is not doing enough (i.e. failing to keep inflation down, resulting in inflation expectations rising).

That begs the question: does the Fed plan on running out the final mile? Declines in used car prices & rents point to a summer of core CPI disinflation, with some speculating that the Fed will then have justification to stop hiking. In fact, fed funds futures pricing imply only ~40% odds of an additional rate hike this year, with 4-5 rate cuts priced in for 2024.

However, this has all come with the labor market continuing to add jobs at a robust pace and despite the Fed expecting below-trend growth, economic growth has accelerated as measured by GDP or private investment. For the Fed to begin to cut rates soon, they’d likely need to see signs of economic conditions weakening. Market participants may be expecting the Fed to bow out of this marathon too early. Remember, the last mile is the toughest one.

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