The most aggressive rate tightening cycle in decades is now on hold, but are there more hikes coming than expected?
Stephanie Roth, Senior Markets Economist
Madison Faller, Global Investment Strategist
Our Top Market Takeaways for June 15, 2023
Before we dig into the details of this week and yesterday’s Federal Reserve meeting, we take the long weekend to honor Juneteenth. As a firm, we reflect on the Black community’s resilience and triumph in the face of adversity, and know that even today there are still trials to overcome.
Market Spotlight
Wait for it…
The Fed just hit the pause button on its most aggressive round of rate hikes in decades. But while that move was long awaited, markets were initially a bit queasy about what might happen from here—after all, a “skip” doesn’t mean the Fed is going to “stop.”
Yet stocks’ U-turn higher into yesterday’s close also reminds us that the market isn’t the economy—the S&P 500 is hovering around the same level as when the Fed first started hiking in March 2022—in spite of 500 basis points of hikes between now and then! Earlier this week, the index even notched a new 14-month high and broke above 4,300 for the first time since August.
And it’s not just big tech anymore, either. So far this month, small- and mid-cap stocks are handily outpacing their large-cap peers, and 13 out of 48 countries’ stock markets we track are outperforming the United States.
So where do we go from here? In today’s note, we break down the latest Fed meeting, and what it all means.
What was expected:
After a whole lot of chatter, the Fed hit pause, holding its target policy rate steady at 5.0%–5.25%.
What wasn’t:
Heading into yesterday’s meeting, most expected just one final hike to follow yesterday’s “skip.” But policymakers showed two more hikes could be in store, with some subtle but important changes to the meeting’s statement. For example:
Last time: “In determining the extent to which additional policy firming may be appropriate”
This time: “In determining the extent of additional policy firming that may be appropriate"
That small but meaningful change suggests more rates hikes are likely ahead, as opposed to just more hikes are possible.
But if more hikes are needed, why pause at all?
It’s all about the data. Things are moving in the Fed’s direction, but taking another month to see how the economy evolves can’t hurt.
With policy rates at their highest since 2007, growth momentum is waning—see the slowdown in housing, weakening in capex, and signs that some consumers are starting to struggle to pay back their loans. Chair Powell also emphasized that it takes a while for monetary policy to work its way through the economy, and the lag can be “long and variable.”
OK, but if it’s all slowing down, then why keep hiking?
Yes, things are slowing down—but from a pretty strong pace. In their summary of economic projections, Fed officials more than doubled their outlook for GDP growth in 2023 to 1% (from 0.4% at their March meeting). That better outlook for growth has had the knock-on effect of stickier inflation: It’s definitely cooling, but it’s still running too high—policymakers’ latest outlook sees core PCE (the Fed’s preferred inflation gauge, which strips out volatile food and energy prices) rounding out this year at a 3.9% (compared to 3.6% in March).
To keep fighting the good fight, Chair Powell and the Fed are focused on three big inflation components: core goods, rent and core services ex-rent (dubbed the “super core” read). Core goods and rent prices both seem like checkmarks, or close to it—either by the official data or leading indicators. That puts the focus on “super core” inflation, which has been notably sticky, given its close ties to the labor market. Think your hairdresser or barista—wages make up the largest cost for those services. There’s been some promising signs of deceleration, but there’s still work to be done.
Disinflation is underway, but the process takes time
The chart consists of three parts. The top part describes the U.S. core goods CPI, rolling quarter-on-quarter % annualized. The line started at 1.2% in December 2018. • Later, it went flat and dropped slightly to reach a bottom level at -3.9% in June 2020. • Then it went up and peaked in July 2021 at 19.3%. • After that point, it went down all the way until the last data point at 3.1% in May 2023. The second part describes the U.S. shelter CPI, which has two lines: one for CPI OER represented by the lefthand side y-axis, and the other one for the Apartment List Rent Index represented by the righthand side secondary y-axis. For the CPI OER line, the first data point came in December 2018 at 3.3%. • Then it went on a downward ramp until it bottomed out at 1.5% in January 2021. • Then it trended up until it reached 8.8% in February 2023. • At the end, it went down a bit and finished at 7.1% in May 2023. The second line (Apartment List): • The first data point came in December 2018 at 2.6%. • It went flat and then dropped to the lowest point in July 2020 at -9.3%. • Then it went up until it peaked at 27.6% in September 2021. • Then it declined subsequently and finished at 2.6% in May 2023. The third part describes the U.S. core services ex-shelter CPI. The line started at 2.0% in December 2018. • Then it went slightly up until it dropped to the lowest point at -3.9% in June 2020. • Later, it went straight up to 4.9% in September 2020. • It stabilized near that level and trended up until it peaked at 8.9% in June 2022. • At the end, it finished lower at 3.7% in May 2023. On this chart: There is a traffic light symbol at the top left corner of each part. For the first (top) part, the top left corner shows a green light symbol. For the second (middle) part, the top left corner shows a yellow light symbol. For the third (bottom) part, the top left corner shows a red light symbol.
Where do we go from here?
The labor market is key—with wage gains keeping “super core” sticky, some cooling in the labor market (through layoffs and a rise in the unemployment rate) may be needed to get wage growth back around 3.5% (which is what most consider consistent with the Fed’s 2% inflation mandate).
Different measures show wage growth has peaked but remains too high
The chart describes the year-over-year % change of different wage growth measures: Atlanta Fed’s Wage Growth Tracker, Employment Cost Index, average hourly earnings. For the Atlanta Fed’s Wage Growth Tracker line, it started at 2.1% in December 2011. • Then it trended up until it peaked at 7.1% in June 2022. • Then it finished a bit lower at 6.4% in May 2023. For the Employment Cost Index line, it started at 1.6% in December 2011. • It trended up until it peaked at 5.6% in July 2022. • Then it finished a bit lower at 5.0% in March 2023. For the average hourly earnings line, it started at 2.0% in December 2011. • Then it trended up until it peaked at 8.1% in April 2020. • Then it went straight down and bottomed at 0.6% in April 2021. • Then it bounced back until it reached another high at 5.9% in March 2022. • Then it finished lower until the last data point at 4.3% in May 2023.
In all, whether it’s one more hike (our base case) or two, it seems evident the Fed is very close to finishing hiking rates.
Elsewhere, the European Central Bank hiked rates by 25bps as expected and revised core inflation projections higher. That said, they still have ground to cover, and chances of a terminal rate at 4% or higher are real.
Investment Implications
You might own too much cash
We released our 2023 Mid-Year Outlook: Recession Obsession last week. But for all the flurry around the potential twists and turns of the economy, we see promise for investors.
With yesterday’s Fed meeting in mind, we’re reminded that reinvestment risk is real as policymakers wind down rate hikes. To us, this means that the opportunity cost of staying in cash is high. For the last seven cycles, cash has underperformed bonds meaningfully in the two years following the last Fed rate hike. This is all the more meaningful considering that our clients’ cash and short-term liquidity balances are almost ~30% of their managed and brokerage assets—and that doesn’t include deposit accounts! That’s a lot, even compared to a year ago.
After the Fed pauses, fixed income tends to outperform cash
This chart describes the average % total return after the Fed’s final hike for U.S. Municipal bonds, U.S. Investment Grade bonds, and U.S. 3-month T-bills. For the U.S. Municipal bonds line, it started at 0 month at 0%. It went up all the way until the last data point at 32% at 24 months from final hike. For the U.S. Investment Grade bonds, it also started at 0 month at 0%. It went up all the way until the last data point at 27% at 24 months from final hike. For the U.S. 3-month T-bills, it also started at 0 month at 0%. Then it went up all the way until the last data point at 13% at 24 months from final hike.
And while there might be volatility ahead, we still think the worst is over for stocks. It’s been almost eight months to the day since the S&P 500 hit its lows, and it’s roared back more than 20% since then. Many use that as a barometer for the start of a bull market. When stocks have rebounded that much from their trough in the past, it has typically meant there are more good times to come. In the last 11 bear markets, after stocks rallied back 20%, the S&P was up on average another +22% over the next year. That could act as a cue to start rebuilding equity portfolios after last year’s de-risking.
For more of our top ideas, and how we are navigating what feels like one of the most well-telegraphed recessions ever, don’t miss our 2023 Mid-Year Outlook: Recession Obsession.
All market and economic data as of June 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
RISK CONSIDERATIONS
• Past performance is not indicative of future results. You may not invest directly in an index.
• The prices and rates of return are indicative, as they may vary over time based on market conditions.
• Additional risk considerations exist for all strategies.
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
