All eyes will be on the US this week with inflation being the main theme as CPI data for July gets released. The July 2023 CPI data are scheduled to be released on August 10, 2023, at 8:30 A.M. Eastern Time. The June US CPI data released in July showed that inflation had cooled down to 3%, below expectations.
But, the US Federal Reserve’s battle against inflation is only half-won. The US Fed’s target of 2% remains some distance away even after prices cooled down substantially over the last 18 months. Markets, meanwhile, expect the Fed is on its last leg of the rate hike and may soon start cutting rates boosting the stock markets recovery in the second half of 2023.
A negative surprise, however, may spoil the stock market party sooner. The U.S. economy added fewer jobs than projected in July, despite good pay gains and a decline in the unemployment rate, implying that the Federal Reserve may keep interest rates higher for longer. Additional interest rate increases are likely to be required to bring inflation down to the Fed’s 2% target.
The consumer price index in the United States is expected to rise slightly in July to 3.3% on an annual basis, while the core rate may remain steady at 4.8%.
There is some upside risk for year-on-year data following their recent deceleration, but this is due to falling energy costs last summer being excluded from the annual comparison. The Federal Reserve, on the other hand, will be focusing on the month-to-month readings.
The heightened attention on the banking industry dampened Wall Street’s optimism, which had already been damaged by recent remarks from a Federal Reserve official suggesting additional rate hikes to control inflation. Additional hikes “will likely be needed,” according to Fed Governor Michelle Bowman, which caused the two-year yield to rise before partially reversing its upward trend.
Investors have been keeping a watchful eye out for signs of stress in the industry as rising interest rates compel businesses to pay more for deposits and drive up the cost of finance from alternative sources. This is because the failure of smaller banks in California and New York this year alarmed investors.
In addition, those higher rates are possibly hurting the balance sheets of lenders by depreciating the assets held by banks and making it more difficult for borrowers in the commercial real estate sector to refinance their debt.
According to ING Think – The move higher in Treasury yields only adds to our conviction that the Fed won’t need to hike interest rates further. We are approaching 4.2% for the 10Y Treasury yield in the wake of the Fitch downgrade and the Treasury funding announcement, and it could go higher over the next week as the extra bond supply hits the market. This, coupled with the stronger dollar and rising market volatility, is tightening monetary conditions and will put up mortgage rates and corporate borrowing costs.
The Federal Reserve Senior Loan Officer Opinion survey shows a further tightening of lending conditions, which in combination with higher interest rates, will be toxic for bank lending. This is going to be a major headwind for economic activity – hence our view that recession risks cannot be ignored.