Inflation and the Fed — Evening Brief – 07.10.24
There has been legitimate cause for considering whether the underperformance in various parts of the fixed income sector has come to an end. Today, U.S. Treasury yields have drifted slightly lower and the technical trend points to additional declines over the next several months. However, investors must still contend with potential changes to the Federal Reserve’s monetary policy in the coming weeks and months.
Most bond sectors have posted moderate gains year to date. Although hardly much has changed since early June, the fact that the market has collapsed is important. Long-term bonds are still posting negative returns for the year, but the market continues to see moderate probabilities that the central bank will soon begin cutting interest rates, which is supporting this year’s gain in other areas of fixed income.
The US investment-grade bond benchmark (BND) is up a meager 0.2% this year. While a minimal gain, it represents a significant improvement from late April when the fund was down 4.5% for the year.
In the near term, the important factor for bonds will be incoming inflation data and Fed policy expectations. Regarding inflation, Thursday’s consumer price index for June is expected to show mixed year-over-year results. Headline CPI is expected to fall to 3.1% from 3.3% in May. In contrast, core CPI is predicted to rise to 3.5% from 3.4%.
Markets will be closely watching how the latest CPI report changes expectations for Fed policy. Fed funds futures currently price in a 95% chance of no change in rates at the next FOMC meeting on July 31 and a 75% chance of an interest rate cut at the September 18 meeting.
Fed Chair Jay Powell hinted at a dovish policy change during his semi-annual trip to Capitol Hill on Wednesday. “In light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face,” he said. “Reducing policy restraint too late or too little could unduly weaken economic activity and employment.”
A revised nowcast for the impending second-quarter GDP report adds to the pressure to cut interest rates. The Atlanta Fed’s GDPNow model currently forecasts a 1.6% increase in output from April to June, just a touch higher than the tepid 1.4% gain observed in the first quarter.
The economic profile favors an interest rate cut, but will the CPI data continue to allow the Fed to loosen policy?