Jerome Powell’s testimony to the United States (US) Congress took centre stage this week, ahead of the key US inflation release on Thursday. Investors are looking for cluesabout the timing of interest rate cuts by the US Federal Reserve (Fed). In this week’s Weekly Market Wrap, we take a closer look at his testimony.
The week’s key themes:
- Powell tows the party line
- US inflation broadly cools and Treasury yields retreat
- Interest rate cut bets drives rotation away from tech Megacaps
- Gold sparkles on rate cut hopes
- Dollar sees biggest decline since May
FED MAINTAINS CAUTIOUS MESSAGING
Fed Chair, Jerome Powell, recently delivered his Semi-Annual Monetary Policy Report before Congress, a two-day event that has become a focal point for market participants seeking clues about the future of US monetary policy. His testimony underscored the cautious approach the Fed is taking toward interest rate cuts, reflecting ongoing concerns about US inflation and the US labour market.
Inflation and economic outlook
Powell expressed confidence that US inflation will gradually align with the Fed’s 2% target, but he emphasised the need for additional data to confirm this trend. “Recent price readings have shown modest further progress,” Powell stated, adding that additional support would strengthen the Fed’s confidence in achieving its inflation goals sustainably. However, Powell refrained from providing specific timing for potential rate cuts, highlighting the risks of acting either prematurely or too slowly.
Labour market dynamics
Powell highlighted that the US labour market has cooled significantly, with the most recent data indicating a slowdown in job growth. June’s Non-farm Payrolls report showed an increase of 206,000 jobs, slightly above expectations but reflected a broader deceleration trend. The US unemployment rate rose to 4.1%, and wage growth slowed, signalling reduced inflationary pressures from the labour market. Powell’s assessment suggested that while the job market remains strong, it is no longer overheated, aligning with the Fed’s goal of a “soft landing” for the economy.
Market reactions and expectations
Global equities displayed mixed reactions following Powell’s testimony, while US Treasury yields saw an increase. Investors remain cautious, reflecting the Fed’s balanced approach to monetary policy. The probability of a rate cut in September, as indicated by the CME FedWatch Tool, remained significant but slightly lower than earlier estimates. Powell’s remarks led to a temporary boost in Wall Street indices, though they did not reach session highs, and bond yields climbed as investors awaited further economic indicators.
In his testimony, Powell covered a few focal points:
Balancing Risks: Powell emphasised the Fed’s delicate balancing act between curbing inflation and supporting economic growth. Lowering rates too soon could reignite inflation, while waiting too long could undermine economic stability. This balancing act is central to the Fed’s current policy considerations.
Banking Regulations: Powell provided updates on new capital requirements for big banks, suggesting that regulators are close to agreeing on revised proposals. This potential regulatory shift, seen as a victory for Wall Street, sent bank stocks higher, with shares of major financial institutions like Goldman Sachs reaching new highs.
Future Data Dependency: Powell highlighted the Fed’s dependence on incoming economic data to guide its decisions. He pointed out that despite recent improvements, the Fed requires sustained progress in inflation and labour market conditions before considering rate cuts.
Market Sentiment: Investors showed cautious optimism, with the S&P 500 continuing its upward trend, driven mainly by gains in technology and financial stocks. However, the broader market sentiment remained vigilant, awaiting more definitive economic data, including the upcoming consumer price report.
Powell’s testimony set the stage for a data-driven approach to monetary policy as markets swiftly turned their attention to the highly anticipated CPI (Consumer Price Index) reading that was released on Thursday afternoon. Powell, in his testimony, reiterated what we have heard numerous times over the past months, that the Fed will remain committed to closely monitoring inflation and labour market indicators. He also emphasised that the central bank’s balance sheet reduction efforts will proceed cautiously to avoid market disruptions and that regulatory changes for the banking sector are on the horizon.
A CLOSER LOOK AT THE MARKETS
With Powell setting the stage with a data-driven approach, the softer-than-expected inflation reading on Thursday triggered a few noteworthy market movements.
US Treasury yields slide to a three-month low
On Thursday, the yield on the US 10-year Treasury note dropped 10 basis points to 4.20%, its lowest level in over three months. This decline followed softer-than-expected inflation data, with headline inflation falling to a one-year low of 3% in June, below market forecasts of 3.1%. Core inflation also decreased more than anticipated, hitting a three-year low. These figures bolstered investor confidence that the Fed will cut rates this quarter, with 85% of the market now betting on a rate cut in September.
In the United Kingdom (UK), the 10-year Gilt yield rose to 4.15% as the probability of a summer rate cut faded. The UK economy grew by 0.4% in May, surpassing expectations of 0.2% growth. Bank of England Chief Economist, Huw Pill, noted that despite hitting the 2% inflation target in May, persistent service inflation and strong wage growth suggest that tighter monetary policy may continue.
South Africa’s 10-year government bond yield remained below 10%, hovering around its lowest since 21 June, as markets continued to cheer the new Government of National Unity (GNU). Investors are hopeful that the coalition will accelerate economic reforms, tackle governance issues, and boost investment and employment. Domestically, the South African Reserve Bank is expected to maintain interest rates at the upcoming meeting, with potential rate cuts of 25 basis points each projected for September and November.
US equity markets continue to soar
The increased bets of a rate cut, driven by the cooler inflation readings, also prompted a shift away from the tech megacaps that have driven the bull market in stocks. This optimism over potential lower rates has led investors to move into riskier parts of the market, moving away from the traditionally safer big tech stocks. The Russell 2000 index of smaller firms outperformed the Nasdaq 100 by 5.8 percentage points, the largest margin since November 2020. Despite the S&P 500 falling nearly 1%, almost 400 of its stocks saw gains.
The FTSE 100 hovered near the flatline, following a 0.7% gain the previous day, after UK economic growth exceeded expectations in May. The European-based DAX added 0.3%, nearing the 18,470 level, with traders awaiting the US CPI report. Germany’s inflation rate fell to 2.2% in June, as anticipated, with top performers including multinational pharmaceutical groups, Bayer and Sartorius, along with building materials group, Heidelberg Materials.
Japan’s Nikkei 225 Index fell 2.3% to around 41,200, in Asian trade as Japanese shares pulled back from all-time highs. The yen surged by 2.6%, likely due to suspected government intervention. Japanese tech stocks followed US peers lower as investors shifted from large-cap tech to small-cap stocks after soft US inflation data reinforced expectations of a Fed rate cut.
The local JSE index traded slightly higher after four consecutive sessions of losses. Investors were largely focused on the US inflation report. Paper and packaging producer, Mondi, property group, Redefine, and real estate investment trust, Primary Health Properties, were among the top gainers, while IT solutions provider, Bytes, and retailer, Pick n Pay, posted significant losses.
Gold rallies for third consecutive session
Brent crude futures rose to $85.50/barrel, marking a second consecutive session of gains due to a larger-than-expected drawdown in US crude inventories. The Energy Information Agency reported a 3.444-million-barrel drop in crude stocks, exceeding predictions. The Organization of the Petroleum Exporting Countries, OPEC, maintained its forecast for robust global oil demand growth, anticipating a future deficit.
Gold prices rose above $2,400/ounce, extending gains for the third consecutive session. The easing of US inflation reinforced the likelihood of a Fed rate cut, bolstering the appeal of gold. Global gold exchange traded funds saw inflows for the second consecutive month, driven by European and Asian funds.
Dollar licks its wounds
The US Dollar Index fell by 0.8% to 104.14, a four-week low, as traders increased bets on a rate cut in September. The euro rose slightly to $1.084/€, with German inflation easing to 2.2%, while the British pound surged past $1.287/£, supported by strong UK economic growth data.
The South African rand reached its highest level since 24 June amid rising bets on a Fed rate cut and optimism over South Africa’s new GNU, gaining nearly 1% in afternoon trade on Thursday.
Key Indicators:
USD/ZAR: 17.99
EUR/ZAR: 19.56
GBP/ZAR: 23.23
GOLD: $2,408.53
BRENT CRUDE: $85.60
Sources: Bloomberg, Refinitiv, Trading Economics and Federal Reserve.
Written by Citadel: Advisory Partner and Citadel Global Director, Bianca Botes.