What’s next from the Fed? Powell’s ‘triple play’

The Fed­er­al Reserve’s July deci­sion is just around the cor­ner, and all eyes are on Fed Chair Jerome Pow­ell, expect­ing him to play three dis­tinct cards, each with a dif­fer­ent impact on the US Dol­lar, stocks, and Gold. With con­tra­dict­ing eco­nom­ic sig­nals and high volatil­i­ty in the air, investors right now are eager­ly await­ing hints about the cen­tral bank’s next moves sched­uled for July 26, 18:00 GMT.

The Fed­er­al Reserve faces a del­i­cate bal­anc­ing act with two man­dates – price sta­bil­i­ty and full employ­ment. Infla­tion has been a pri­ma­ry con­cern, with the bank’s efforts to bring it down from its peak of 9.1% YoY in June 2022 to 3% in June 2023. Core infla­tion, exclud­ing volatile ener­gy and food prices, also declined from 6.6% to 4.8% YoY in June.

Inflation and labor market concerns

The Fed’s ulti­mate goal is to achieve an under­ly­ing infla­tion rate of 2%, but con­cerns remain about labor-relat­ed infla­tion, even though goods prices have declined. Ser­vices costs, depen­dent on peo­ple, con­tin­ue to rise, indi­cat­ing per­sis­tent infla­tion­ary pres­sures. The labor mar­ket remains robust, with sub­stan­tial job growth, but the recent trend of ris­ing week­ly job­less claims rais­es ques­tions about chang­ing trends.

Three scenarios

Pow­ell hints at more hikes, but not immi­nent­ly: The most like­ly sce­nario is that Pow­ell main­tains the Fed’s pre­vi­ous pro­jec­tions from June, indi­cat­ing two more rate hikes this year. He may sug­gest anoth­er hike is like­ly but with­out urgency, result­ing in a pause in Sep­tem­ber and a final move in Novem­ber. This taper­ing down of hikes would be well-received by the mar­kets, lead­ing to a rise in the US Dol­lar, a fall in Gold, and stocks retreat­ing ini­tial­ly. How­ev­er, any ini­tial move is like­ly to be short-lived, with data poten­tial­ly turn­ing neg­a­tive, reduc­ing the chances of anoth­er hike. Gold would present a buy­ing oppor­tu­ni­ty, while the US Dol­lar would be a sell.

Back-to-back hikes: While less prob­a­ble, Pow­ell could sig­nal a return to rais­ing rates every meet­ing, caus­ing a hawk­ish mar­ket response. Investors would be spooked, lead­ing to sink­ing stocks, a decline in Gold, and a surge in the US Dol­lar. Recov­er­ing from this sce­nario would require excep­tion­al­ly weak growth and job­less claims figures.

Wait and see: The dovish sce­nario, with a low prob­a­bil­i­ty, involves Pow­ell end­ing the tight­en­ing cycle here and mon­i­tor­ing the impact before con­sid­er­ing fur­ther hikes. Falling infla­tion and glob­al growth con­cerns cre­ate a slim pos­si­bil­i­ty of Pow­ell sig­nal­ing a high bar for future increas­es. This sce­nario would lead to a sharp decline in the US Dol­lar, while Gold and stocks would rally.

Apart from the infla­tion and labor mar­ket fac­tors, the US man­u­fac­tur­ing sec­tor’s con­trac­tion adds com­plex­i­ty to the sit­u­a­tion. While the shift to ser­vices may sug­gest an end to tight­en­ing, the rise of green ener­gy and infra­struc­ture projects may bring a man­u­fac­tur­ing boom in 2024.

The glob­al land­scape also influ­ences the Fed’s deci­sions, with strug­gling economies in Europe and ten­sions with Chi­na. Incen­tives mea­sures in Chi­na could impact trade with the US, while ele­vat­ed pri­vate debt and the need for con­trol may lim­it Chi­na’s expansion.