Stocks are currently experiencing optimism with cooling U.S. inflation, pushing the S&P 500 to a 15-month high. However, tightening credit conditions and potential interest rate hikes are still posing risks that could disrupt the upward trend and lead to a recession.
The S&P 500 surged above 4,500 last week, as both the consumer price index and producer price index showed cooler-than-expected inflation in June. Some expect the index to reach an all-time high later this year, considering the improved economic outlook and the possibility of earnings catching up.
Despite this positivity, the Federal Reserve might continue raising interest rates to tame inflation. Future funds traders predict at least one more rate hike by the year’s end. However, there’s optimism that interest rates might have peaked, which could fuel further expansion.
A weaker U.S. dollar is also boosting risky assets, as the ICE U.S. Dollar Index fell to its lowest level since April 2022. If other central banks maintain rate hikes while the Fed stops, it could further weigh down the greenback.
Yet, several challenges could hinder the stock rally. Raymond Bridges anticipates U.S. stocks to end the year lower due to tightening credit conditions. As the Fed’s balance sheet shrinks, banks will have to repay emergency loans, leading to a net liquidity draw.
Further rate hikes after July might also undermine the U.S. economy. The Fed’s dot-plot forecast showed officials expected two more rate increases by year-end. This, along with tighter credit conditions, could set the stage for a recession.
“While we do anticipate at least one more rate hike, we think the ending of a two-year track of rate hikes is going to put more certainty into the market and very importantly, have the U.S. economy achieve a soft landing and avoid a recession,” MarketWarch quoted Greg Bassuk, chief executive at AXS Investments, as saying.
While analysts expect inflation to decrease, there could be occasional spikes, impacting the Consumer Price Index (CPI) and Producer Price Index (PPI). Such fluctuations could influence the market sentiment.
Scott Ladner, chief investment officer at Horizon Investments. “This is increasingly looking like an economy that just can’t get knocked off its footing,” said Ladner in a phone interview.
Despite these risks, U.S. stocks ended the past week higher, with the Dow Jones Industrial Average up 2.3%, the S&P 500 gaining 2.4%, and the Nasdaq Composite finishing 3.3% higher. Investors are closely watching U.S. retail sales, housing starts, and initial jobless claims data for the coming week.
As analysts remain divided on the economy’s future trajectory, with some foreseeing a soft landing while others predict a mild recession, investors should stay vigilant and consider these factors when making decisions in the market.