The debate continues over the future of monetary policy.
"The U.S. is not out of the woods when it comes to inflation," said Peter Berezin, chief global strategist at BCA Research, "which means that it is too early to conclude that the Fed can stop raising rates."
It is uncertain how quickly inflation will fall, given the resilience of the economy, he said, "and if it does fall, whether it will stay down." Forward-looking data tracked by BCA suggests "inflationary pressures may be starting to build again," Berezin said. Recent data suggest inflation expectations are growing despite the lower actual inflation numbers, he said.
The University of Michigan' consumer sentiment survey showed inflation expectations in June "near the upper end of the historic range that has prevailed since the late 1990s," Berezin noted.
The five-year, five-year forward TIPS inflation breakeven rate also grew recently. Oil prices and agricultural prices also contributed to higher inflation expectations, he added.
The firm lifted its "subjective odds of a resurgence of inflation later this year or early next year to 30% from our previous estimate of 20%."
Risks to bond yields are "skewed to the upside in the near term," Berezin added.
Despite traders pricing in a 25% chance of another rate hike this year, Tom Garretson, senior portfolio strategist at RBC Wealth Management, said, "we maintain our view that the rate hike cycle is effectively over."
Federal Reserve Board Chairman Jerome Powell noted late last year, a "soft landing was 'still possible,' [but] the path had 'narrowed,'" Garretson noted. "Now it looks like the Fed could land a 747 on it."
The Fed doesn't expect a recession this year, he added, "and we think it's easy to see why." Second quarter GDP accelerated from the first quarter. "While at first glance that may appear at odds with the idea that the rate hike cycle is over, prices rose just 2.2% in Q2, well below the 3.0% consensus expectation."
The Conference Board's consumer confidence survey "showed a similar dynamic — consumer confidence rose to a two-year high while consumer inflation expectations fell to the lowest level since November 2020," Garretson said. "Of course, given this kind of economic backdrop where consumers remain remarkably resilient, and perhaps more confident as the scourge of inflation fades, there will likely be an underlying risk the Fed will choose to abort the landing and proceed with further rate hikes before trying to land this thing again."
Still, he sees downside economic risks outweighing upside risks for the rest of the year "as the cumulative impact of policy tightening on economic activity has yet to fully bite."
Additionally, many business surveys suggest disinflationary pressures are ahead, Garretson said, "supporting our view that the bar for further hikes will be quite high, though truly dependent on the next two months of consumer price index and labor market data."
More tightening is coming, according to Raymond Bridges, portfolio manager of the Bridges Capital Tactical ETF. "For the first time since this hiking cycle began, Powell did not used the press conference to signal to the market where policy is likely to head at the next meeting. Powell walked a tight line to present an image of being data dependent."
But, Bridges said, Powell gave clues when he said he doesn't expect inflation to fall below 2% until 2025, and that Fed staff no longer expects a recession. "Each of these two statements saw an immediate reaction in the equity markets that was not overall positive."
Since the Fed is more concerned with inflation than employment at this point, Bridges said, "if the Fed does not expect a recession, along with expectations of persistent risk of inflation, I believe Powell has the cover he currently needs to remain on the stable prices side of the dual mandate. Tightening is not over."
The Fed rate hike last week, with its statement that more may come "was an acknowledgement that the Fed's battle to bring down inflation to its 2.0% target over the medium term may not yet be entirely over," said Scott Anderson, chief economist at Bank of the West.
"I believe there is a better than 50% chance the Fed will need to hike again before the end of the year, and it may come in September rather than November," he said. "This likely means 10-year Treasury yields staying over 4.0% for some time and the 30-year mortgage rate exceeding 7.0%."
Labor market tightness and consumer demand could keep inflation up, he noted.
The Conference Board's consumer confidence index reaching its highest level since the summer of 2021 "is a telling indication of the ongoing strength of the labor market and consumer spending power," he said. "The recent drop in inflation pressures is bringing much needed relief to household budgets and real income growth. Without more weakening in the labor market and consumer demand, a prolonged decline in inflation cannot be assured."
The better-than-expected GDP read makes it "much less likely the U.S. economy will fall into an outright downturn this year or next due to monetary tightening alone," Anderson said. "However, the Fed will still need to calibrate interest rates and monetary policy carefully in the months ahead to keep inflation on its downward path without overdoing the additional economic slowing that will be required to achieve the fabled soft-landing."
Sean Snaith, director of the University of Central Florida's Institute for Economic Forecasting, agreed recession this year "seems less likely."
While in January "a soft landing seemed like a pipe dream," he said, "it's more and more on the table as a possible outcome. We're probably facing more of a 'near recession' now than an actual one."
Labor market strength made it harder for inflation to fall to 2%, Snaith said, "but it's also a key reason that rapid rate increases haven't completely derailed the economy."
Data suggests there will be another rate hike. Jose Torres, senior economist at Interactive Brokers, said in this
Consumers have jobs and are spending, he said. "The consumer staying strong is essential to the soft landing narrative. The soft landing narrative can't happen if the consumer falls off a cliff in the fourth quarter of this year."
