Fed to Keep Hiking

While US consumer spending on services was way up in May, the reverse was true of goods spending. It looks as though necessary health expenses primarily drove increases, with travel helping. Meanwhile, spending on goods that could be delayed, such as for motor vehicles and spare parts fell significantly.

Overall consumer spending simply flatlined in May, up 0.1%. The nature of the services to goods split really does show signs of further significant economic slowing ahead. The US consumer is mainly only spending on what they have to. Though travel remains strong too. It is fair to say consumer activity is somewhat vulnerable with risk to the downside.

This will not forestall the Federal Reserve from maintaining a tightening bias and the prospect of further rate hikes however. It is the ivory tower detached policy of the Fed, and others, to inflict pain on the economy, to create a slowing and for un-employment to go up. This is a stated outcome objective.

It cannot be highlighted enough, that a slowing economy and even significantly higher un-employment should it eventuate, will not impact the Federal Reserve’s thinking on rates one iota. This is why all along we have consistently forecast much higher rates for longer.

The market’s bizarre expectations of a pivot were always a fantasy and this has been seen to be the case. Nevertheless, markets have been climbing. Not because the market is getting what it wants fundamentally, but simply because it ‘wants’ to go higher. Such ‘wants’ if continuing to remain un-supported by the fundamental reality, have throughout history never ended well.

There are two questions then. Firstly, can the economy suddenly accelerate, and will inflation drop away?

In reality the market does not need the Fed to be cutting rates to validly go higher. The validity, in the end, always comes from earnings of course. Strong earnings are achievable in a variety of economy matrices. However, a weak economy is not the foundation for such an outcome and that is where the US is at and likely to be for some time.

The view and forecast here remains on-going frustratingly slow to negative economic performance. If correct, then even stability in the interest rate outlook may not be enough to sustain current stock valuations.

Meanwhile, inflation remains well above any degree of comfort for the Federal Reserve. The PCE Index released on Friday showed core prices merely nudging lower by just 0.1% to 4.6%. Rather than reassuring, this will be somewhat alarming to the Fed that core prices are stubbornly continuing to rise at a heightened pace. In such circumstances the Fed is left with a serious need to raise rates higher if the only focus is fighting inflation. Which is how it is.

Equity prices, while seen to be rising, are doing so in a very concentrated fashion. While much of the market begins to stall on the back of the ever more evident slowing economy.

And the Fed will continue to hike rates another 1-3 times.

Caution of this run up in overall index prices is entirely appropriate.

Clifford BennettACY Securities Chief Economist

The view expressed within this document are solely that of Clifford Bennett’s and do not represent the views of ACY Securities.

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