Friday's Market Minute: The Broad Market And Economy Are Currently Aligned

The equity market continues to make incremental gains with the S&P 500 testing the 4,300 level established back in August of last year. The focus of most investors has shifted away from the recent fiscal debt ceiling political theatrics and back to the fundamentals of interest rates, the reassessment of inflation, and the health of the overall economy.

Next week’s inflation report should provide more clarity as to whether the disinflation process remains intact. The labor market remains tight and although headline inflation has been trending lower since June of last year, core inflation has remained relatively firm since last December.

Based on data from the CME Group, markets still expect that a 25-basis point increase in July will be the last of the current cycle. The market-implied federal funds rate for the end of this year has risen steadily since March. It was just a few months ago that the broad consensus was monetary tightening was near the apex, and that rates would begin to fall in the second half of 2023. Perhaps due to the regional bank calamity and looming concerns of a systemic liquidity crisis, the consensus is now that rates will still hover around the 5 to 5.25 percent mark in six months’ time.

Many investors who had previously thought the Fed would lower rates significantly later this year have backed out due to the economic conditions that suggest the economy is slowing down without aggregate signs of an imminent recession. Economic measures such as manufacturing surveys and the inverted yield curve imply economic weakness.

However, labor conditions remain robust and overall year-over-year corporate earnings have not fallen as much as expected with aggregate forward estimates rising across many industry groups. Since corporate earnings follow broad economic conditions, it should be no surprise to see equity markets recover from last year’s lows.

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