Market preview for the next trading session
Traders will open the next session with a complex set of signals. Inflation data has firmed over the past few months while household income and spending stayed positive in July. At the same time the Federal Reserve appears ready to cut rates in less than three weeks. Those facts together create an unusual set of incentives for investors. Price pressures make the case for caution, but policymakers are signaling they intend to ease policy to support growth and address increasing economic risks.
This week’s inflation picture shows the Personal Consumption Expenditures Price Index, the Fed’s preferred gauge, steady at 2.6 percent year on year. The core measure, which excludes energy and food, rose to 2.9 percent year on year and has increased for four straight months. On a three month annualized basis core PCE ran at roughly a 3 percent pace, up from 2.6 percent in June. Those numbers point to a pickup in underlying inflation trends that market participants cannot ignore.
At the same time consumer income rose 0.4 percent in July and spending rose 0.5 percent. The data were enough to move the Atlanta Fed’s real time GDP tracker from an estimated 2.2 percent to about 3.5 percent for third quarter growth. That improvement in near term growth expectations will support risk assets if investors take it as a sign corporate earnings can hold up. It will also complicate the story for rates since stronger growth normally argues against rate cuts.
Policy makers appear willing to make that trade because their view is not anchored to recent headline numbers. The working assumption among Fed officials who favor easing is that some price increases, including those driven by recent tariffs, are a one time jolt to prices rather than a persistent upward trend. If tariffs raise costs they may also erode household real disposable income and damp consumer demand in the months ahead, creating a feedback that reduces inflationary pressure over time.
Comments from a sitting Fed governor underscore this approach. He noted that growth for the first half of the year ran around 1.2 percent and said that limited evidence is consistent with continued sluggish growth. He argued that tariff related price effects will dent household spending and corporate profits, and that downside risks in the labor market are building. He also said that he favored reducing the federal funds rate at the Fed’s July meeting and that subsequent data supported that choice.
For markets that means short duration instruments will be closely tied to the timing and size of the expected cuts. If the Fed signals a firm plan to move in under three weeks, short end yields should move lower as traders price a clear easing path. Longer dated yields face a more complex trade off between higher near term inflation readings and the prospect of easier policy ahead. Expect intraday swings in the Treasury complex as investors parse comments from Fed officials, any additional inflation data and economic releases that can change the odds of a cut.
Equity markets will react to the same cross currents. Rate sensitive growth names and sectors that benefit from cheaper financing stand to gain if a cut is clearly priced. At the same time, the health of consumer demand matters for cyclicals and consumer discretionary companies. The recent gains in consumer spending were driven largely by large moves in autos and recreational vehicles. Those categories have showed sharp swings and remain flat over a longer horizon, which suggests gains may not be broad based.
Bank stocks will watch the slope of the yield curve. A move down in short rates with little change at the long end compresses net interest margins and could pressure regional lenders. Conversely any sign that long yields are falling in step with the short end would be a more positive backdrop for financials. Credit markets will be sensitive to signs of weakening in the labor market since job deterioration would raise default risks among lower quality borrowers.
Currency traders should react to how clearly markets interpret Fed intentions. A firm message that cuts are coming could weigh on the dollar, which would be supportive for commodity prices and multinational earnings when translated back into dollars. If policy confusion persists or legal and governance concerns introduce uncertainty at the Fed, safe haven flows could strengthen the dollar and depress risk appetite.
There is another source of uncertainty for investors to factor in this session. The president’s recent firing of a Federal Reserve governor has produced a rapid legal fight over whether the removal is valid. The fired governor has asked a court to allow her to remain in office while the matter proceeds. The administration has asked the judge to deny that request. The Federal Reserve is named as a defendant because it is tasked with carrying out the firing. The court is expected to issue a swift ruling and whichever side loses is likely to appeal.
That legal dispute creates a political and governance risk for markets. Any question about the independence of the central bank or uncertainty about leadership could increase volatility around Fed commentary and decisions. Traders may demand a premium for that risk in short intraday moves. Separately a federal housing regulator reported making a further referral to the Department of Justice related to allegations about the fired governor’s financial disclosures. Those procedural developments are likely to add to headlines and market attention in the near term.
In summary, expect an active session that tests market assumptions on where policy is headed. Stronger inflation readings argue for caution. Firm consumer income and spending numbers and an uptick in near term growth expectations support risk assets. Policymakers are signaling a readiness to cut despite those data which should keep rate sensitive sectors and short dated fixed income in focus. Add legal uncertainty around the central bank and the result is likely to be increased headline driven volatility, especially around policy remarks and any fresh inflation or labor market readings. Traders should watch Fed commentary and the court docket closely as indicators that could swing sentiment rapidly.
