For the Fed, ‘one and done’ is a reasonable scenario from here, given the recent inflation prints in the US (and China). But there remains a high bar to rate cuts. The S&P 500 Information Technology index hit a new all-time high last week and is up 43.9% YTD. A thawing technology sector could provide an important, additional tailwind for the economy, lifting capex and hiring.
Real average hourly earnings are now firmly higher on a y/y basis, up 2.22% for production & non-supervisory employees. Consumer sentiment jumped at the start of July. The Freddie Mac house price index had risen by an annualised 5.8% in the three months to May. Homebuilder shares are up 38.4% YTD.
The drop in inflation is providing a lift to equity markets. But the widening federal budget deficit cannot be constructive for the stock market over the medium term. Running federal budget deficits of ~8% of GDP, at this stage of the cycle, is not sustainable and will (all else equal) push real yields higher. Real interest rates may have risen above the underlying growth rate of the economy (r > g).
Looking further ahead, the risks to the debt burden from climate change will intensify. Severe weather events are growing in frequency, but the true costs are not reflected in long-term projections for government debt-to-GDP ratios. Governments have been called upon time and time again, to counteract the ‘extraordinary’ series of crises that have buffeted advanced economies since the turn of the millennium. Each successive rise in the public sector debt burden, however, has proved irrevocable. The fiscal risks from climate change will be felt acutely in the coming decade as governments will once again be asked to foot the bill.
