Stocks climbed on the back of encouraging economic data, reinforcing a “Goldilocks” scenario where the U.S. economy appears resilient enough to sustain growth, yet soft enough to justify the Federal Reserve’s anticipated rate cuts. The S&P 500 trimmed earlier losses and was on track for its fourth consecutive monthly gain, signaling growing investor confidence. Meanwhile, Treasuries held steady, poised for their longest streak of monthly gains since 2021, as swap traders continued to price in approximately 100 basis points of rate reductions by the Fed before the year’s end—indicating a possible substantial cut, though not necessarily in September.
The latest consumer sentiment data, showing its first improvement in five months, reflects the impact of slower inflation and the prospect of rate cuts on personal finance expectations. The Fed’s preferred inflation gauge, the core Personal Consumption Expenditures (PCE) price index, rose at a subdued pace, further solidifying the case for easing monetary policy.
“This week’s economic reports dispel concerns about a looming recession and runaway inflation,” noted David Russell at TradeStation. “We could be entering a ‘Goldilocks’ phase as Jerome Powell prepares to adjust the Fed’s course.”
Federal Reserve Chair Jerome Powell recently signaled that the time has come for the Fed to reduce its key policy rate, reinforcing market expectations for the start of a rate-cutting cycle next month. His comments emphasized the Fed’s commitment to avoid excessive cooling in the labor market.
The S&P 500 gained 0.7%, while the tech-centric Nasdaq 100 advanced 1.1%. Treasury 10-year yields remained stable at 3.87%, and the U.S. dollar fluctuated but was on pace for its worst month this year. Oil prices dropped sharply following reports that OPEC+ plans to proceed with previously announced output hikes in the fourth quarter.
Chris Low of FHN Financial remarked that the market-friendly inflation data aligned with expectations for the Fed to begin easing policy. “The July PCE data ticks all the boxes for the Fed, bolstering the case for a 25-basis-point cut in September,” added Tim McDonough at Key Wealth. “All attention now shifts to the August jobs report, as the Fed’s focus transitions from inflation to labor market dynamics.”
Market analysts are closely watching the upcoming employment data to assess whether the economy is cooling at an acceptable pace or risking a more significant slowdown. “With inflation contained, the focus now turns to whether the labor market can maintain its momentum without sparking recession fears,” said Chris Larkin at E*Trade from Morgan Stanley.
The report suggests it’s time to start easing the Fed’s restrictive monetary stance, despite the fact that inflation-adjusted consumer spending accelerated from the previous month. “Today’s PCE data, showing only a modest rise in core inflation, aligns with the Fed’s anticipated policy direction,” commented Gary Pzegeo at CIBC Private Wealth US. “However, the Fed may need to see further labor market softening before considering a more aggressive rate cut.”
Interest-rate swaps show traders see a 20% chance the Fed could cut rates by half a point at the next policy meeting in September, down slightly from pre-data estimates. Contracts now imply a total of 97 basis points of rate cuts for the remainder of 2024. Bret Kenwell at eToro highlighted that investors and the Fed are increasingly focused on labor market data, with next week’s jobs report poised to be a critical determinant of rate cut expectations.
“Weakening inflation provides the Fed with ample room to start cutting rates, while steady household spending creates the ideal conditions for a soft landing,” observed David Alcaly at Lazard Asset Management. “While the immediate focus is on the pace of rate cuts, the depth of the rate-cutting cycle will ultimately have a more significant impact.”
U.S. government bonds returned 1.5% in August through Thursday, marking a fourth consecutive month of gains according to the Bloomberg US Treasury Total Return Index. The gauge has been rallying since late April, with a year-to-date gain of nearly 3%, reflecting growing confidence in lower borrowing costs.
“The upcoming jobs report will likely set the tone for the Fed’s next move—whether they start the rate-cutting cycle with a 50 or 25 basis point reduction, which could differentiate between an emergency cut and a normalization cut,” said Florian Ielpo at Lombard Odier Investment Managers.
Barclays Plc strategists, led by Emmanuel Cau, suggested that continued good economic data could further support the broader market rally beyond the tech sector. “The monthly U.S. jobs data next week will be pivotal in confirming or dispelling recession concerns,” they wrote. “A weaker report could trigger a negative reaction in equities, but a stronger-than-expected figure might alleviate short-term recession fears and be positive for stocks.”
Investment flows also suggest growing optimism, with cash funds seeing inflows of approximately $24.5 billion in the week through Aug. 28, marking the fourth consecutive week of additions. Additionally, $20.7 billion flowed into bond funds, while stocks attracted $13.7 billion, according to data from Bank of America Corp., citing EPFR Global data. U.S. equities enjoyed a ninth straight week of inflows, totaling $5.8 billion.
Bank of America Corp. strategists are now advising investors who follow the widely adopted 60/40 strategy—allocating 60% to stocks and 40% to fixed income—to consider shifting some bond holdings into commodities. The BofA strategy team, including Jared Woodard and Michael Hartnett, noted in a report that commodities may offer better returns in an environment of persistently high inflation.
“The commodity bull market is just beginning,” the strategists wrote, suggesting that commodities may be a more effective component than bonds in a 60/40 portfolio during the 2020s.
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