Market Commentary

At the outset of May, equities continued their decline prodded by reports from retailers that higher prices were causing consumers to spend less. Fortunately, inflation finally showed some signs of peaking which prompted equities to reverse course and end the month in the green. This was a welcome respite from the unrelenting declines seen earlier this year. Fixed income also fared well in May, as intermediate and long-term bond yields retreated due to the increased risks of recession (bond prices rise as yields fall).

While there are two common measures of inflation, the Consumer Price Index (CPI) and the Personal Consumption Expenditures price index (PCE), the Federal Reserve’s preferred measure of inflation is the PCE.  Additionally, each index also provides two flavors, headline (all goods) and core inflation (excludes volatile food and fuel). Regardless, both the CPI and PCE indexes declined in April. If inflation continues to trend downward, it will be a helpful tailwind to corporate earnings and the economy.

The Federal Open Market Committee (FOMC) released a statement toward the end of May. They acknowledged that economic activity declined in the first quarter, even though consumer and business spending remained strong. Job gains were robust, and the unemployment rate declined substantially. The committee expects inflation to return to its 2% objective and the labor market to remain strong. According to the CME FedWatch tool, there is a 98% probability that the Fed will raise rates by 50 basis points in June.  The FOMC indicated that they would adjust course if risks emerged. 

Although the likelihood of a recession has increased, the economy still seems to be in good shape.  Vanguard’s recent forecast for full-year U.S. growth of 3.5% is unchanged. However, they commented “we’re watchful for signs of slowdown, with early indicators suggesting second-quarter activity tracking below expectations.”¹

How long inflation remains elevated, and how much the Fed raises rates to address inflation, will be meaningful drivers of the U.S. economy. Our expectation is that inflation will peak soon and the Fed will stop raising rates when the target rate hits 3.00-3.25%. If this is the case, we expect that the U.S. economy to experience a soft landing.