A Fed pivot looking unlikely for 2023 while cold war comes step closer

July’s US stock market rally has spilt over to August as investors have chosen to ignore economic policy makers’ tougher rhetoric on inflation in speculating that slowing economy will force the US central bank to reverse course and start cutting rates by next year. This anticipation has made Fed’s work even more complicated as the recent declines in long term rates is hardly helpful to cool down rising prices. This conundrum could even force the US central bank to sell its treasury holdings in its quantitative tightening operations rather than to just run off from its balance sheet as they mature.

As we have outlined in the past few weeks, although we see some temporary easing of inflation gauge globally, in line with recent declines in shipping rates and falling commodity prices, we think wage and housing-related costs will continue to rise. We also see a likelihood for the broader CPI gauge to rebound as we approach the next quarter given the continued tight supply/demand conditions in food and energy.  

As we have also noted, with US (and Japan) facing structural labour shortages, we can’t see unemployment rates rising to levels that will force the Fed to back off from its fight to ease inflationary pressures. Indeed, last week’s release of shockingly strong July US employment data came as a rude reminder that the US economy is not anywhere near weak enough to cheer for a coming easier monetary policy stance in 2023.

The resulting rise in treasury yields and a rebound in the US dollar provided more pause for thought as we continue to believe the recent stock market rebound could prove very premature, especially as corporate earnings are likely to weaken further for the rest of the year. Although next week’s US July CPI data should bring some temporary relief, any disappointments in the rate of monthly price declines could provide more market shock waves.  

With geopolitical tensions between US and China running red hot following the US House speaker’s visit to Taiwan, triggering China’s biggest military exercise yet around the island that has temporarily narrowed trade routes to and from Taiwan, we seem to have taken a big step closer towards a cold war. This is leaving trade with China even more at risk, especially for Japanese firms which remain highly dependent on exports of high tech capital goods and materials to the region.