Jason's World

A shimmer of hope has emerged for the months ahead as inflation cools more than expected this month. The PCE index has cooled substantially from April, to 3.8% from the 4.3% registered in April. This is lower than the 3.9% that was forecasted for this month.

Last week, the Fed as a whole sent a rather uncertain message regarding their future path. Chairman Jerome Powell did not specify how high he thinks rates should go, but maintained a hawkish tone as inflation remained at double the target rate of 2%.

Looking to the rest of the world, interest rate hikes have proved to be headwinds for other economies, with business expansion in Europe grinding to a halt as the central bank rate rose from 0% to 4%. This was a large reason behind the stock market’s cooling off last week from a historic streak of gains. Investors were fearful of the prospect of further hikes dragging the world economy into a recession, especially given the fact that stocks have rallied for weeks, which raised fears about a bubble.

But this week’s inflation report has given hope, at least for investors in the United States, that the Fed may tune down its hawkishness in the near future.

Why does the Fed focus on PCE rather than the topline inflation rate? Because the PCE focuses more on what consumers actually buy rather than on a fixed set of goods represented by the CPI. To the Fed, the faster than expected decline in PCE shows that inflation is taking a less toll on ordinary people’s consumption than it used to.

Meanwhile, a historic milestone has been achieved as Apple recently hit a market cap of $3 trillion, being the first company to do so. This has resulted in a rally in many tech stocks: for example, Nvidia rose 3.63% on Friday.

Furthermore, the largest bear case is crumbling as the Advance/Decline Line for the S&P 500 has reached a high, indicating that the breadth of the current bill market may be widening. This can be explained by the recent GDP report that revised the Q1 growth rate dramatically upwards. The broadening stock market rally is a vote of confidence in the economy in general.

There is, however, one reason to be skeptical about the current rally. The growth in consumer spending, 70% of the US economy, has slowed down to a trickle. Even so, the Fed remains likely to raise interest rates at its July meeting, and Chairman Powell has left open the possibility for consecutive rate hikes in the near future.

Given the fact that interest rate hikes have a delayed effect on the economy, it can be said that the real effects of the rate hikes over the past year have just been rearing their ugly heads. That has the potential to strike a blow to the feeling since earlier this year that the U.S. economy is invincible. If economic data over the next few months show more cooling, then markets will realize that the economy is not, in fact, invincible, and will inflict some pain on investors. But, until then, investors will continue to bask in the euphoria fueled by the seemingly invincible U.S. economy.

However, there is one big factor that could override any lingering concern about the economy for now-one that ironically was considered a bear case by many.

As the US Treasury issues massive amounts of bonds after the resolution of its debt ceiling crisis, the Fed may be compelled to increase its balance sheet. An analyst forecasted that the Fed’s balance sheet may grow to $16 trillion, almost double the current level.

A return to quantitative easing will be quite a boon for stocks. Easing was a core factor fueling the bull market of the early 2010s, even though the economy was recovering rather slowly. Easy access to capital spurred by QE will likely be a great boon for industries with a high demand for borrowing, such as tech and real estate, and may ease fears of a recession.