【MACRO Insight】The Crossroads of the American Economy——Inflation, Employment, and the Fed’s Policy Choices

On the global economic stage, every fluctuation in the US economy touches the pulse of the markets. Recently, remarks from US Treasury Secretary Yellen and Federal Reserve Chairman Powell have provided a crucial window for understanding the current economic conditions and policy direction in the United States.

Yellen, speaking at a hearing of the House Financial Services Committee, pointed out that during the economic rebound following the COVID-19 pandemic, the labor market was once very tight. However, with a significant increase in labor supply, the current labor market is stronger, thereby alleviating some of the inflationary pressures. Yellen's comments reflect the transition of the US labor market from tight to more relaxed, which occurred following the increase in labor supply, demonstrating the economy's self-adjusting capability during the recovery process.

Meanwhile, Powell mentioned during a Senate hearing that recent employment data indicates a significant cooling in the labor market. His remarks suggest that the Federal Reserve may consider lowering interest rates at an appropriate time in response to the new developments in the labor market. However, some economists express concern, seeing the slowdown in employment as a potential precursor to further economic deterioration.

In June, the number of long-term unemployed reached its highest level since the beginning of the year, sparking concerns in the market about a potential further slowdown in the labor market. Claudia Sam, Chief Economist at New Century Advisors, pointed out that while there are currently no clear signs of recession, the cooling trend in the labor market is undeniable and may indicate deeper underlying issues suggesting economic slowdown.

Regarding inflation, J.P. Morgan's trading desk predicts that the upcoming CPI data release could act as a catalyst for market volatility. Options market data indicates that investors anticipate a 0.9% fluctuation in the S&P 500 index prior to the CPI data release. Slowing growth in core CPI is seen as a better indicator of potential inflation, while trends in housing prices directly impact inflation expectations.

Taylor and his team wrote in their client briefing that if the final reading of core CPI for June exceeds 0.3%, it could likely trigger selling in risk assets, potentially causing the S&P 500 index to fall between 1.25% and 2.5%. However, the probability of this scenario occurring is only 2.5%. Conversely, if the month-over-month growth rate of core CPI falls between 0.15% and 0.20%, the S&P 500 index is expected to rise by 0.5% to 1%.

Against this backdrop, the market expects the Federal Reserve to maintain its policy stance at the July meeting but anticipates a growing possibility of rate cuts in September. This sentiment is particularly fueled by unexpected increases in the unemployment rate, potentially triggering the “Sam Rule,” which suggests that when the 3-month average unemployment rate rises 0.5 percentage points above its 12-month low, it may indicate an economic recession.

However, even if the Sam Rule is triggered, the Fed may choose not to act immediately, considering political factors in an election year and the need for further evidence of inflation decline. Powell himself emphasized his desire to see inflation sustainably decrease to the 2% target. Therefore, if the upcoming CPI data shows a significant increase in inflation, market expectations for a rate cut in September could diminish significantly.

The dynamics of the U.S. economy and labor market, as well as changes in inflation expectations, have profound implications for Federal Reserve policy decisions. Market participants are closely monitoring upcoming economic data releases and statements from Fed officials to capture signals of policy direction. Against this backdrop, investors need to prepare for potential market fluctuations and closely watch the Fed's next steps. Meanwhile, trends in housing prices, changes in core CPI, and the condition of the labor market will all be critical factors influencing Fed decisions. The U.S. economy is at a crucial juncture, and its policy choices will have far-reaching effects on the global economy.