The Markets Wrap Up With a 'Goldilocks' Outlook Bolstered by Data

Stocks rallied after recent economic data indicated that the U.S. economy remains resilient while still allowing for potential Federal Reserve interest rate cuts later this year. The S&P 500 pared down its losses for the week, poised to achieve a fourth consecutive monthly gain. Treasury yields remained largely unchanged, with the market on track for its longest streak of monthly gains since 2021. Meanwhile, swap traders continued to anticipate about 100 basis points of rate cuts from the Fed by the end of the year, suggesting the possibility of a substantial rate reduction, though not necessarily as soon as September.

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U.S. consumer sentiment improved for the first time in five months, driven by slowing inflation and the likelihood of Fed rate cuts. The Fed's preferred inflation measure, the core personal consumption expenditures (PCE) price index, increased modestly, signaling that inflationary pressures may be easing.

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David Russell of TradeStation commented on the economic data, noting that it alleviates fears of a recession and persistent inflation. He suggested that the economy might be entering a "Goldilocks" phase, where conditions are just right for growth without overheating, as Fed Chair Jerome Powell prepares to shift monetary policy.

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Powell recently indicated that the time has come for the Fed to lower its key policy rate, reinforcing expectations that officials will begin cutting borrowing costs next month. His statements also clarified his intention to prevent further weakening in the job market, which remains a central concern for the Fed.

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On the stock market, the S&P 500 rose by 0.7%, while the Nasdaq 100, which is heavily weighted toward technology stocks, gained 1.1%. Treasury yields on 10-year notes remained steady at around 3.87%, and the U.S. dollar experienced fluctuations, heading toward its worst monthly performance of the year.

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In the commodities market, oil prices dropped sharply following reports that OPEC+ plans to proceed with previously announced output increases in the fourth quarter.

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Chris Low of FHN Financial noted that the recent inflation data was in line with expectations, describing it as "Fed-friendly" and supportive of the start of policy easing in September. Tim McDonough of Key Wealth echoed this sentiment, suggesting that the July PCE report supports a 25-basis-point rate cut in September. He added that the focus will now shift to the upcoming August jobs report as the Fed transitions its attention from inflation to the labor market.

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Chris Larkin of E*Trade from Morgan Stanley remarked that the PCE data contained no surprises and confirmed that inflation appears to be under control, which is positive for the economy and investors anticipating lower interest rates. The market's attention will now turn to the next week's jobs data to determine if the economy is cooling at an acceptable pace or if there is a risk of a more significant slowdown.

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Friday's economic report reinforces the belief that it is time to begin easing the Fed's restrictive monetary policy, despite the fact that inflation-adjusted consumer spending showed acceleration from the previous month. Gary Pzegeo of CIBC Private Wealth US commented that the mild increase in core PCE inflation shouldn't alter the Fed's current trajectory. However, he noted that the data does not support calls for more aggressive rate cuts, emphasizing that the Fed will need to see additional signs of weakness in the labor market before considering a larger rate reduction.

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Interest-rate swap markets now indicate a 20% probability that the Fed will lower its key rate by half a percentage point at its September meeting, down slightly from a 24% chance before the data release. Overall, traders are pricing in a total of 97 basis points of easing for the remainder of 2024.

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As the Fed's focus shifts from inflation to the labor market, next Friday's monthly jobs report will be closely watched. Bret Kenwell of eToro noted that last month's jobs report was a significant disappointment, raising concerns that the Fed may have delayed rate cuts for too long. Another weak report could increase speculation about a 50-basis-point cut instead of the currently expected 25-basis-point reduction.

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David Alcaly of Lazard Asset Management observed that the combination of weakening inflation and resilient consumer spending creates a favorable environment for the Fed to begin cutting rates, potentially leading to a soft landing for the economy. He cautioned, however, that the pace of rate cuts in the short term may be less important than the overall depth of the rate-cutting cycle.

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U.S. government bonds have delivered a 1.5% return in August through Thursday, marking the fourth consecutive month of gains. The Bloomberg U.S. Treasury Total Return Index has been rallying since late April, with year-to-date gains approaching 3%, as investors grow increasingly confident in the prospect of lower borrowing costs.

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Florian Ielpo of Lombard Odier Investment Managers remarked that next week's job market data will be critical in determining whether the Fed opts for a 50-basis-point cut, signaling a more urgent need to normalize monetary policy, or a 25-basis-point cut, indicating a more measured approach. Barclays Plc strategists, led by Emmanuel Cau, also emphasized the importance of the upcoming jobs report as a bellwether for the stock market's direction, with strong data potentially calming recession fears and benefiting equities.

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