Daily Update: June 28, 2024

Step right up! In managing monetary policy, the US Federal Reserve is performing a daring high-wire act. 

If the central bank tightens interest rates too much, the economy could cool to the point of recession, putting households and businesses in freefall. If it loosens interest rates too much, the economy could overheat and stoke runaway inflation.

While inflation has come down from its mid-2022 high, the Consumer Price Index has remained persistently above the Fed’s 2% target. The Fed raised interest rates 11 times between March 2022 and July 2023, and it has since maintained its target rate at 5.25%-5.50%.

So far, GDP growth and the labor market are proving resilient despite higher-for-longer rates. That’s led some market observers, such as US Treasury Secretary Janet Yellen, to raise hopes of a soft landing, in which inflation gently reduces as economic growth and employment stay strong. S&P Global Market Intelligence economists expect US GDP to grow 2.49% in 2024, slightly under the 2.54% expansion of 2023.

Different sectors are being affected by higher rates in a variety of ways. In the financial sector, banks are feeling the heat of higher funding costs, which are pressuring their net interest margins. Normally, the pressure on banks would be offset to some degree by the higher interest rates earned through loan portfolios. However, this effect has been limited by hedging activity and seasonal shifts in demand.

Many US banks have said their net interest income has bottomed out, or will do so in the near future. Yet, even if the Fed eases rates, the upside for banks may be delayed as assets are likely to reprice faster than customer deposits, according to BofA Global Research.

In the technology sector, interest rates and inflation have combined with enthusiasm about AI to generate wild swings in investor appetite. Investor sentiment toward tech companies turned sharply negative in January but recovered one month later to reach the highest level since November 2021, according to the S&P Global Investment Manager Index. Research and development budgets and venture capital investment in the tech sector tend to be curbed by higher rates, which have led to a fall in dealmaking since the second half of 2022. 

Regardless, all the buzz around AI is still attracting plenty of attention. In the first quarter, the top 35 venture capital firms in the sector announced 51 AI funding rounds, up from 31 a year earlier, S&P Global Market Intelligence reported. 

In the traditionally capital-hungry metals and mining sector, the higher rate environment in the US has drawn unfavorable comparisons with China, which has kept interest rates below 4% since the end of the COVID-19 pandemic to stimulate its economy.

In the US, higher-for-longer rates have increased mining companies’ interest expenses and made the prospect of building new mines, or expanding existing ones, less appealing. In contrast, Chinese miners’ lower financing costs have helped them expand and tighten their hold on the critical minerals supply chain.

Consumers are also being affected by elevated rates. The wealth gap between the richest 1% and poorest 50% of Americans reached a record $40.917 trillion at the end of 2023, according to Fed data. This reflects the fact that wealthy consumers benefited from rallies in asset prices, while poorer consumers faced higher borrowing costs and relatively steeper increases for items such as food, gasoline and rent.

“[Poorer] households don’t have any excess savings left and they haven't benefited from the massive run-up in stock prices and home values,” Oren Klachkin, a financial market economist at Nationwide, told S&P Global Market Intelligence. “This is a reminder of the fissures beneath what looks like a strong economy at the headline level.”

Rising incomes in lower-paying industries have offered some respite. For example, average wages for leisure and hospitality workers were up 33.1% in April compared with the same month in 2019, above inflation of 22.7%, according to the US Bureau of Labor Statistics.

All eyes are on the Fed’s next move in its delicate balancing act.

Today is Friday, June 28, 2024, and here is today’s essential intelligence.