Market View

The battle of Centre Court: aces or unforced errors

To mark the beginning of British summertime, Wimbledon has taken centre stage with its iconic tennis championships.

Jeremy Sterngold
Tennis court

While the hopes for the title sadly faded for the British players in the first week, the tried and tested combinations of both Pimm's and lemonade and strawberries and cream should be enough to lift the spirits of the attendees to this auspicious event. As the tournament is due to end this weekend, tennis fans will relish these last games before waiting for the US open tournament to commence at the end of the summer.     

Meanwhile for investors, the most closely watched Centre Court battle has been that of the Federal Reserve (Fed) with inflation. While both contenders talked a good game, it seemed like the Fed was overconfident in its ability to read transitory shots coming its way which led to unforced errors, and saw it drop the first set. 

As the Fed began the process of stopping asset purchases, which ramped up in the second set, it seemed like the momentum may swing back in its favour. Alas, it then fell foul of the large supply shocks caused by Russia’s war in the Ukraine and a much tighter labour market. With two sets down, the Fed had a reality check and attempted to regain its composure. It started the third set cautiously with a 0.25% hike resulting in some easy points. The Fed then built on this momentum with a 0.5% hike before really smashing an array of aces with four back-to-back 0.75% rate hikes. A very decisive third set win for the Fed.  

The fourth was a bit more balanced. While the Fed retained some momentum, it focussed on the endurance battle of winning the next two sets. It slowed the pace of hikes to 0.5%. Meanwhile, inflation still managed to return shots from base(line) effects. Elsewhere on the court, its seemed that its ability to deliver surprising blows was diminished. However, the fourth set was then interrupted by the stormy conditions, which could have altered the momentum. This collapse of Silicon Valley and Signature Bank raised financial stability concerns. However, despite the remaining clouds, the roof was now covered, and thus the Fed continued with a series 0.25% hikes before trying to take stock of its strategy. The fourth set was eventually won by the Fed as unforced inflationary errors kept creeping up. From an annualized rate of 4.9% in April, headline CPI decline further to 4% and then 3% in May and June respectively. The last shots proved extremely decisive, as core inflation rose by only 0.16% Month over Month in June. 

While the annualised core inflation rate is still elevated at 4.8%, if we annualise the latest monthly data, this would see core price below 2%. 

As we approach the decisive fifth, and final, set, the Fed seems to retain some momentum. Despite the inflation appearing to fade, aided by falling input costs and China battling deflation, the Fed still seems determined to up the ante with another 0.25% hike in two weeks’ time, potentially the last one of this hiking cycle. The question is now whether it is necessary to still proceed with this, especially given the effects of past tightening is yet to be fully transmitted to the economy. While the labour market remains historically tight, job gains have been more muted and job openings have declined meaningfully over the past year. Economic growth, while more resilient than anticipated, still seems set to be below trends levels for the US. Real interest rates will move higher as inflation cools, meaning the level of policy becomes more restrictive over time without any rate cuts to compensate. All in all, while it seems like the Fed is not far off the “game, set and match” in its epic battle versus inflation; it needs to be careful that it does not cause a big injury to the economy by overtightening in the process. That would be an unforced error that is unlikely to go down well in Flushing Meadows or Washington. 

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