Blog: You, us, everyone

Recent US inflation data has caused some concern among retail investors, but the Federal Reserve is still expected to ease policy starting in September. While the immediate risks are skewed upwards, there is no reason to maintain a more defensive stance on interest rates as part of a well-diversified portfolio oriented toward the long term.

In fact, combined with a slowdown in the pace at which the Fed is shrinking its balance sheet, helped reassure professional investors that financial conditions aren’t likely to tighten further shortly.

The stock market has since recouped its April losses. However, investors are advised to remain vigilant, as they might develop a false sense of security by the Fed’s guidance and may overlook mixed signals coming from two key areas of the economy.

Labor Market: Heating Up or Cooling Down?
With the monthly job creation being solid, the US job market looks robust. The unemployment rate is a historically low 3.9%, and unemployment claims have remained consistently below the long-term average. The Employment Cost Index, a measure of what employers are paying in compensation, is annualizing at 4.8%, well above its pre-pandemic pace. Hiring intentions among large companies have improved, and consumer confidence metrics suggest that workers still think jobs are easy to get.
 
However, there is room for some concerns. A recent Job Openings and Labor Turnover Survey revealed that job openings fell to their lowest level in three years. Furthermore, quit rates have normalized, suggesting that employee flexibility and audacity are fading. Finally, research suggests that SME hiring intentions have turned negative on the back of higher-for-longer interest rates.

Growth
Recent data related to economic growth is messy - PMI was at 50 in April, indicating neither expansion nor contraction, and the ISM Manufacturing Index slid back below expansion territory. The good news is though that demand is not decreasing for now - durable goods orders and capital spending trends remain solid. And notably, existing U.S. home prices continue to reaccelerate which in turn generates additional spending power for US consumers.

Can you trust the FED guidance?
The Fed, itself, doesn’t seem to have an explicitly stated framework on inflation or employment, despite its dual mandate to pursue maximum employment and price stability. Similarly, while Powell continues to assert that inflation is a result of supply shortfalls in the economy, there is no evidence that the demand acceleration was driven by monetary or fiscal decisions.
 
All this considered, even as Powell was explicit in his latest guidance that the Fed is not contemplating rate hikes, there is some concern that the central bank is overconfident. Given increasingly mixed data, separating noise from signal is hard, and the odds of a policy mistake in either direction are rising.

Investors should keep an eye on consumer and labor-market metrics to determine whether they are heating or cooling, and prepare for markets to churn within a relatively narrow range.
 
Consider restoring over- or under-weight allocations in your portfolio back to longer-term targets and erring on the side of diversification. With mega-capitalization and large-cap equities likely to outperform small-caps, consider adding international exposure, staying neutral-to-underweight on longer-duration bonds, and using real assets and hedge funds to help mitigate emerging risks.