Monetary
The Fed is unanimous in expecting a mild tightening cycle of no more than 75 bps, but that outcome is contingent on a rapid drop in core inflation in 2027.
We remain constructive on US equities, but higher yields, slower EPS growth and heavy IPO issuance remain significant risks to valuations, leaving the path to our year-end target increasingly dependent on earnings. Tactically, there has already been a significant, but benign, compression in multiples, as earnings have outpaced prices. A well-communicated Fed hike could ease rather than intensify bond-market uncertainty.
The US Treasury department’s attempts at yield suppression are doomed to fail unless the Federal Reserve gets involved.
An acute shortage of AI hardware will support tech stocks into year-end. However, AI companies may need to ultimately generate $10 trillion per year in revenue to justify their capex. Barring a massive increase in productivity growth, this will be very difficult to achieve. Despite today’s Treasury announcement of upsized buyback operations, bond yields are likely to remain elevated over the coming months. Rising crack spreads have reduced the demand for crude, which is not encouraging for global growth. On the FX front, recent intervention to support the yen will probably be insufficient, but there is significant long-term upside for the currency.
Despite today’s hold, the bar for a rate hike in September remains low and contingent on the next two core CPI reports.
We discuss what recommendations to expect from the Fed’s balance sheet task force. We conclude that any future balance sheet consolidation will be smaller than many anticipate.
May CPI data show no evidence of passthrough from energy prices to core inflation. This will keep the Fed on hold for the time being.