The S&P 500 and Nasdaq both fell over 2% this week as rising interest rates spooked investors. Upside surprises in economic data, including better than expected July retails sales, housing-starts and industrial production showed that no recession is in sight. In fact, there is growing concern that the Federal Reserve will need to raise rates still further to tame inflation.
Good economic news generally results in higher interest rates and vice versa. For the first half of 2023, falling inflation, weaking economic data, and worries about an impending recession drove interest rates, as measured by the 10-year treasury, to a low of 3.28% in April.
Meanwhile inflation fell from a high of 9% in 2022 to a low of 3% in June. The market cheered inflation’s demise and we all enjoyed a recovery rally in both stock and bond markets.
But we remain in a risky market. July’s inflation rate went back up to 3.2%, showing that the war on inflation is hardly over. The Atlanta Fed’s GDPNow tracking model raised the Q3 real GDP growth rate projection to a seasonally adjusted 5.8%, surprisingly strong growth that could make it tough to reach the Federal Reserve’s 2% inflation target without further rate increases. The Bond market responded to the good economic news with a sharp rise in interest rates. The 10-year Treasury bond yield rose to 4.25% topping last year’s high, and mortgage rates, as tracked by Freddie Mac’s Primary Mortgage Survey, topped 7%, back to 2022 levels.
Can the Federal Reserve get inflation under control without causing a major recession? That is the question everyone is asking. July’s economic data shows that the recession has not arrived, but the inflation fight is far from over.