Conflicting Signals Add Uncertainty to Fed’s Rate Path

Choppiness in the equity market continues as investors look to see a debt limit deal approved.

Though the markets remained optimistic about the chance for a bipartisan deal on extending the federal debt limit, May was nonetheless a time of waiting and seeing, extending a streak of equity market choppiness into a second month.

Affirmation came during the Memorial Day weekend with the White House and House leadership announcing a deal to ensure the government continues to pay its debt. Despite a list of legislators pledging to vote No, the deal is expected to pass, averting a jump into the unknown.

Meanwhile, underneath the political drama, the domestic economy remained stronger than expected. As has been the case during this period of inflation, news that appears good at first glance often has an asterisk. Personal consumption expenditures were higher than expected in April – a sign of economic confidence – though real disposable personal income remained flat on account of higher-than-expected inflation, meaning Americans had to dip into savings to spend.

The prevailing view has been that after its last interest rate increase in early May, the Federal Reserve (Fed) would hold the line on its inflation-fighting strategy. However, if May’s inflation performance, once tallied, resembles April’s, the Fed could be spurred to take another step on the baseline interest rate. This seems unlikely considering other evidence that the economy is slowing down, but it is a possibility that could drag at the performance of the equity market.

“These conflicting signals have added uncertainty to the Fed’s rate path,” said Raymond James Chief Investment Officer Larry Adam. “With many Fed officials still favoring rate hikes, market expectations for rate cuts in the second half of 2023 have faded.”