Economic Outlook

Growth

Employment

• Payrolls increased 139,000 in May
• Unemployment held flat at 4.2%
• Wage increases continue to be moderate 

  
  

The US economy added a moderate 139,000 jobs in May. Unemployment has gradually moved up from 3.4% from two years ago but remains low at 4.2%. Wage increases have held to a level that should not contribute very meaningfully to inflation. Reported job openings have declined to 7.4 million, only slightly higher than the number of unemployed workers. Job openings were over 11 million in early 2022. With respect to employment, any evidence of a slowdown is showing up primarily in the lower number of open positions, rather than in the number of unemployed.  

Inflation

• May CPI held at 2.4%
• Core CPI was also flat at 2.8% 
• Inflation improving, but still above 2%

  
  

For the 12 months ending in May, CPI inflation was 2.4%. Declines in the price of gasoline helped lower the inflation rate, however, natural gas and electricity were up.  Housing continues to make an outsized contribution to inflation, while food inflation has moderated. Air fares have come down over the past year with declines in energy, however, war in the Middle East may limit further progress on energy inflation. Improvements in inflation are occurring at a slower rate and the overall rate of inflation remains above the Fed’s 2% target. Tariffs, which will add to the cost of many goods, are not yet reflected in the inflation rate. The consumer’s perception of inflation remains elevated because prices remain elevated. Inflation is a measure of the rate of change in prices, not the overall level of prices.

Interest Rates

• Federal Reserve faces a very tough dilemma 
• Short-term target rate held at 4.25%–4.50%
• Key 10-year Treasury rate at 4.44%

The Federal Reserve’s Open Market Committee met on June 17 and 18. As expected, they left their target for short-term rates unchanged, as they did at their previous meeting. Political pressure is mounting for a rate cut; however, the futures market is indicating that the first cut will probably come no sooner than the September meeting. Political pressure is almost always in favor of lower rates. We cannot recall any President ever arguing for higher rates, even during periods of high inflation.  

With the economy slowing down and inflation still above their target of 2%, the Fed is facing a very tough dilemma. Cut rates too soon and inflation may stop improving or even turn up, especially if tariffs contribute significantly to the cost of goods. If they wait too long, the economy may stall or even fall into recession. The labor market continues to be solid, so unemployment is not forcing their hand at current levels. Most projections, and the bond market itself, are indicating that we will still get two rate cuts by the end of 2025. While some short-term rates, notably the three-year Treasury, are lower, the 10-year Treasury remains above 4.3%. A great deal of longer-term credit rates, such as 30-year fixed mortgages, are priced off the 10-year Treasury yield. Under most circumstances, the Federal Reserve has very little influence over intermediate term rates, such as the 10-year Treasury yield. The persistence of high yields on intermediate term bonds, can be attributed to the pace of government borrowing. That borrowing is, in turn, pushed up by continued deficit spending. The “Big Beautiful Bill” working its way through Congress does nothing to reduce the pace of government borrowing.  

Markets

• Stocks sell off then recover on news of war
• International stocks outperforming US
• Bonds earning yields above inflation rate 

Stocks sold off following the beginning of hostilities between Israel and Iran but quickly bounced back and have traded in a range for most of this month. This selloff was much shallower and more short-lived than the selloff following the announcement of tariffs on April 2. At this writing, the S&P 500 is trading at about 5966 and is up just over 1% so far this year. It has experienced a lot of volatility for such a lack of direction. International stock indexes, which have trailed their US equivalents for the last several years, have outperformed domestic stock indexes in this volatile environment. The MSCI World index is up 5.9% YTD and Euro Stoxx 50 is up 6.9% YTD. Investors seeking diversification may want to consider exposure to international stocks.

The US dollar has lost ground against most major currencies; the US currency is down over 9% YTD compared to a basket of major foreign currencies. The dollar decline reflects tariff turmoil, excessive federal debt and the loss of America’s last AAA credit rating. Today, more international companies are asking for payment in currencies other than US dollars, something rarely seen since WWII.

Real interest rates on bonds–the yield above the rate of inflation–are at highs that have not been seen since 2007. Investors seeking preservation of capital can earn interest at rates above the pace of inflation, a condition not seen in the ultra-low rate environments following the financial crisis and COVID. Surprisingly, US Treasuries did not benefit substantially from the outbreak of war, signaling that US debt is no longer the automatic safe-haven it has been during past geopolitical crises. Yields on the 10yr-Treasury bond have declined 8 basis points (0.08%) since this time last month and now stand at 4.38%. 

If we can help you navigate this changing business climate, please do not hesitate to contact your United Community banker. We appreciate your readership.