The Nord Stream pipeline has resumed pumping gas after planned maintenance. Even though Europe could cope with further cuts, the resumed flow of natural gas is welcome news. Eurozone manufacturing PMIs have dipped below 50, indicating a slight contraction, so anything can help at this point.

There is no reason that this has to end in a full-blown recession, as labour markets are healthy and fiscal support remains in place. Of course, the sore point remains the very high inflation prints. The latest reading will likely get close to the 9% mark, keeping the European Central Bank on its toes.

Across the pond this week, the US Federal Reserve (Fed) will likely decide to make another 75-bps rate hike, which is quite unusual from a historical perspective.

Number of the week

But the world does not stand still and eventually the Fed will need to switch from inflation fighting to staving off a potential recession. So, after peak inflation, we will have peak interest rates at or around 3.25% early next year, as the economic headwinds will become too much. If the past is any guide, this level of interest rate should be just about manageable for the economy, and we have the desired soft landing.

This week, we will have peak earnings season as well. 45% of the S&P 500 market capitalisation will report results. Front and centre will be ’Big Tech’. So far, the earnings season has delivered what we expected: more disappointments than usual and cautious guidance all around, particularly for cyclical stocks. This is usually a good sign that the bottom is near.

The FOMC in focus

We expect the Federal Open Market Committee (FOMC) to decide this week to hike the US Federal Reserve funds target range by 75 basis points from currently 1.5%–1.75% to 2.25%– 2.5%. After June inflation data had been reported higher than expected, discussions about an even larger hike have intensified. At the same time, some important inflation drivers like US gasoline prices have declined in July, reducing somewhat the pressure on the Fed to deliver a hawkish surprise.

Further and more importantly, there are more signs that inflation expectations have peaked. The University of Michigan consumer survey also shows that consumers expect less inflation over the longer term, giving the Fed some reassurance that its rate normalisation so far is helping to limit the inflation dynamics over the longer term.

In addition, there are more and more signs that the economic activity is slowing, led by softer residential construction, the area most affected by higher borrowing costs. Together with an already considerable front loading of interest rate normalisation, the FOMC appetite for a surprise at this week’s meeting should be rather low.

Beyond this week’s meeting, we expect the Fed to turn away from its habit to provide guidance regarding the future path of its monetary policy and become even more data dependent. The headwinds for growth from tighter monetary policy and tighter overall financial conditions will peak only in the coming three months, accelerating the current growth slowdown. This calls for maximum flexibility when deciding how much additional tightening is necessary.

Further, the initial estimates for Q2 gross domestic product to be released this week will most likely confirm that the US economy has stopped to expand in the first half of this year. Weak residential construction activity has been a major headwind in May and June. We forecast the Fed to hike rates by less than what consensus expects, namely 50 basis points in September, and conclude the tightening cycle with a final 25-bps rate hike in November this year.

Due to Swiss National Day on 1 August, the next edition will follow on 8 August.