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Fiscal Policy Coming Into Focus

Though August is a notoriously slow month for many due to vacation plans and back to school prep, financial headlines were plentiful as fiscal policy came into focus along with a host of fresh readings on economic data and key updates from the Fed.

First off, the Inflation Reduction Act was passed into law. Analyses from non-partisan economists point to little effect on inflation in the short term, but the act is expected to shrink the trade deficit over time. In additional news from Capitol Hill, President Biden announced a plan for broad-based student loan forgiveness that is estimated to cost about $600B over the next decade, with much of the expense front-loaded. Economists remain divided on how the effects of the program will play out in terms of the broader economy.

In economic news, heavy scrutiny of the consumer price index continued to be a theme. Headline inflation was flat month-over-month but still increased at an 8.5% clip year-over-year, moderating slightly from June’s 9.1% increase. Core inflation (which strips out the typically volatile food and energy components) rose 5.9% year-over-year, matching last month’s increase and indicating that July’s headline number was heavily swayed by a decline in energy costs. Equity investors initially appeared to cheer the data, anticipating a potential pivot in Fed policy and driving stock indices higher. However, Fed Chair Powell in a key speech at the Jackson Hole Economic Symposium reiterated the Fed’s commitment to tighter monetary policy, quelling the optimism and sparking a meaningful selloff that saw stocks close lower for the month.

International developed equities lagged their U.S. counterparts modestly in August, as inflation continued to run exceptionally high across Europe and leading economic indicators declined moderately in the region. Energy costs remained a concern with Russia signaling further disruptions in natural gas supply, thereby raising prices, and potentially squeezing both business profits and consumers’ discretionary spending as we head into the winter months. Emerging markets were a bright spot in August, as they eked out a positive return amid a round of interest rate cutting in China despite questions surrounding economic growth.

Volatility continued in fixed income markets as markets tried to gauge where monetary policy might be headed. The yield on 10-year US treasuries began the month at 2.6% and rallied all the way to 3.1% over the ensuing weeks, leading to broad-based declines in bond prices. All eyes will be on the September Fed meeting with markets now anticipating a third straight 0.75% hike in the federal funds rate.