The U.S. Economy Is Stronger Than Expected. That Could Keep Interest Rates Higher for Longer
The U.S. Economy Is Stronger Than Expected. That Could Keep Interest Rates Higher for Longer.
S&P Global's composite PMI climbed to 53.6 in July, its highest reading in eight months, signaling roughly 2% annualized GDP growth in Q3.
Rising input costs, supply chain disruptions, and the fastest selling-price increases in years give the Fed little reason to cut rates before 2027.
Companies with strong balance sheets, free cash flow, and pricing power are best positioned to outperform in a higher-for-longer rate environment.
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The biggest question facing investors today isn't whether the U.S. economy is slowing -- it's whether it's slowing enough for the Federal Reserve to finally begin cutting interest rates. New data suggests the answer may be no.
S&P Global 's flash PMI report for July showed business activity accelerating more than expected, pointing to an economy that continues to expand despite elevated interest rates and lingering inflation pressures. That's good news for corporate earnings, but it also makes it harder for the Fed to justify easing monetary policy anytime soon.
S&P Global's composite PMI climbed to 53.6 in July from 51.9 in June, its highest reading in eight months. Both major parts of the economy contributed to the improvement, with the services PMI rising to 53.6 while manufacturing remained solid at 53.8.
According to S&P Global Chief Business Economist Chris Williamson, the survey is consistent with annualized GDP growth of roughly 2% during the third quarter. Hiring improved for the first time in three months, while business confidence climbed to an eight-month high.
Perhaps most encouraging was the balance between sectors. Earlier in the recovery, services largely carried the economy while manufacturers struggled. Now both are expanding, suggesting growth has become broader and more sustainable.
Normally, stronger economic growth is something to celebrate. But for the Fed, it also raises the risk that inflation remains stubbornly above its 2% target.
While June's inflation report showed encouraging progress, the PMI survey painted a more complicated picture. Input costs rose at the fastest pace in 14 months, supplier delivery delays reached their worst level in nearly four years amid Middle East disruptions, and businesses reported the strongest selling-price increases in years.
The labor market also remains uncertain: it appears healthy, with unemployment hovering around 4.2%, but there are also record numbers of people leaving the workforce.
Taken together, those trends reduce the urgency for rate cuts. Markets overwhelmingly expect the Fed to leave rates unchanged at its late-July meeting, and many economists now believe the first cut may not arrive until 2027.
For long-term investors, this isn't necessarily bad news. A resilient economy supports corporate profits, even if borrowing costs stay elevated. Companies with strong balance sheets, consistent free cash flow, and pricing power tend to perform well in a "higher for longer" rate environment, while heavily indebted businesses often struggle as financing costs remain elevated.
There are still risks. Energy prices and geopolitical tensions could reignite inflation, while an unexpected slowdown could quickly shift the Fed's outlook. But for now, the latest PMI report reinforces that the economy continues to grow at a healthy pace rather than slipping toward recession.
Instead of trying to predict exactly when the Fed will move, investors are generally better served by focusing on owning high-quality businesses, staying diversified, and taking advantage of market volatility when opportunities arise.
July's PMI data suggests the U.S. economy entered the third quarter with more momentum than expected, reinforcing the likelihood that interest rates remain higher for longer. While that may disappoint investors hoping for quick rate cuts, a durable economy is ultimately a positive backdrop for long-term wealth creation.
Rather than betting on Fed policy, investors should focus on businesses capable of growing earnings through a variety of economic conditions.
