“Return to normalcy” was a campaign slogan used by Ohio Republican Warren G. Harding during the 1920 U.S. presidential election. Harding, who won the White House with more than 60% of the poplar vote, promised to restore America to the simpler era that existed before World War I.

Lately, it seems as if Wall Street has adopted that slogan. As summer looms ahead, economic growth, the jobs market, inflation, and monetary policy are simultaneously going through a post-COVID period of normalization.

The ongoing economic expansion, now better aligned with easing inflation pressures, and the initiation of rate-cutting cycles by two major central banks, have led to rising stock prices in the U.S. and globally. I believe that this confluence of trends will become more pronounced in the second half of the year.

Despite elevated inflation and the Federal Reserve’s aggressive tightening, U.S. gross domestic product (GDP) managed to grow above 2% for six consecutive quarters until early this year. Factors such as pandemic-era savings, fiscal spending, and low fixed-rate mortgages have mitigated the impact of rising interest rates.

However, high borrowing costs are gradually affecting the economy. Low- and middle-income consumers are beginning to push back against rising prices, as noted by several retailers in their latest quarterly operating results.

Wage growth has outpaced inflation over the past year, supporting consumer spending. But with the labor market cooling and inflation progress stalling in early 2024, real wage growth has slowed, weighing on discretionary spending. The recovery in housing and manufacturing also is mixed, though improvement is expected.

From my perspective, the economy is on track for a soft landing in 2024, whereby growth slows enough to control inflation without causing a recession. Scenarios of rapid growth and inflation (no-landing) or a severe recession (hard-landing) seem less likely this year.

Wall Street is coming around to this view, as evidenced by the positive week posted by the main equity indices (see chart).

The tight labor market has been a notable feature of this business cycle, supporting economic expansion while raising inflation concerns. Recent data indicates that the labor market remains strong but is gradually loosening. Regardless, the likelihood of “stagflation” is remote.

Last week, the Bank of Canada lowered its interest rate to 4.75% from 5%, and the European Central Bank followed with a quarter-point cut to 3.75% from 4%. These actions mark the start of a measured, multi-year rate-cutting cycle, though without a fixed path.

Growth in Canada and the eurozone remains sluggish, and officials aim to avoid overly restrictive monetary policy. However, looser policy could increase services inflation in Europe and revive Canada’s housing market.

The Federal Reserve is expected to keep rates steady at 5.5% at its meeting June 11-12, with new projections likely indicating one or two rate cuts this year, down from three projected in March. As the labor market and economic growth moderate, further inflation progress may allow the Fed to cut rates, possibly starting in September.

Global interest rates have likely peaked for this cycle and will gradually decline as central banks pivot to rate cuts. I expect the Fed to start normalizing policy soon, leading to lower bond yields over the next year. Investors with high allocations to cash investments should consider diversifying into intermediate- and long-term bonds to mitigate reinvestment risk.

In the meantime, the many pieces of the puzzle are coming together. The stock market rally should have sufficient impetus to continue in the coming months.

The week ahead…

Keep an eye on the following economic reports, scheduled for release in the coming days: NFIB optimism index (Tuesday); consumer price index (CPI) and Federal Open Market Committee (FOMC) decision on interest rates, followed by Fed Chair Jerome Powell’s press conference (Wednesday); producer price index (PPI), initial jobless claims (Thursday); consumer sentiment (Friday).

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John Persinos is the editorial director of Investing Daily.

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