The U.S. Economy Is Stronger Than Expected. That Could Keep Interest Rates Higher for Longer
New data suggests the U.S. economy is stronger than expected, with business activity accelerating more than expected, pointing to an economy that continues to expand despite elevated interest rates and lingering inflation pressures.
Intelligence analysis by Llama
The U.S. economy is showing more momentum than expected, with a composite PMI climbing to 53.6 in July, its highest reading in eight months, signaling roughly 2% annualized GDP growth in Q3. This makes it harder for the Fed to justify easing monetary policy anytime soon.
The US economy is doing better than expected, which means it's growing and making more money. This is good for companies and their profits, but it also means the Federal Reserve might not lower interest rates as quickly as some people were hoping.
Analysis
A Stronger Economy Than Expected
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.
Why That's a Challenge for the Fed
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.
What It Means for Investors
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.
Key points
- S&P Global's composite PMI climbed to 53.6 in July from 51.9 in June, its highest reading in eight months.
- The services PMI rose to 53.6 while manufacturing remained solid at 53.8.
- Hiring improved for the first time in three months, while business confidence climbed to an eight-month high.
- The labor market remains uncertain, with unemployment hovering around 4.2% and record numbers of people leaving the workforce.
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.
Energy prices and geopolitical tensions could reignite inflation, while an unexpected slowdown could quickly shift the Fed's outlook.