Economic Surprise Index and the Fed
Table of Contents
Federal Reserve Chair Jerome Powell said the U.S. economy remains in a “solid position” and is not facing imminent recession risks, despite growing concerns over the inflationary impact of President Donald Trump’s tariffs. His remarks came during opening testimony before the House Financial Services Committee on June 24, less than a week after the Fed voted to hold interest rates steady for a fourth consecutive meeting.
“Despite elevated uncertainty, the economy is in a solid position. The unemployment rate remains low, and the labor market is at or near maximum employment,” Powell stated.
Committee Chair French Hill highlighted a potential disconnect between Powell’s outlook and the latest GDP report, which showed a slight contraction in the U.S. economy during the first quarter. Both Hill and Powell acknowledged that the contraction was likely driven by importers front-loading their purchases in anticipation of upcoming tariffs, rather than underlying economic weakness.
Supporting Powell’s view, the Atlanta Fed’s GDPNow model suggests the economy is not on track for a recession, defined as two consecutive quarters of negative GDP growth. The model’s latest forecast projects 3.4% GDP growth in the second quarter.
Still, warning signs are emerging beneath the surface. Bloomberg’s U.S. Economic Surprise Index fell sharply in June to its lowest level in nine months and is declining at one of the fastest rates in three years.
The index tracks whether economic data beats or falls short of consensus expectations. Positive readings signal stronger-than-expected economic data, while negative readings suggest weakness. This week, the index—which incorporates metrics such as industrial production, retail sales, and manufacturing and services PMIs—plunged to -23.
The Citigroup Economic Surprise Index, which weighs macroeconomic indicators based on their effects on foreign exchange markets, paints a similar picture with a reading of -20.8 as of June 23.
“Data continues to suggest slowing economic activity in the U.S.,” wrote The Kobeissi Letter, a markets commentator.
Extensive research from LSEG has shown that economic surprises—defined as the difference between actual data releases and consensus forecasts—affect currency markets, U.S. bond prices, and equity valuations. Across all three markets, the most impactful indicator was U.S. nonfarm payrolls, followed by private payrolls and ISM manufacturing PMI.
LSEG observed similar effects in a separate study of U.S. equity indexes, identifying inflation surprises as the most influential indicator.
Adding to these concerns, the Conference Board’s Leading Economic Index for the U.S. edged lower in May, with the index’s six-month growth rate officially triggering the recession signal. While the Conference Board’s Justyna Zabinska-La Monica said she doesn’t expect a recession to materialize, she acknowledged that a “significant slowdown in economic growth” is likely.
Widening Interest Rate Differentials
|
Monetary Authority |
Current Policy Rate |
|
U.S. Federal Reserve |
4.50% |
|
European Central Bank |
2.00% |
|
Swiss National Bank |
0.00% |
|
Bank of England |
4.25% |
|
Bank of Canada |
2.75% |
Economic surprises have influenced the Fed’s decision to keep interest rates on hold, with Powell emphasizing the central bank’s obligation to prevent inflation from becoming a bigger problem.
“We’re just trying to be careful and cautious,” Powell said during his congressional hearing. “We really think that’s the best thing we can do for the people that we serve.”
With the Federal Reserve slow to adjust interest rates, global monetary policy has taken an unusual turn, as European central banks have moved more aggressively to lower rates. In June 2024, S&P Global noted that it was only the third time in history that the European Central Bank (ECB) had “started a cycle of monetary policy easing before the U.S. central bank.”
Twelve months later, interest rate differentials between the United States and Europe have continued to widen.
On June 5, the ECB cut its key interest rate to 2%, marking its eighth reduction this year and the lowest since early 2023. Meanwhile, central banks in Switzerland, Sweden, Denmark, and the United Kingdom have also lowered rates in recent months.
Most notably, the Swiss National Bank (SNB) reduced its key rate by 25 basis points to 0% this past week, becoming the first major central bank to return to the zero-bound. The Bank of England and Norway’s central bank held rates steady last week, following earlier cuts this year.
Unlike the Fed, European rate-setters have seen inflationary pressures ease in recent quarters, with the SNB noting that its inflation outlook is “within the range of price stability over the entire forecast horizon.”
As JPMorgan research analyst Mary Park Durham noted, these rate differentials may remain elevated “as markets are currently pricing in only a limited number of Fed cuts” compared to other central banks.
A widening interest rate differential between the United States and Europe, where U.S. rates are higher than European rates, can significantly impact currency values, capital flows, and economic growth in both regions. Historically, higher U.S. rates attract foreign investment, strengthening the dollar and potentially eroding the euro’s value. However, the market’s reaction this year has been far from conventional.
Market Reaction
Despite some interest rate advantages, the U.S. dollar is off to its worst start to a year in decades, according to Dow Jones Market Data.
The U.S. Dollar Index (DXY), which tracks the greenback against a basket of six major currencies, has fallen nearly 10% since the beginning of the year.
The U.S. Dollar Index has fallen below 98.00. Source:
Concerns about the long-term impact of tariffs and the potential for a resurgence in inflation have weighed heavily on the dollar. The Organization for Economic Cooperation and Development (OECD) recently raised fresh alarms, projecting U.S. annual inflation to reach 3.9% by year-end. The forecast was significantly more pessimistic than a recent projection by former Fed Chair and Treasury Secretary Janet Yellen, who estimated that inflation would likely rise to 3% as a result of President Trump’s trade agenda.
According to Kamakshya Trivedi, head of global foreign exchange, interest rates, and emerging markets strategy at Goldman Sachs Research, the dollar’s weakness is likely to persist amid a deteriorating economic outlook marked by rising tariffs, softening corporate earnings, and declining consumer sentiment.
“That combination, alongside the fact that people are over-allocated to US assets, means that there is a shift taking place that benefits other currencies—chiefly the euro, but also the pound,” said Trivedi.
Although a significant portion of the dollar’s decline occurred during April—a month punctuated by extreme volatility as President Trump proposed “Liberation Day” tariffs on more than 50 countries—Charles Schwab’s chief fixed income strategist, Kathy Jones, expects turbulent conditions to persist throughout the year.
“If the U.S. continues to pursue an aggressive trade policy, the dollar is likely to trend lower,” she said. “It appears that investors have begun to reduce allocations to U.S. markets after years of accumulating U.S. dollar assets.”
