Rotation continues, but Europe doesn’t benefit

We went from ‘the Federal Reserve (Fed) could hardly cut in September’ to ‘it would be a mistake not to cut in July or September’ (source: Mohammad El Erian’s Linkedin feed) in a blink of an eye. Everything seems upside down since last week. The Big Tech stocks that have been rallying relentlessly since the beginning of 2023 are hit hard by rapid outflows as worries regarding the AI spending and the realization that it may take time to see the benefits of this massive spending push investors to take a part of their profits and walk away.

Walk away where?! Walk away toward the treasuries and government bonds with the expectation that the Fed and other central banks will either start or continue cutting their rates, and walk away toward the smaller and cyclical pockets of the equity markets. In this context, we’ve been seeing the lower S&P500 and Nasdaq countered by a rise in economically sensitive sectors since about two weeks now. And diving into the S&P500, around 300 of the stocks in there actually gained yesterday, US crude rebounded after testing the $77pb support and the Rusell 2000 stocks rallied 1.26% – reinforcing the rotation trend – from tech to non-tech - after the latest growth update showed that the US economy not only secured a 2% growth but grew at an impressive pace of 2.8% last quarter – double the first quarter number which had seen the growth rate fall to 1.4%. Consumer spending grew 2.3% and helped keeping the US economy on a strong path – although the savings are melting and credit card debt is rising to levels not seen in a decade. Core PCE prices eased from 3.7% to 2.9% during the quarter. And although the easing in prices was not as much as analysts expected, the Fed rate cut expectations didn’t really got hurt by the strong numbers as again, it’s now thought by some big names that not cutting rates in one of the two next meetings would be a policy mistake for the Fed. I personally think that cutting rates next week would be a mistake too, given the still-strong inflation and unbelievable growth numbers. Presently, activity on Fed funds futures don’t show a meaningful bet for a July cut; the probability of a cut next week is given less than 7%.

We have one more important data to go before next week’s decision: the core PCE index, the Fed’s favourite gauge of inflation. That number is expected to show a slight slowdown from 2.6% to 2.5%, although we may see a certain quickening in the monthly figure. But all in all, if not catastrophic, the Fed will probably hint that a rate cut is coming in fall, when they meet next week. The US 2-year yield shortly fell to 4.34% despite the strong GDP read, the 10-year yield sit on 4.25% and the US dollar index hovered around the 200-DMA as the economic picture wasn’t as sunny as in the US elsewhere. On the contrary, weak French and Germany business surveys came to complete the cloudy picture painted by PMI surveys printed earlier in the week. And the earnings from European companies are less than enchanting, preventing the European stocks from benefiting from the sector rotation in the US. Kering- which is the house of luxury brands including Gucci and Balenciaga – dropped 7.5% after warning that its profit is set to tumble in Q2 and pulled LVMH, Hermes and Burberry down with. And note that Hermes couldn’t escape the luxury selloff even after announcing that its own sales jumped… Stellantis fell more than 7% after revealing that their earnings plunged in the H1 and Nestle dropped 5% after downgrading its sales outlook for the year. All in all, the earnings didn’t look great. If we do an overall summary, around 40 of MSCI Europe stocks released earnings this far, and only half of them have beaten analyst forecasts. So the Stoxx 600 really looks toppish right  now. The weak economic data and meagre earnings boost the European Central Bank (ECB) rate cut expectations for September, but I don’t know if the ECB alone could cheer up investors. The EURUSD found support near the 1.0825 despite unpleasant news and data. But the sticky US growth limits the Fed’s rate cut potential, hence could also limit the euro’s upside potential against the greenback.

Elsewhere, the USDJPY tipped a toe below the 152 yesterday and on rising expectation that the Bank of Japan (BoJ) could hike its policy rate next week. But the BoJ is not the Fed, or the ECB. Just because the market expects a rate hike doesn’t mean it will actually happen. The BoJ could easily disappoint those anticipating a hike next week, delivering a blow to long yen positions.