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MARKETS

Mimicking a cautious Fed, the S&P 500 closed slightly lower on Friday, snapping a four-day streak of record highs. However, gains in technology shares cushioned the decline, which helped the Nasdaq to eke out another record close. The tech-heavy index ended the week up a solid 3%, fueled by a series of softer inflation prints that had Wall Street tongues wagging about the possibility of a September rate cut.

While the broader index decided to take a breather, the Nasdaq continued its ascent. Investors increasingly note the silver lining in the softer inflation data, with whispers of a potential rate cut in September growing louder. The anticipation of a more dovish Fed adds a hopeful buzz to the market, even as the S&P 500 took a momentary pause from its record-breaking run.

Providing a "bad news is good news" gauge of how soon the Federal Reserve might be able to cut interest rates, the preliminary reading of the University of Michigan's Consumer Sentiment Index slipped to 65.6 in June, sharply lower than expectations. This dip in consumer sentiment suggests that the economic outlook may be softening enough to prompt the Fed to consider easing its monetary policy sooner and deeper than indicated in the new Dot Plot released this week.

US consumer sentiment deteriorated for the third month in a row in early June, according to the preliminary read on America’s marquee sentiment gauge. At 65.6, the University of Michigan headline is now at its lowest since November. Consensus had expected a reading of 72 from the last of this week’s US macro releases.

The Michigan release did feel like an afterthought in a week dominated by the June FOMC meeting and favourable inflation data. While Wall Streeters tout strong job numbers and continued disinflation as a boon for equities, Main Streeters have a different story to tell. They remind us that a new home remains out of reach for most, and the 26% increase in grocery bills since 2020 isn’t sitting well.

While Wall Street analysts might scratch their heads over the pervasive gloom, consumers are clearly feeling worse than the aggregated economic numbers suggest, where the sentiment on Main Street doesn’t match the data scrolling on Wall Street computer screens.

Survey director Joanne Hsu noted that assessments of personal finances slipped this month “due to modestly rising concerns over high prices as well as weakening incomes.” While the stock market is basking in record highs, the average American, who cares little about what’s happening on Wall Street, is grappling with a reality where good economic news doesn’t necessarily translate into personal financial comfort.

FOREX MARKETS

Softer-than-expected US inflation data should have sent the dollar tumbling. After all, it hinted that the upcoming May core PCE price data—scheduled for release on June 28—could clock in at a mere 0.2%, or even 0.1%, month-on-month. That would be music to the Federal Reserve's ears, suggesting the possibility of a September rate cuts. However, instead of the dollar weakening, it started gathering a steady safe-haven bid. The catalyst? European markets reacted to an opinion poll showing French President Emmanuel Macron's approval rating dropping to its lowest since 2018. In other words, it looks like European politics, not US inflation data, will be the dominant driver of FX markets this month. It suggests international investors will need substantial convincing to part with their dollars this month.

Another reason to hold onto your dollars is the Bank of Japan's decision to keep rates unchanged, disappointing those who were hoping for a reduction in BoJ JGB purchases. (I guess I can raise my hand on this one.) Let's see how long it takes for the Bloomberg FX editors to start touting 160 USD/JPY. But don't expect USD/JPY to rally excessively.

The general rise in FX volatility should trigger an unwind in carry trading, and along with the drop in US rates, it should eventually push USD/JPY lower. In fact, USD/JPY broke through 157 on Friday ( after hitting 158.25 earlier), following BoJ Governor Kazuo Ueda's remark that any reduction in bond buying would be 'substantial.' So, watch for more action as the story unfolds, but the real fireworks will likely come at the July 31 BoJ meeting.

FRANCE TEETERS ON THE POLITICAL CLIFF EDGE

Investors are not thrilled with the latest political drama in France. The CAC 40's dramatic decline has sent shockwaves through European markets. A 6% drop in a single week is a significant hit, especially when it erases around $100 billion in market value. This isn't just a hiccup—it's a full-blown market tremor. The double-digit losses suffered by France's largest banks further underscore the severity of the situation.

While most analysts and political pundits argue that the chances of France exiting the European Union are slim, the market's reaction suggests a growing unease. Investors are starting to factor in the remote possibility of “Frexit”, spurred on by political rhetoric and the overall instability in the country.

Le Maire and Macron might see fear as their only viable strategy when facing potential disaster at the polls. By amplifying concerns over a potential Frexit, they could be attempting to rally support and stabilize their political standing. It’s a high-stakes game of brinkmanship, with the economic ramifications playing out in real time on the trading floors.

WEEKLY MARKET REVIEW

Equity markets were a mixed bag, where encouraging U.S. inflation data provided a glimmer of hope, but the spotlight was clearly on technology stocks. The S&P 500 edged up 1.6%, while the Nasdaq surged ahead with an impressive 3.2% gain. Tech stocks alone propelled the S&P 500 higher by 6.4%, joined marginally by communication services and consumer discretionary sectors as the sole gainers.

Wednesday was the ultimate showdown with the release of the May U.S. CPI report and the awaited FOMC announcement within a six-hour window. The inflation report delivered better-than-expected news, with the headline rate cooling to 3.3% year-on-year from 3.4% and core inflation easing to 3.4%. May saw core inflation rise by a modest 0.2%, and even the 'supercore' index fell for the first time since 2021. Although the three-month annualized trends still showed room for improvement, the numbers offered a much-needed breather after a challenging start to the year.

With this data in hand, the Federal Reserve kept rates unchanged as widely anticipated. Acknowledging the positive CPI report, the Fed's tone shifted from highlighting a lack of progress to modest improvements toward their 2% target. However, the median outlook now anticipates only one rate cut this year, down from three previously projected. Nevertheless, expectations for more easing in 2025 hint at a gradual approach to normalizing rates by 2026.

Despite the mixed performance, markets closed the week positively, with stocks holding onto their gains. The bond market continues to price in a 50-basis-point cut by the Fed by year-end, keeping September in the spotlight. With three upcoming CPI reports, PCE reports, and employment reports before the September meeting, investors are cautiously optimistic about further moves—provided inflation figures cooperate.

Navigating Turbulence: Fed's Flight Path Amid Economic Clouds

Imagine the Federal Reserve as a pilot circling endlessly over your local airport, awaiting clearance for a safe landing. Jay Powell, our intrepid pilot, eyes the runway, aiming for that elusive "soft landing" where both Wall Street and Main Street can cheer in relief. This week's FOMC meeting hinted that we may need another round of circling before we get that all-clear signal.

So, what's holding up the Fed's landing? Besides the usual requirement of "greater confidence that inflation is sustainably moving towards the 2% goal," Powell dropped hints during his press conference. He skillfully dodged when asked if a few solid inflation reports like May's could suffice, emphasizing the Fed's staunch "data dependence." They're eyeing inflation and the entire economic picture—balancing risks and closely watching labour market dynamics.

Investors and analysts are now on high alert for upcoming inflation reports, key labour market indicators, and growth metrics like retail sales and industrial production. Any unexpected strength in these could throw a wrench in the Fed's rate-cut plan. Ironically, recent economic data suggest a sharper slowdown than expected, with surprises consistently disappointing forecasters.

Specifically, the surge in initial jobless claims and varying economic indicators across states highlight potential cracks in the labour market. Powell stressed the Fed's focus on broader inflation trends rather than isolated factors like home prices, signalling vigilance across all sectors—especially energy and commodity markets.

As we buckle up for the coming months, keep an eye on inflation trends beyond year-on-year measures, which might lag behind real-time economic shifts. The Fed's cautious approach balances the need to control inflation while avoiding a downturn in employment, navigating a complex path through uncertain economic terrain.

In essence, strap in—because the data ahead will shape financial markets for the remainder of the year, potentially determining when and how the Fed will finally guide us to a smooth economic landing.

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