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MARKETS
 

U.S. stock indexes edged back from their record highs on Thursday, driven by a dip in Nvidia's shares following a mixed set of economic reports. The S&P 500 declined by 0.3% from its all-time high set before the pause for the Juneteenth holiday. The Nasdaq composite also retreated from its record, slipping 0.8%. In contrast, the Dow Jones Industrial Average outperformed, gaining 299 points, or 0.8%.

Nvidia, a favourite on Wall Street, saw its early gains evaporate, ultimately closing down 3.5%. This drop jeopardized an impressive eight-week winning streak and allowed Microsoft to reclaim the top spot as the most valuable company in the market. Nvidia has been a significant player in the artificial intelligence (A.I.) boom, with its chips at the heart of this technological revolution. A.I. enthusiasts anticipate massive growth in productivity and profits, driving Nvidia's stock up 164% this year, following a more than threefold increase last year.

The remarkable gains for Nvidia and other AI-driven stocks have raised concerns about a potential market bubble where investor enthusiasm may be reaching unsustainable levels. Despite these concerns, the strong performance of these companies has bolstered the stock market, even as the U.S. economy displays signs of weakness.

High interest rates aimed at curbing inflation have negatively impacted both the housing market and the manufacturing sector. Additionally, lower-income households are increasingly grappling with rising prices, exacerbating economic concerns. The housing market, in particular, is confronting mounting challenges, with affordability issues and higher mortgage rates dissuading potential buyers and sellers, the latter of whom are reluctant to give up their lower-interest mortgages that many locked in during the Covid pandemic.

As investors continue to pour into AI-related stocks, the broader economic picture remains mixed, highlighting the disconnect between market performance and underlying economic health. While the enthusiasm around A.I. technology underscores its transformative potential, the broader implications of the weaknesses manifesting in the U.S. economy are becoming difficult to ignore.

May's new construction pace, at 1.277 million, was nowhere near consensus. Thursday's release showed a 5.5% month-over-month decline against expectations for a small gain. Single-family starts were the lowest since October, at 982,000. Recall that October was the crescendo of a three-month selloff at the long end of the U.S. Treasury curve. Mortgage rates peaked near 8% that month. In November, builder sentiment came within three points of matching the cycle low. With sentiment deteriorating and construction activity flagging anew, builders are evident in the June vintage of the NAHB survey: high rates are a problem.

Treasury yields ticked higher in the bond market following a spate of mixed reports on the economy. The number of U.S. workers filing for unemployment benefits eased last week, but not by as much as economists expected. A separate report said manufacturing in the mid-Atlantic is growing, but not as quickly as economists thought. Home builders, meanwhile, broke ground on fewer new homes last month than expected.

Adding further complexity, The Bank of England held rates steady but hinted at a possible cut in August.

FOREX MARKETS
 

Currency interventions by Japanese authorities seemed to have minimal impact on the yen's weakness across the board. The yen is hitting historic lows against the British pound and other currencies, driven by carry trades where investors borrow yen at low interest rates to invest in higher-yielding assets.

The market's reaction to the Bank of Japan's cautious stance at its recent policy meeting exacerbates the selling pressure on the yen. Investors appear to be interpreting the BOJ's policy approach as a signal that the yen's weakness will persist, further fueling currency speculation and contributing to the yen's continued decline against a range of global currencies, despite more intervention chatter.

Japanese life insurers have significantly reduced their hedging against a strengthening yen, reaching the lowest level in a decade. According to reports compiled by Bloomberg, as of March 31, nine of Japan's largest life insurers had only 47% of their foreign securities protected with derivatives to shield against yen appreciation. This reduction in hedging suggests that insurers might anticipate a continued weakening of the yen. By not hedging, insurers indicate a belief that the yen will either depreciate further or remain stable enough that the cost of hedging outweighs the benefits. This strategic shift could reflect broader expectations about Japan’s economic conditions, monetary policy, and global financial trends in the coming months.

In Asia, the USD/CNH spiked after the People’s Bank of China set the USD/CNY at its highest level this year. Despite this, a substantial move in USD/CNH is unlikely as China aims to avoid significant capital outflows. However, the weaker CNH exerts a notable influence across Asian foreign exchange markets, impacting currencies like the yen.

The Euro is also facing challenges, slipping ahead of the first-round parliamentary vote in France on June 30. If things go poorly, the Euro's fate lies with the European Central Bank and its willingness to backstop French bond yields to prevent broader contagion risk. According to Reuters reports, European Central Bank policymakers have no plan to discuss emergency purchases of French bonds. They still think it is up to French politicians to reassure investors spooked by the prospect of a far-right government.

Goldman Bullish On Gold
 

Goldman Sachs analysts Daan Struyven and Lina Thomas recently emphasized significant risks to inflation and bond returns under a potential Republican electoral sweep. They argue that gold should be considered a hedge against these risks, labelling it "Your (Golden) Inflation Hedge for US Elections."

Their analysis suggests that post-election scenarios involving higher tariffs, reduced immigration, stricter sanctions on Iranian oil, lower taxes, and increased attempts to influence Federal Reserve policy could amplify inflation risks. They view these factors as potentially driving up inflation more under a Republican sweep than other electoral outcomes.

Goldman Sachs recommends long positions in gold, citing its historical role as a hedge during periods of geopolitical uncertainty and concerns over US debt levels. They project a base case price target of $2,700 for gold by year-end, driven by robust demand from emerging markets and Asian households.

Struyven and Thomas also foresee a potential 15% increase in gold prices in response to new financial sanctions or heightened concerns about US debt. They highlight potential friction between Federal Reserve Chair Jerome Powell and the Trump administration, suggesting that any perceived "Fed subordination" could further bolster gold prices.

Overall, Goldman Sachs' analysis underscores the strategic value of gold as an inflation hedge in the context of evolving geopolitical and economic dynamics surrounding the US elections and Fed policy.

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