3rd June 2024
Summary
Equity markets were mildly negative in a short week due to the bank holiday. Despite last week’s decline, May showed positive returns for most regions
There was continued upward pressure on bond yields, driven by hawkish Federal Reserve (Fed) officials, strong US economic data, and unremarkable inflation figures. Yields remain slightly below their peak for the year
Eurozone inflation rose to 2.6% in May, slightly above expectations, with core inflation at 2.9%
European sovereign yields increased, with the 10-Year German Bund yield rising 0.08% to 2.66%
In the US, core Personal Consumption Expenditures Price Index (PCE) inflation softened to 0.2% month-on-month, and the 10-Year Treasury yield closed at 4.5%, up just 0.03%
US equities fell by 0.5%, with small caps and value stocks outperforming
UK equities ended marginally lower but outperformed global equities and have gained 2.3% in May.
The week ahead
European Central Bank (ECB) Rate Decision: The ECB is expected to cut rates by 0.25%, with a 95% probability priced in by the swap market
US employment data: After the prior, unexpectedly weak, payrolls data, a slight recovery is anticipated. Unemployment is expected to remain at 3.9%.
Markets last week
Market environment
Equity markets were mildly negative in an shorter week, due to the bank holiday. Despite the decline last week, May was a positive month for most regions. There was a subdued atmosphere in bond markets where the trends beginning in mid-May persisted. The second half of May has been characterised by firm upward pressure on yields, driven by hawkish tones from Fed officials, strong US economic data and unremarkable inflation figures. This has kept the prospect of rate cuts in the US and UK on the backfoot. Although hikes still seem like an outside probability, such talk is creeping back into conversation. Notably, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, suggested that hikes were not "off the table".
Inflation and bonds
Inflation continues to drive market sentiment. On Friday, the Fed’s favoured gauges, core-PCE, and eurozone inflation were released.
The eurozone inflation data, the last before the ECB meeting on Thursday, showed a rise from 2.4% in April to 2.6% in May, slightly above predictions. This increase, partly due to base effects from German public transport, saw both headline and core inflation rise more than anticipated, with core inflation reaching 2.9%.
As a result, European sovereign yields increased over the week, with the 10-Year German Bund yield rising by 0.08% to 2.66%. Inflation has fallen a long way since 2022 and one marginal surprise is unlikely to sway the ECB from cutting rates this week. The ECB are set to beat the Fed and the Bank of England (BoE) to cut rates, it is typically the Fed that moves first. The swap market is pricing in a 95% probability of a cut - more on this in the week ahead section below.
In the US, the PCE report offered some positives: core inflation softened month-on-month to from 0.3% to 0.2% and personal spending continued to slow. US treasury yields fell on Friday following the release of the data, and thus ended the week only slightly higher, with the 10-year yield closing at 4.5%. Treasury yields were under pressure for most of the week as bond auctions were met with particularly meagre demand – the 10-year peaked at 4.62% mid-week. Elevated volatility in rates markets persists as debates around the neutral interest rate continue, with many market participants believing it could be considerably higher than the Fed’s 2.5%, with estimates ranging from 2.5%-5%.
Equities
US equities fell 0.5%. Small caps outperformed large caps and value stocks outperformed growth. It was an unusual week in which technology went from being the only sector in positive territory, but then fell towards the end of the week to become the worst performing sector. This was due to idiosyncratic factors such as poor earnings from a cloud-based customer relationship management platform business.
Tech remains the key sector for the US market as the index gains are increasingly reliant on a select few tech stocks - with a particular dependence on a key chip manufacturer. This company alone has contributed to over 30% of the US market’s total return year-to-date. As one of the primary drivers of profit growth within the index, the company has reported an average year-over-year earnings growth of approximately 500% over the past four quarters. The dispersion in tech last week can be summarised by artificial intelligence (AI) ‘winners’ outperforming and AI ‘losers’ underperforming.
While the technology sector has thrived, other sectors are navigating their way out of a previous earnings slump. There have been signs of a broadening of the market drivers which resurfaced, albeit subtly, last week with energy and utilities the best performing sectors.
UK equities ended marginally lower but continued to outperform global equities. It was the third weekly decline for the UK index, but May was overall a positive month with the market gaining 2.3%. Last week mid-sized stocks outperformed but are behind large caps year-to-date. There wasn’t much dispersion under the bonnet of the index on a sector basis; communication services and energy contributed positively while technology, materials, industrials, and consumer discretionary detracted.
The Week ahead
Thursday: ECB rate decision
Our thoughts: The ECB is highly likely to cut rates by 0.25% this week with the swap market pricing in a probability of 95%. Although the most recent inflation data was a marginal disappointment, eurozone price growth has moderated significantly from the peak in 2022. Members of the Governing Council have outlined that some noise in the underlying inflation data is to be expected with policy easing appropriate irrespective of such noise. Christine Lagarde, ECB President, could hint at further cuts. The market currently expects a second cut towards the end of Q3 or in Q4.
Friday: US employment data
Our thoughts: April’s payrolls report, released in early May, was significantly weaker than expected with 175,000 jobs added falling from 303,000 in March. This was well below the 240,000 expected. May’s data, released on Friday, is anticipated to show some recovery in the labour market. Many market participants will be hoping for some gentle softening of the labour market, which remains too tight, keeping wage pressures and inflation stubbornly elevated. Unemployment is expected to hold steady at 3.9%.
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