We are forcefully entering a period of ‘bad news is good news’ as the Federal Reserve (Fed) moves toward its first rate cut. We don’t know when the Fed will cut the rates – the Fed members themselves can’t tell you that without more evidence of slowing economy and easing inflation as printed by yesterday’s Fed minutes – but we know that the weaker the data the closer the first rate cut.
Yesterday soft data from the US fueled the Fed doves yesterday. The latest ADP report showed that the US economy added 150’000 new private jobs in June, less than expected by analysts and slightly less than last month, initial jobless claims rose, the factory orders unexpectedly fell in May and the ISM services unexpectedly contracted in June, the employment component plunged while prices fell more than expected.
As such, investors saw in the data the evidence that the Fed is looking for to cut its rates. The US 2-year yield tipped a toe below the 4.70% but bounced back to this level before the July 4th holiday, the 10-year yield dropped to 4.35% while the US Dollar Index slipped below its June ascending channel base and tested the 50-DMA to the downside. The S&P 500 and Nasdaq advanced to a fresh record yesterday.
The US stock rally continues to be shouldered by the technology sector, the others remain timidly upbeat, a lower rate environment should broaden the rally to other sectors but other sectors could hardly print the same amplitude of gains than the tech. If the heftily-valued tech tumbles, the rest of the market will suffer.
Time to Say Goodbye?
Brits are heading to the polls today aiming to oust the Conservatives from power after 14 years. Labour is walking into this election with more than 20 points advance over the Tories – even the most Conservative parts of the country seem tired of a 14-year Tory rule. The two most likely scenarios are a good Labour majority with 150 seats – which is almost double Boris Johnson’s 80-seat majority in 2019 - or a supermajority.
Both will give the Labour a very large margin to pass whatever reforms they want to pass in the coming years. Normally, investors prefer Conservatives as they have a better grip on spending and debt levels. But this time, even investors want to see Labour take over the reins. For Wall Street, a Labour win is positive for both the UK stocks and sterling. Small and medium-sized British stocks will likely benefit more from a Labour win than the FTSE 100 – which is mostly exposed to global market conditions.
Cable rallied to 1.2772 yesterday and is consolidating gains near 1.2740 at the time of writing. Combined with a soft dollar, we could see the end of the Tory rule support the pound and back a move toward 1.30. Yet once the election vibes are over, eyes will turn to the Bank of England (BoE) rate cut bets, and the latter could eventually limit the pound’s upside potential, but not the stocks’.
On this side of the Channel, the broad-based dollar weakness sent the EUR/USD past the 1.0750 resistance yesterday, the pair tested shortly traded past the 1.08 level, but the French political risks prevail and visibility is low into the second election weekend in France where we just don’t know whether Le Pen will or will not win a parliamentary majority. Investors wish for a hung government that would prevent Le Pen’s National Rally from exploding debt, hence keep the borrowing costs and the yield spread with Germany at acceptable levels and avoid a Liz Truss like market reaction.
Yet a hung government is not an outright positive scenario for France as it will prevent politicians from making any important move for years without changing the fact that these latest elections have been a massive win for Marine Le Pen. But a hung government will certainly trigger a relief rally both in the French stocks and the euro next week, while a Le Pen victory – which is not the base case scenario as per the market pricing – would dampen the mood from Monday.
Far from these jitters, the Japanese Nikkei is up for the third consecutive session and is approaching an ATH level reached back in March. The USD/JPY doesn’t dare to move above the 162 for now. A broad based dollar weakness helps keeping the pressure contained; Japanese policymakers would be as happy as any investor and mortgage holder to see the Fed move closer to the first rate cut.