Weekly Market Recap

The major development over the weekend was the assassination attempt on former U.S. President Donald Trump. According to online prediction market PredictIt, the probability of Donald Trump winning the upcoming U.S. election has risen from 60% to about 66% since the event.

Market reactions have been relatively muted despite such a dramatic event, but there are some important observations as markets price in a higher chance of Trump being re-elected.

Longer-term U.S. government bond yields have edged higher relative to shorter maturity bond yields. That is because a Trump re-election is expected to be more inflationary due to tariff threats. Markets also believe there will be a bigger fiscal deficit and more supply of bonds because of Trump’s pledge to extend tax cuts. U.S. equities reacted favourably, but that may also be due to higher hopes for rate cuts as soon as September.

Cuts come into view

The U.S. consumer price index was the most anticipated data last week and coincided with Federal Reserve (the ‘Fed’) Chair, Jay Powell’s semi-annual testimony at the Senate earlier in the week. The outcome of both events helped cement the market’s view that U.S. interest rate cuts are coming soon. Powell said the latest data shows that U.S. labour market conditions have cooled considerably from where they were two years ago.

We discussed the week before last how the U.S. unemployment rate has been steadily picking up and temporary help services jobs have fallen sharply. Because the labour market is no longer as tight, wage growth has slowed meaningfully. U.S. economic data indicated more of a soft patch recently, and Powell recognised that elevated inflation is not the only risk the Fed faces anymore.

The Fed’s mandate has two objectives namely 2% inflation and full employment. In the past two years, the priority has been on curbing inflation. But, as inflation has made great progress, the balance of priority is now shifting toward full employment. Powell is perceived to be leaning on rate cuts, but he’s keen not to commit to a specific timeline. The guidance is that more good data would strengthen the Fed’s confidence that inflation is moving sustainably towards 2%.

U.S. inflation eases

The Fed and the markets did not have to wait long for that evidence. Last Wednesday, both U.S. headline and core Consumer Price Index (CPI) inflation were reported at below estimates. U.S. headline inflation surprisingly contracted by 0.1% month-on-month (MoM) in June, which was the first time the CPI was negative since we started getting the high prints back in 2021. CPI slowed more than expected on a year-on-year (YoY) basis too, with headline CPI now at 3% and core CPI at 3.3%.

The slowdown in inflation is broad-based, which is welcome. The categories most responsible for driving the downturn in core inflation were the two big shelter categories, rent and owners’ equivalent rent, which together account for over 43% of the weight in the index. Both decelerated sharply, rising just under 0.3% MoM.

This is finally starting to reflect the slowdown we have observed in new lets inflation. Core goods inflation is now negative for the third consecutive month. Notably, durable goods prices fell sharply by 4.1% YoY in June, which could be a symptom of weaker demand. Airfares and new or used car prices were all falling in June.

The Fed’s preferred measure, so called supercore CPI (core services excluding housing), contracted marginally for the second month in a row, a very different picture compared with the average +0.7% MoM pace in the first quarter of the year. The satisfactory set of inflation data and cooling jobs data paves the way for the Fed to cut soon. Markets are now pricing in about 62 basis points of rate cuts by the end of 2024 and have fully priced in a 25-basis point cut in September. It feels like we really are finally inching towards a Fed interest rate cut, following wild fluctuations in expectations throughout the year.

The market reacts

Perhaps the most interesting aspect of the CPI release was the market reaction. Bond markets saw a marginal reduction in bond yields across maturities, while gold prices gained as real yields fell. The U.S. dollar weakened as real yields fell and interest rate differentials between the U.S. and other major economies are likely to narrow.

Lower bond yields and a dovish Fed tend to support growth stocks due to their sensitivity to interest rates, as their prospective profits are further out into the future. But mega-cap technology stocks, particularly the so-called “Magnificent Seven” (Microsoft, Apple, Alphabet, Tesla, Amazon, Meta and Nvidia), have plunged post-CPI, dragging the S&P 500 index down due to being heavyweights of the index.

Meanwhile, the S&P 500 Equal Weight Index and S&P 500 ex-Magnificent Seven posted gains. The most stunning move was the Russell 2000 (small cap) Index, which surged +3.6% on the day, the biggest outperformance versus the large-cap S&P 500 since 2020. While it’s tempting to extrapolate a one-day move, the CPI report spurred excitement on the resurrection of small cap stocks via a rotation away from valuation-rich mega-cap stocks.

Time for the lightweights to shine?

The obvious reasons for being more bullish on small caps is the rate cuts argument, smaller businesses have struggled in the higher rates environment, whereas mega-cap companies have robust cash reserves that have shielded them. Positioning is another argument.

Given the extended rally in mega-cap tech stocks due to their embrace of artificial intelligence (AI), it’s unsurprising that investors are taking profits on winners and seeking out laggards. That said, it’s not a foregone conclusion that small caps can persistently outperform. The conditions needed for small caps to outperform are low rates and a robust economic environment (usually at the recovery phase of the business cycle).

Small caps tend to lead the markets when coming out of a downturn, but the U.S. economy is not coming out of a downturn, it’s in late cycle. Also, a shallow rate cut cycle is expected, provided there’s no recession. All in all, lower inflation, rate cuts, and a soft landing are beneficial to the entire market backdrop. We may well be heading into an environment where both small and large caps can prosper.

It’s not a zero-sum game, as fresh capital can be deployed as investors become increasingly confident in the outlook. Index concentration has been raising concerns amongst some investors, so a broadening of the rally is a welcome development and would support a more sustainable long-term rally for the broad indices.

A brighter outlook

Across the Atlantic in the UK, luck is in the air since a new government took office. The outlook for the UK has brightened despite the contentious weather this summer. One notable piece of data to be cheerful of is that the UK Gross Domestic Product (GDP) growth in May (+0.4% MoM) was double that expected by economists.

This means not only did the UK come out of a shallow recession, but activity is recovering faster than expected, with second quarter growth likely to be around 0.6% to 0.7%. This will be a boost to the new Chancellor Rachel Reeves, who wants to make kickstarting economic growth a ‘national mission’. With stronger GDP data, a new government that is perceived to bring stability and a pushback on UK rate cut expectations, the pound traded at its strongest level in a year against the dollar, and in almost two years against the euro.

Investors are increasingly singing their praises for UK assets, a huge change from being one of the least popular regions since Brexit. Fundamentally, the pound remains cheap compared to its long-term average and purchasing power parity, whereas UK equities are trading at half the valuation of U.S. equities. There is indeed room for UK equities to catch up if more international investors upgrade their allocation from negative to neutral or overweight.

Our view is that some diversification into the value plays that the UK is so heavily weighted in makes sense at this stage. It can provide a relatively cheap hedge against inflation risks and growth-style equities in portfolios. in June, the case for a September rate cut will have become very compelling.

It was politics that occupied the news headlines last week. While it’s had some impact on markets, the UK general election was met with market apathy given that the result had been expected, that’s despite a historic seat gain for Sir Keir Starmer’s Labour Party.

This result is popular with the markets, as Labour is seen as a more functional governing party compared to the years of infighting, division and leadership contests under the Conservative Party.

A strong majority for Labour means an endorsement of the party’s leader and policy agenda. In Labour’s case, its commitment to avoid a repeat of Liz Truss’s infamous brush with fiscal mortality means a likely period of economic orthodoxy is welcome.

In France, by contrast, a majority for Marine Le Pen’s National Rally Party over the weekend would’ve been a concern for markets because her policy agenda seems fiscally cavalier.

However, last week, it seemed increasingly likely that National Rally wouldn’t achieve a majority, causing French assets to perform relatively well. Indeed, National Rally came third in the second round of voting on Sunday. Left-wing alliance New Popular Front won 188 seats while President Emmanuel Macron’s liberal coalition Ensemble came in second with 161 seats.

The strength of Labour’s performance stands in contrast to a general tide of increased preference for more socially conservative policies. UK voters don’t necessarily have a different perspective on what’s important, but they do have a different political system, and this victory for Labour had more to do with the fracturing of the right-wing vote than a triumph of the left.

This was Labour’s third highest seat haul, but its sixth lowest share of the popular vote, since 1945. Its vote share was up less than 2% on the 2019 election, in which Jeremy Corbyn’s Labour was trounced by Boris Johnson.

The splitting of the right-wing vote across the Conservatives and Reform UK was instrumental in delivering huge seat gains for Labour and the Liberal Democrats. Also contributing towards Labour’s success was the decline in the Scottish National Party’s vote share.

Source: RBC Brewin Dolphin

With a Labour majority always seeming the most likely result, the market was apathetic, with no discernible movement in bonds or currency markets.

Within the FTSE 100, the housebuilders were amongst the leaders. They are perceived to benefit from Labour’s plan for a blitz of planning reform, which will enable more housebuilding. The policy will doubtless be unpopular with many existing constituents, but a large majority helps quell any stirrings of rebellion.

Is a change on the cards for the Democrats?

The biggest political headlines were drawn by U.S. President Joe Biden, as he has been fighting to retain his position as the presumptive Democratic nominee to contest the presidential election this November.

A few Democrats have finally started to break cover and call for Biden to stand down. By convention, a sitting president is not challenged when seeking re-election, but Biden’s advanced years have caused many to question the wisdom of him standing.

The issue has been that nobody else has been seen to stand a better chance of beating Trump than Biden, but that seems to be changing with head-to-head polling suggesting that Vice President Kamala Harris may have a better chance than Biden.

She would be the easiest replacement candidate for the party as she was already Biden’s stated running mate. Prediction markets and betting odds seem to suggest that Harris may even be considered more likely to face the voters.

Bond markets would likely look fondly on a change in Democratic candidate now that Biden’s chances have diminished so much. They perceive Trump as a malign inflationary influence.

However, the economic consequences of a Trump presidency are more complex than that, depending on whether his party would also control the Senate and House of Representatives (all of which are quite possible).

Is economic momentum slowing?

It’s easy to get distracted by the politics but, of course, the more tangible factor affecting markets is economics. Last week’s business surveys from across the globe painted an ambiguous picture of the economic outlook.

Manufacturing activity remains muted although the low level of inventories should reassure us that downside is limited. Services sector activity continues to expand but does so at a slower rate than in May. There were confusing irregularities in the data, making it difficult to see a distinct trend.

In general, the economy looks to have lost some momentum compared to the first quarter. What’s consistent is evidence that price growth is slowing.

Source: LSEG Datastream

The book end to last week was Friday’s U.S. employment report. Headline employment growth was slightly ahead of expectations, but there were plenty of caveats to threaten the positive headline.

The unexpected jobs growth came from government hiring, with the private sector slower than expected. The unemployment rate ticked up and this has been moving higher in a way that could be consistent with a recession. However, the moves have been about increasing labour supply, rather than job losses or a slowdown in hiring. April and May’s jobs growth was also revised down to a more modest pace.

Finally, wage growth slowed on an annual basis. Taken as a whole, this was a labour market report that will help the Federal Reserve to build the case for rate cuts. If services sector inflation (excluding housing) is reasonable in June, the case for a September rate cut will have become very compelling.

The election-heavy year continued with France hitting the polls on Sunday for the first round of legislative elections. Candidates are competing for one of 577 National Assembly deputy positions, which they will win if they receive 50% of votes in their constituency, representing at least 25% of registered voters.

However, if they do not win a position, a second round will take place where voters will select one of the top three candidates who have achieved 12.5% or more of the votes. In this round, the candidate who receives the most votes is elected. Marie Le Pen’s far-right National Rally party won 33% of the popular vote, while President Emmanuel Macron’s centrist Together coalition (which includes his Renaissance party) achieved 21%. The second round of voting takes place on Sunday.

The UK election looms…

Taking place between the two French rounds of voting is the UK general election. The two leaders, Labour’s Sir Keir Starmer and the Conservative Party’s Prime Minister Rishi Sunak, debated last week and the consensus seems to be that the Prime Minister won the argument but still won’t prevail in the election.

When the election comes, the market’s reaction is likely to be muted, as a Labour victory has seemed so likely for a long time, but the margin of victory could be important.

UK elections are notoriously difficult to poll, and prediction models are producing some wildly different forecasts of the possible Labour margin of victory (from 50 to 150 seats). This could be due to a lack of enthusiasm for the opposition or the performance of other parties, such as Reform or the Scottish National Party.

The size of the margin gives a new Prime Minister a mandate and equates to their right to make decisions. If this was accompanied by a bold policy agenda, investors would react to those policies being implemented. However, as Labour’s offering has been relatively vanilla, the mandate should therefore protect the leadership from rebellions and contribute to a feeling of general political stability.

Belief in the U.S. president weakens…

More newsworthy was the first U.S. election debate on Thursday. President Joe Biden, who has been lagging former President Donald Trump in the polls, pushed for this debate because it was seen as an opportunity to expose Trump’s weaknesses.

However, it was also recognised as a risk if Biden was to appear frail, which is exactly what happened. His voice and the dithering nature of his answers will have reinforced the suggestion he’s too old to serve another four-year term.

Prediction markets immediately marked his potential chances lower, but Biden’s losses were bigger than Trump’s gains (and the gains of potential candidates Gavin Newsom and Kamala Harris). Speculation’s now mounting that Trump might end up facing a different candidate in November.

The obvious candidate would be current Vice President Kamala Harris, but there is little evidence that she would perform well against Trump. For that reason, Governor of California Gavin Newsom is the most likely pick, with a handful of other state governors also amongst the speculation.

So far, they have all been firm in their commitment to Biden’s cause, so any change of candidate would need to be initiated by him deciding not to stand. The candidacy will be confirmed at the Democratic National Congress in late August.

The third-party candidates line up…

This year’s election will also feature some third-party candidates. That’s not unusual, however, their influence tends to be limited. In fact, no third-party candidate has won any Electoral College votes (effectively winning a single state) since 1968.

However, it is possible for third-party candidates to influence the election. In 1992, Ross Perot is credited with taking votes from George H. W. Bush, which ultimately helped Bill Clinton. The highest polling third-party candidate in this election, Robert F Kennedy Jr., has appeal across both voter bases, but is especially popular with the young.

Third-party candidates usually underperform on election day, although the low level of satisfaction with the big party candidates could change that.

The Green Party’s Jill Stein is also expected to run. It is sometimes observed that her vote share in Michigan, Wisconsin and Pennsylvania in the 2016 U.S. presidential election was greater than Trump’s margin of victory over Hillary Clinton in each of those states. Therefore, Clinton might have won that election had Stein not run and her supporters had instead supported Clinton (which they might not have).

Although unlikely, it is possible that a third-party candidate wins enough Electoral College votes to prevent either Trump or Biden (or his replacement) from winning the 270 votes required to become President. Under those circumstances, the newly elected House of Representatives would select the new President on the basis that each state has a single vote (despite a state like California having 60 times the population of Wyoming).

Therefore, regardless of which party controlled the largest number of seats in Congress, the fact that there are more Republican states than Democrat states means this approach would likely favour Trump.

The debate seeming to improve Trump’s chances led to a rise in the dollar. Traders may have perceived that Trump will cause growth, inflation, or both by virtue of promised tax cuts and threatened import tariffs. However, the gains didn’t last and historically, markets have seemed to find it hard to really think through the implications of different Presidents. Hardly surprising given there are so many different potential combinations of Presidential and Congress control.

The Falcon Heavy lands…

The threat of higher inflation is one scenario but continued progress in the contemporary space race offers some hope for deflationists.

Elon Musk’s Falcon Heavy rocket successfully deployed the final satellite in the geostationary operational environmental satellite series (GOES-R), with the now familiar sight of its boosters landing in an upright position.

The conquest of space seems like science fiction but is believed to carry tangible economic benefits. One of these is the implementation of space-based solar power, in which energy is captured by space-based solar panels and beamed to earth in the form of microwaves for conversion to electricity.

It is also anticipated that an unmanned nuclear power plant could be built on the moon, allowing for further expansion of human influence in space, including asteroid mining. Realistic returns from space are years away but could see enormous changes in availability of some natural resources, with knock-on effects for the countries that might currently supply them on earth.

Last week markets were reasonably positive, with stocks and bonds generally higher, but this sentiment has shifted slightly over the past few days as investors reflect on high valuations in some areas of the market.

The improvement in bond markets followed benign inflationary data released by the U.S. Bureau of Labor Statistics the week before last. This firmed investors’ expectations that the next move in interest rates will be down rather than up.

However, around that theme, there were differences in bond market performance. At a time when national finances are stretched and there’s an unprecedented number of elections taking place, political factors are likely to be important.

Populism and bond turmoil: The French connection

We still have months to go until the U.S. election, but in Europe, voting will be taking place much sooner. The French bond market has been adjusting awkwardly to new political uncertainty.

The poll-leading National Rally party spent the 2022 presidential election pledging to slash VAT on energy, exempt the under-30s from income tax, and allow retirement at the age of 60 for many workers, with only reduced immigration and a clamp-down on fraud as potential means of funding these enormous tax cuts/spending increases.

Also riding high in the polls is the New Popular Front, an alliance of left-wing parties that also advocates a big fiscal expansion. This has seen a rise in French borrowing costs as investors try to discern the likelihood of these policies coming to pass.

Since calling the election, the polls continue to suggest populist parties that have made unrealistic spending pledges will win the largest share of the vote. The historical evidence would suggest they will moderate their plans once in office.

To be fair, it’s true of almost all parties, whether populist or establishment, that their commitments reflect more wishful thinking than firm policy promises. It is just that the difference between aspiration and outcome is likely to be far starker with the populists.

Reality check: A French revolution

It’s possible the new French government attempts to enact its fiscal largesse, in which case, we could see a bond market revolt. It might be tempting to call this a repeat of the Liz Truss mini-Budget, but even in that instance, the most likely ultimate outcome is a chastened government conducting a policy U-turn.

Ultimately, the Truss government in 2022, the populist Italian coalition government in 2018, and French President Mitterand in 1983 all succumbed to more conventional fiscal policy under pressure from the market.

Is the UK banking on a change?

In the UK, we are just over a week away from the election and the polls continue to favour the Labour party by a historic margin. The government heralded some good economic news last week, as the inflation rate declined, and public finances improved.

If you recall, one of the arguments in favour of holding the election early was that there was a very strong chance of an improvement in inflation numbers in this last release before polling day.

The prime minister can now demonstrate inflation has returned to target, but he can be less confident about the path of prices thereafter. Another reason to bring the election forwards was that there was no longer a rationale to wait and deliver more tax cuts in an autumn Budget.

Does the good news on public finances released on Friday change that? Not really. Although it means the UK is no longer borrowing more than the Office for Budget Responsibility had forecast on a cumulative basis this year, the meaningful fiscal pressure remains.

Neither main party seems likely to be able to meet its manifesto commitments without finding new tax revenue after the election due to the unrealistically low departmental spending budgets that have been forecast.

Coming back to the inflation numbers, and they showed the inflation rate returning to target. However, much of that is a reflection of volatile price movements in food and energy, which are considered outside of the Bank of England’s gift to influence.

Core inflation runs at 3.5%, well above target, and the services category, which could be considered to reflect wage inflation, was particularly sharp. Services prices rose by 5.7% over the last year and 0.6% over the last month alone. There was little within this print to justify a cut in interest rates.

Nevertheless, when the Bank of England’s Monetary Policy Committee (MPC) met last week to consider interest rate policy, it clearly felt the case for a cut was building. Two members voted for a cut outright, and the minutes of the meeting reveal a discussion about this troublesome services inflation.

Of the seven remaining members, ‘some’ felt that services inflation indicated that inflationary pressure remains. ‘Some’ is MPC speak for two to three members. It’s distinct, for example, from ‘several’, which would mean three to four members.

The others were less troubled by services inflation, believing it to be driven by temporary factors like the seasonal increase in the national living wage. These ‘others’ would seem sufficient, if added to the two currently proposing a cut, to reach a majority, and the wisdom of the markets now implies there’s a 60% chance of rates being cut in August.

But if these members feel that way, why are they not cutting now? Clearly, they need to see some further evidence of inflation slowing or the economy weakening between now and then.

A fly in the ointment of the improving inflation story is the persistence of some alternative measures of inflation. We calculate the median monthly inflation move to give a more stable indication of underlying inflationary pressure.

Since 2021, this measure has exceeded the 0.2% that would be consistent with the Bank of England’s inflation target. An improvement in this metric would seem a necessary precondition to inflation staying close to target.

Things can only get better?

In the absence of moderating services inflation, why do people feel comfortable expecting interest rate cuts? Because the economy is slowing. The key evidence for this comes from the labour market, but the data is inconclusive, and key measures like redundancies certainly suggest that employment is not collapsing.

Meanwhile, consumers have been recovering from post pandemic inflation and are now beginning to increase spending. National Insurance has been cut, which increases their post-tax incomes, and survey evidence suggests consumers have replenished their savings with wages outstripping price growth for a few quarters.

This was reflected in Friday morning’s retail sales numbers for May, which were quite strong. A combination of better weather than in April, income growth, rebuilt savings and lower goods prices have enticed consumers back to the shops.

Hopefully, nothing happens to upset the improving national mood, but with an election and the European Football Championship taking place over the next fortnight, it could be an emotional time.

From macroeconomics and central bank interest rate decisions to corporate news and politics, there were plenty of things to digest for investors, but there has been a clear divergence in U.S. and eurozone market performances.

The S&P 500 and the Nasdaq Composite reached new record highs last week, as investors continued piling into U.S. tech stocks and other equities, bolstered by multiple good news reports.

To summarise, the positive drivers are disinflation trends, the Federal Reserve signalling it’s willing to cut interest rates, and supportive corporate developments relating to artificial intelligence (AI).

U.S. inflation data lower than expected

Let’s first look at the trigger moment for last week’s U.S. equity rally, which was the lower-than-expected U.S. consumer price index inflation (CPI) data for May. Both U.S. headline and core CPI (which excludes food and energy) slowed more than expected in May, from 3.4% to 3.3% year-on-year and from 3.6% to 3.4% year-on-year, respectively. This is the lowest figure for core CPI since April 2021.

The fall in gasoline prices was a key driver of CPI being flat month-on-month, which helps offset the ongoing strength in shelter inflation. There are a few positive reads in the report, such as a big drop in airfares and modest falls in new vehicle prices and car insurance.

The elephant in the room remains the elevated shelter inflation, which is taking longer to slow, but leading indicators suggest it will eventually.

Overall, the latest U.S. CPI reports have provided more evidence of disinflation and removed some concern from earlier in the year that inflation has re-accelerated. We have a way to go with U.S. disinflation, but there is progress despite some bumps along the way.

Adding to the enthusiasm is that U.S. producer prices contracted in May on a month-on-month basis, driven by the fall in gasoline prices. Core producer prices inflation (which excludes food and energy) slowed from 2.3% to 2.2%, which was below estimates.

While producer price releases don’t tend to move markets, the idea is that the lower inflation experienced by manufacturers will trickle down and help ease the price pressures consumers are experiencing, every little helps with the disinflation narrative.

U.S. disinflation has important implications for both Wall Street and the main street. Real wage growth (wage growth adjusted for inflation) accelerated from 0.5% to 0.8% in May, meaning the average household is benefitting from a resilient labour market and lower inflation. This supports the soft-landing thesis.

The U.S. inflation reports provide support to our baseline macro view of ongoing disinflation and a soft-landing, with an overweight position in U.S. stocks.

U.S. interest rates, and a revised ‘dot plot’

On the same day U.S. CPI data were released, the Federal Reserve announced its interest rate decision and released its updated summary of economic projections. It was widely expected that the Fed would hold rates unchanged, so all eyes were on its macro projections, particularly the 'dot plot', which is a summary of rate expectations gathered from the Federal Open Market Committee’s members.

Since the Fed has revised up its near-term inflation forecasts, it is perhaps no surprise that the dot plot now only indicates one rate cut by the end of 2024, down from the three cuts expected previously.

However, the dot plot now shows that four rate cuts are expected in 2025, up from a previous three. Meanwhile, the Fed expects the U.S. unemployment rate to rise only modestly to a peak of 4.2% in 2025, from 4.0% currently.

Inflation is expected to trend to 2% by 2026 as real gross domestic product growth is expected to be sustained at 2%. In short, this is as goldilocks as you can get, a soft landing is the main scenario for the Fed, with inflation coming down without any great damage to the labour market.

During the press conference, Fed chair Jay Powell was grilled by journalists’ questions on the prospective policy path and the thought process of its decision making. The market’s interpretation is that this is a Federal Reserve that is in no big rush to cut, but wants to and stands ready to do so, it just needs to see a few more inflation reports that are in line with the disinflation narrative.

Even though the Fed is flagging only one cut by 2024, markets are pricing in two, with an over 50% chance of the first cut happening in September, shortly before the U.S. election. As you can imagine, markets will remain very sensitive to any upcoming inflation data points.

Tech market rallies…

The Federal Reserve is not the only thing affecting markets at this juncture. As the strong year-to-date performance of large technology companies shows, corporate fundamentals matter more.

Last week, we saw Apple briefly regain its top spot in terms of market capitalisation, after temporarily falling into third place behind Nvidia. Microsoft reclaimed the top spot by the end of the week, but the battle of the big three is getting tight.

Analysts generally believe Apple has the tremendous opportunity to capitalise on a wave in the hardware upgrade cycle and get AI applications to mass-consumers at its fingertips. It’s also in a prime position to capitalise on the budding AI-enabled software and apps ecosystem, given its dominance in consumer devices and wearables.

Investors have turned hopeful, but the execution of its AI strategy will be key. There is immense competition, and the blistering pace of tech innovation means any near-term progress can’t be taken for granted.

Semiconductor companies continued to rally against the backdrop of AI infrastructure build outs, anticipation of hardware upgrades, and cyclical recovery in the sector. The Philadelphia Stock Exchange Semiconductor index has risen by about 34% year-to-date, outpacing even the near 18% rally in the Nasdaq.

We remain constructive on key companies in the semiconductor value chain.

European stocks take a turn for the worse

The mood in European markets couldn’t be more different, with European stocks ending the week in the red. The epicentre of the downbeat sentiment is France, where its CAC 40 Index was down almost 6% last week, completely erasing the gains made so far this year.

The trigger is the uncertainty in French politics after President Macron called a legislative election to be held in two rounds on 30 June and 7 July, after the disastrous results from the European Parliamentary votes the week before last.

It is widely regarded by markets as a huge political gamble with a high risk of scoring an own goal (no pun intended as the European Championship gets underway).

Currently, Marine Le Pen’s National Rally party leads polls by a wide margin, but it is not just the far right that Macron’s centrist Renaissance Party has to contend with. In a further blow to market sentiment, a coalition of left-wing parties has presented a manifesto ranging from reversing the government’s pension reform and reinstating the right to retire at 60, to raising the minimum wage.

The polls show the far-right party leading with the coalition of left-wing parties being second. Either outcome is feared by financial markets as being more inflationary and detrimental to the state of France’s public finances.

With so much uncertainty ahead, and a possibility of a shift in economic policy and weakened commitment to fiscal discipline, it is no wonder investors in French assets ‘sell first and ask later’.

It is indeed a difficult period to endure before the market has more clarity. It is worth noting the sell-off in French equities has been indiscriminate this week and even spilled over to the broader European stock market. Market dislocation driven by political events tends to open opportunities for investors to pick up discounted quality stocks with solid fundamentals and international earnings exposure.

Another week has passed in the UK election campaign. So far, there is no sign that the polling has improved for the government. Instead, the news early last week that Nigel Farage will stand for election risks giving impetus to the Reform Party and dividing the right-wing vote further in a way that stands to benefit the Labour Party.

The ITV leaders’ debate seemed to be a draw in which both leaders underwhelmed. Labour holds a 20-point lead, while some polls show the gap between Reform and the Conservatives narrowing.

The performance of the economy has been improving, which would normally be a boost to the incumbent party. But with dissatisfaction over the cost of living, the ideal situation would be a reduction in inflation and interest rates that doesn’t coincide with an increase in unemployment.

We have seen some increase in growth and some decrease in inflation but recently, hopes of falling interest rates have moderated, and that means that things like fixed rate mortgages are becoming more expensive.

For the last two years house prices have become quite tightly correlated to mortgage rates and, therefore, to interest rate expectations. Good news on growth becomes bad news on mortgage costs and that in turn weighs on house prices. Last week’s data from Halifax suggest that house prices have stagnated, and mortgage rates are currently still rising.

Will interest rates fall this Autumn?

When are interest rates likely to fall in the UK? The market now sees it as more likely than not that this will happen in September or November, but that could obviously change as the economic data roll in. As discussed, a few weeks ago, central banks at this stage in the interest rate cycle are inevitably data dependent. 

This week will be important because of the UK employment and wage data, but last week saw the Purchasing Managers Indices (PMIs) released, which gives a snapshot of economic activity around the world.

It is notable that in the vast majority of regions, we’re seeing an increasing proportion of companies experiencing faster new order growth. The phenomenon is repeated across manufacturing and services. There are exceptions, and the UK is one of them, although that may partly reflect the disappointing weather we had in late spring. But even in the UK, the services sector seems to be in good shape.

A subindex of the PMIs, which we have referenced before, is the services sector prices charged index. This has been a useful gauge because while headline inflation rates have slowed, there has been some nuance to be aware of. Goods prices have seen some significant moderation, and it could be argued that the manufacturing sector has suffered a recession of sorts after the very strong goods demand of the lockdown era. But that disinflation has been offset by sticky services sector inflation.

Across most regions, the persistence of services sector inflation is the biggest headache for central banks. It’s the reason why we might see inflation level off rather than continuing to decline. However, services sector inflation is more materially impacted by wages than other sectors.

Central banks can slow wage growth by raising interest rates, in contrast to other categories of inflation, such as commodity prices, which are largely out of their direct control. So, when the market expects fewer rate cuts, it is largely because it’s not seeing the expected slowdown in services sector inflation. Fortunately, the services sector prices charged PMIs eased slightly and, hopefully, reflect a slowdown in services sector wage inflation. As mentioned, commodity prices are beyond the direct control of the central bank. After rallying in the first quarter, the oil price has eased off again and that should help headline inflation decline. 

Oil ‘group’ production cuts extended to 2025

The weekend before last, the Organization of the Petroleum Exporting Countries (OPEC+) discussed at a meeting held in Saudi Arabia how much oil it plans to pump in future periods. The organisation extended its ‘group’ production cuts until the end of 2025. These are cuts that affect all members, and which had been scheduled to run until the end of this year. That news was good for the oil price because it signalled lower supply. However, there were other elements to the announcement. 

Added to these group restrictions are voluntary restrictions, which are met by a smaller group of countries, OPEC+ suggested these will start to be phased out from October this year. The persistence of voluntary cuts over the summer should push the market into deficit and support prices, but there had been speculation that they would be extended to the end of the year, so it wasn’t all good news for oil.

OPEC+ aims to keep supporting crude prices while also easing production restraints that have been frustrating some members, such as the United Arab Emirates (UAE). The UAE was awarded a 300,000 barrels-per-day increase in 2025.

This puts in place an 18-month plan that does involve some increase in supply through the UAE exemption and the phasing out of voluntary cuts, but the latter is data dependent and could most obviously be reviewed in August.

First G7 members cut interest rates

Although the economy and inflation have been enough to dissuade most central banks from easing interest rates, last week was a landmark for major developed markets, as it saw the first G7 members cut rates since inflation rose following the pandemic. 

Canada got the ball rolling on Wednesday, with the European Central Bank following on Thursday. It’s extremely unusual to see the Europeans cutting rates before the U.S. Federal Reserve.

So, when will the Federal Reserve cut rates this cycle? 

When the economic data suggest it is time. There were some indications early last week that time might be drawing nearer, with a sharp decrease in the number of job openings. However, the main focus, as always, was on the non-farm payroll report, which would tell us how many new jobs were created during May. 

The answer was 229,000, well above the expected 180,000. Wage growth was faster than forecast too. 

This data suggests that the Federal Reserve will not b