Investment Viewpoint: healing process continues

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Markets and macro insights with Bernard Swords, Chief Investment Officer

What happened in financial markets last week?

• A ‘healing’ process is continuing in equity markets, with world equities just over 1% in local currency terms. The IT and Cyclical sectors are still leading the market, as fears about extreme tariff levels dissipate. Bond markets are relatively calm. The euro area bond market declined slightly last week, due to pessimism about further interest rate cuts, following the European Central Bank (ECB) policy meeting. Discussion about increased defence spending by the euro area NATO countries did not strengthen a bond market generally more sensitive than its US counterpart to news about fiscal deficits and government debt levels.

• We have seen a strong recovery in equity markets: year-to-date world equities are up nearly 4% in local currency terms. However, a weak US Dollar means that this growth actually represents a decline of 3.6% in euro terms. All regions are now up year-to-date, but growth has probably reached its peak for the moment. In the absence of a conclusion to substantive trade talks, we still see downside risk in current economic and profit growth forecasts. Data releases are unlikely to have a positive impact in the next few months, as strong figures will be attributed to front-loading caused by tariff uncertainty, while weak results will be interpreted as signalling a slowing economy. Therefore, in the foreseeable future, equity markets will probably move sideways.

What were the main recent economic developments?

• Last week’s most significant event was the ECB policy meeting. Thankfully, it delivered as expected a 0.25% cut in interest rates, leaving its main deposit rate at 2%. The text accompanying the announcement said that the governing council “will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance.” However, in the press conference, President Lagarde indicated that policy rates were in a “good place.” Consequently, only larger, unanticipated downturns in activity would precipitate further cuts. Inflation may not prove an obstacle to further cuts. Core CPI dropped to 2.3% year-on-year, the lowest since 2022 and well on track to be within target levels this year.

• Recent data from the US is indicating some slowing after surprising strength at the start of the current quarter. Non-Farm Payrolls came in a bit better than expected (139,000) but there were downward revisions to the previous two months. However, job creation running at over 100,000 does not suggest a stressed economy. This week both ISM surveys (Manufacturing and non-Manufacturing) dipped below 50, indicating a drop in activity. However, these results are so close to 50 (Manufacturing ISM 48.5, non-Manufacturing 49.9), that they probably indicate a stalling rather than a contraction. We must also bear in mind that, over the last few years, actual activity has been stronger than sentiment surveys suggested. Inflation news was better, with the core PCE inflation rate (the one more closely watched by the Federal Reserve) dropping to 2.3% year-on-year, the lowest rate since the beginning of 2021, and not far from target levels.

• Business surveys in China are giving conflicting signals. The Caixin China manufacturing PMI survey (skewed towards smaller, private and export-oriented companies) dropped significantly to 48.3. Against this, the official Manufacturing PMI increased slightly to 49.5. Both surveys did indicate that the export sector holding up better than the domestic sector. The official Services PMI was flat over the course of the month. As in the US, the sentiment surveys are indicating flat to a slight decline in activity as we enter the month of June.

The week ahead: what to watch out for

New data will be sparse this week, and its relevance remains questionable until the impact of tariffs becomes clear. In the US, we will see the inflation reports (PPI and CPI). From the euro area, we will receive Industrial Production data, and from China data on monthly trade.