Inflation behaves, Macron calls snap election
Author: Tom McGrath – Chief Investment Officer, 8AM Global
Market Review
Looking at the movement in markets of the various regions we monitor, we see a distinct impression of déjà vu in the returns from last week. India and the US are at the top, with the UK, Europe and China lagging, which has been the status quo for much of the year. It was an important week on the macro front as we got vital US inflation data (it came in lower). We also had the June meeting of the Federal Reserve, where the mood music was a touch more hawkish. Bonds enjoyed another good week, with gilts in particular doing well as the 10-year yield is fast approaching 4%. France grabbed the headlines when Macron called a snap parliamentary election and unnerved European investors, opening the door for a power grab for the far-right.
Vive La France!
Emmanuel Macron called a snap French legislative ballot in an effort to curb the rise of Marine Le Pen following a crushing defeat in the European elections that saw gains by far-right parties. The Euro dropped all week, while European stocks declined, and the spread of ‘French Oats’ (the name for their bonds, like our gilts) over German Bunds widened.
Latest opinion polls suggest that Le Pen’s party (RN) is likely to emerge as the single largest party in the parliamentary elections but fall short of an absolute majority. If Le Pen manages to form a coalition, there is a possibility that a far-right candidate could become the next Prime Minister of France. This transition would be at a time when the French deficit and debt picture is already looking weak. Debt to GDP is close to 110%, while the deficit stands at 5.5% and is unlikely to come below the 3% target over the next five years. Market concerns range from a stalling of the reform process and possible rating downgrades to increasing concerns over talk of a breakup in the Euro area.
A few points are worth making:
- In France, the majority of power lies with the President and not the Prime Minister. Defence and foreign affairs will largely remain with Macron. A far-right PM from a party that does not even have an absolute majority cannot start the process of taking France out of the Euro area.
- Looking at past elections, it’s clear that traditional mainstream parties have been hesitant to form a coalition with Le Pen. This raises a significant question: will the RN be able to secure a PM position? The answer is far from certain, adding a layer of uncertainty to the political landscape.
- The two-phase system of French elections has historically been against Le Pen, implying that the parliamentary election results may be different from those of the European elections. In the second round, parties will likely unite against the RN candidate.
When dust settles, so too should equity markets and I would expect a return to the status quo, and the risk premium being built into European assets should evaporate.
Big US Macro
Finally, we got a good inflation print out of the US on Wednesday last week, as core CPI Inflation slowed more than expected to an annualised 3.4%. On a month-on-month basis, the so-called Core Consumer Price Index (which excludes food and energy costs) climbed 0.2%, which, when combined with the deceleration in the core CPI in April, may indicate the early stages of inflation resuming a downward trend. However, policymakers have emphasised that they need to see several months of receding price pressures before considering lowering interest rates, particularly with the latest jobs report reigniting the debate over the restrictiveness of current policy.
The release was then swiftly followed later in the day with J Powell’s summary of the June FOMC meeting. The committee members might just have had time to readjust their forward dot plot projections on interest rates following the inflation release, but I believe none did, and the tone coming from the chairman was more hawkish than in previous meetings. Officials voted unanimously to maintain the benchmark federal funds rate in the range of 5.25% to 5.5% — a two-decade high first reached in July.
However, policymakers now indicate they expect to cut rates only once this year, compared to the three reductions forecasted in March, according to the median projection. They now anticipate four rate cuts in 2025, up from the three previously outlined.
An economic soft landing for the US became more challenging on Friday, at least in terms of consumer perceptions. The University of Michigan’s Consumer Sentiment Index fell to 65.6 in June, contrary to economists’ expectations of a rise. The persistent gloom has continued to affect President Joe Biden’s approval rating despite a long and steady list of positive indicators. A measure of consumers’ current assessments of their personal finances dropped 12 points to 79, the lowest since October, and views on economic conditions are the worst since late 2022.
It’s widely recognised that America’s political polarisation significantly influences consumer sentiment, with Democrats more likely than Republicans to view conditions positively.
However, despite the slight upward revision, or the pushback of rate cuts to next year, investors still took heart from the lower inflation print and decided, all in all, it had been a good day and drove the S&P 500 and the Nasdaq to new highs, and bond yields nudged lower. Interestingly, a shift in sentiment that I have been looking for seems to be underway, and this is one where investors start thinking that a strong economy will be sufficient to power share prices without necessarily needing a rate cut. According to a Bloomberg Survey there is now a slight majority that think exactly this, that markets can move higher without rate cuts.
The strong US equity move on Wednesday was again driven by Big tech, or the magnificent 6 or 7 depending if you decide to include the lagging Tesla or not. Nvidia was of course involved in the charge, but it was the original mega tech stock Apple that did much of the lifting as it unveiled a new product offering, Apple Intelligence, which will utilise AI which was enough to send investors’ pulses raising. Who would bet against this trend from the Mag 7 at this moment in time, as they are natural beneficiaries of a more benign inflationary environment? But even stalwart technology bulls (and I include myself in that list) are beginning to question whether this might have gone a little too far, too fast, as this powerful chart highlights. I think it is probably not a bad shout to bank some profits soon.
The land of the Rising Sun and Rising Inflation – Japan
Japan remains an enigma on the world stage as it has been fighting deflation for most of my investment career. Inflation has not been a problem there for many years; in fact, monetary policy has been held incredibly loose in an effort to provide sufficient stimulus to kick start their flagging economy, and in the last year or so, it has begun to have the desired effect. The question the BoJ faces is just how much they are willing to let inflation establish itself, and in May, they decided to temper stimulus as they raised interest rates for the first time in 17 years, ending the world’s last negative rate regime. On Friday, following their latest committee meeting (rates were left unchanged at 0.1%), they announced they would start reducing their level of bond purchases – effectively signalling that yields could move higher, a move that acts in a similar fashion on the economy as a rate increase. They also did not rule out a rate increase in July.
So far investors have welcomed the return of inflation, and the stock market has recovered to set an all-time high, with the Nikkei advancing over 40,000 for the first time in 30 plus years not long ago. Much of the gain in the market has been eroded by Yen weakness for global investors, as the following chart shows. Here we can see if you bought a hedged share class rather than the unhedged Yen class, the difference is dramatic.
At some point the BoJ will decide that a weak Yen is no longer desirable and the combination of higher rates in Japan, at a point in time when it looks like the rest of the world will be cutting rates, could move the dial and usher in another era of Yen strength. We could be nearing a point where we will witness gains not only from an equity market boosted by rising corporate profits and fanned by improving shareholder reforms but also from currency appreciation.
UK Economy Grinds to a Halt, or Does it?
Last week, the ONS published data that showed UK GDP growth was flat for April, and most media reports were keen to jump on the narrative of an economy grappling with higher interest rates and sliding towards stagflation. However, I don’t know about you, but April was so wet that I definitely spent more time at home. Retail sales data suggested the public at large was not out shopping much nor seeking entertainment, and construction output was also down 3.3%, and I reckon much of that could also be put down to the weather. I would suggest that without those drags, the UK economy would have recorded another month of growth on top of the higher first-quarter GDP figure, so I think it is too early to conclude that we are sliding toward stagflation. In fact, if you look at the quarter-on-quarter % change, it shows a clear upward path annualising way higher than other European economies and arguably challenging the growth trajectory of the US economy.
Let’s see what next week brings…
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