07/15/2024

Last week’s macroeconomic highlight was undoubtedly the release of US inflation data for June, which surprised significantly on the downside. Importantly, the weakness was widespread, affecting both services and core goods, including the anticipated moderation in rental prices.

The U.S. central bank can now be more confident that inflation is steadily approaching the 2% target. In this context, several Federal Reserve members praised the June Consumer Price Index (CPI) as excellent. Similarly, given the improving inflation outlook, recent messages from the Federal Reserve, including Chairman Powell’s testimony before Congress, indicate a shift in focus toward the labor market rather than solely on prices.

Consequently, the likelihood of a rate cut in September has gained significant attention, and the market is now pricing it in with near certainty. In fact, the expectation now stands at 2.5 rate cuts in 2024. Nevertheless, it remains highly probable that the trajectory of monetary easing will proceed gradually, given the strong underlying fundamentals of the economy, which indicate robust activity.

However, as the outlook for official US interest rates becomes clearer, the visibility of US policy grows more uncertain. President Biden’s spontaneous press conference last week continued to provide reasons for questioning the suitability of his candidacy for the presidential race. In view of the Trump team's strong views on tariffs, migration and taxes, a victory by the former president, especially if combined with Republican control of Congress, would have major implications not only for the United States, but also for the global economy. This Trump victory scenario was reinforced over the weekend, following the failed assassination attempt on the president at a rally in the state of Pennsylvania.

Similarly, the first week after the French legislative elections has not made it clear who will be the new prime minister. The recent elections in France led to a seemingly ungovernable parliament. Neither the left nor the presidential coalition currently holds a position to govern without the support or tacit consent of other political blocs. Due to the absence of relevant historical precedents and the limited tradition of coalitions in France, forming a stable government is likely to necessitate protracted negotiations.

In contrast, the new Prime Minister of the United Kingdom has already assumed office, and ministerial appointments have been finalized. The Labour Party has also initiated structural reforms. A more specific announcement regarding the government’s policy agenda is scheduled for this week during the King’s Speech on July 17.

Meanwhile, after several weeks of concern about the disproportionate concentration of the S&P 500 index’s gains in a few large-cap technology firms, market breadth significantly improved last week. Previously overlooked segments of the market have now joined the upward trend.

The catalyst was the June CPI data for the United States mentioned earlier. This data sets the stage for the Fed to initiate its rate cut process in September. Notably, the decline in US inflation triggered a significant sector rotation. Large-cap technology companies, which had previously been favored by investors, were now abandoned, while sectors that thrive in an environment of Fed rate cuts experienced aggressive buying.

During the last two sessions of the week, US small-cap stocks, which are considered winners in a lower US interest rate environment, outperformed the tech-heavy Nasdaq 100 index by 6.3 percentage points. This represents the largest gap in their favor since November 2020.

The broader participation of small caps is beneficial for active managers and provides additional support for the continued upward movement of the US stock market. While we will need to monitor whether this rotation persists in the coming days, even modest profit-taking within the Magnificent 7 group could generate significant momentum across the other 493 stocks in the US stock index.