Week #22 — Market Update for May 27-31, 2024

Executive Summary

The U.S. stock market finally retreated after a swift four-week rally, though this wasn't a broad selloff. All value segments posted confident gains, and eight out of eleven sectors showed positive dynamics, with the Technology sector being the main outsider.

Investors have been cautious about the mega-cap cohort known as the Magnificent 7, which has surged to twice the growth of the S&P 500 this year. This caution is understandable given their high valuation, with a forward P/E ratio of about 33.5 compared to 20.7 for the benchmark, and the increasing market concentration. Since the end of 2023, the combined weight of the Magnificent 7 in the S&P 500 Index has risen to 31.1% from 28.5%.

However, concerns about market concentration might be overblown. Despite the perception that the U.S. stock market is overly dependent on a few large technology stocks, historical context suggests that today's concentration levels are not unprecedented. According to Morningstar’s John Rekenthaler, the profit share from the top five companies has spiked significantly over the past decade, but this is not the first instance of such dominance. For example, in the 1960s, the top ten firms accounted for an even larger share of the total profits among the 100 highest-earning U.S. companies. Moreover, he suggested that these periods of high concentration did not necessarily correlate with increased market volatility.

Looking ahead, the Magnificent 7's profit growth is unlikely to continue at the pace it has shown over the past years (an annual 36% since 2015) due to their considerable size.

Globally, stock markets mostly followed the U.S. market. Developed markets outside the U.S. even showed slight gains, as tracked by IDEV, defying the thesis of a worldwide risk-off.

The New York Fed Staff Nowcast model downgraded its U.S. GDP growth forecast for Q2 2024 to 1.76% from 2.04% a week ago, mainly due data revisions and negative surprises from personal consumption data. Similarly, the Atlanta Fed's GDPNow revised its estimate downward to 2.7% from 3.5%.

The earnings season is nearing its end. According to Refinitiv, 489 companies in the S&P 500 Index have reported their earnings for Q1 2024 so far. This indicates that 98% of companies have already disclosed their earnings, up two percentage points over the week. Of these companies, 78.3% have exceeded analysts' expectations, a minor increase from 77.9% the previous week.

Turning to monetary policy, market expectations of the Federal Reserve's actions have evolved slightly. The likelihood of a rate cut in September has increased to 62.8% from 53.4%. Accordingly, traders have revised their projections for 2024's monetary easing to 36 basis points, up from 34.

In the bond market, the U.S. Treasury yield curve barely moved, with the 10-year bond yields increased by 5 basis points to 4.51%, and the 30-year bond yields rose by 8 basis points to 4.65%.

For comprehensive insights and a deeper understanding of these developments, readers are encouraged to refer to the full article.

US Stock Market

The U.S. stock market finally retreated after a swift four-week rally, though this wasn't a broad selloff. All value segments posted confident gains, and eight out of eleven sectors showed positive dynamics.

Investors have been cautious about the mega-cap cohort known as the Magnificent 7, which has surged to twice the growth of the S&P 500 this year. This caution is understandable given their high valuation, with a forward P/E ratio of about 33.5 compared to 20.7 for the benchmark, and the increasing market concentration. Since the end of 2023, the combined weight of the Magnificent 7 in the S&P 500 Index has risen to 31.1% from 28.5%.

However, concerns about market concentration might be overblown. Despite the perception that the U.S. stock market is overly dependent on a few large technology stocks, historical context suggests that today's concentration levels are not unprecedented. According to Morningstar’s John Rekenthaler, the profit share from the top five companies has spiked significantly over the past decade, but this is not the first instance of such dominance. For example, in the 1960s, the top ten firms accounted for an even larger share of the total profits among the 100 highest-earning U.S. companies. Moreover, he suggested that these periods of high concentration did not necessarily correlate with increased market volatility.

Looking ahead, the Magnificent 7's profit growth is unlikely to continue at the pace it has shown over the past years (an annual 36% since 2015) due to their considerable size.

In terms of sector performance, eight out of eleven sectors showed positive dynamics.

The Fear & Greed Index, which measures market sentiment, decreased to 48 from 53 a week ago.

The SPY ETF, which tracks the S&P 500 Index, almost touched the support level at the 50+day moving average. Due to sharply increased volatility (VIX +8% over the week) it is likely both to once again test the support or see new highs.

The earnings season is nearing its end. According to Refinitiv, 489 companies in the S&P 500 Index have reported their earnings for Q1 2024 so far. This indicates that 98% of companies have already disclosed their earnings, up two percentage points over the week. Of these companies, 78.3% have exceeded analysts' expectations, a minor increase from 77.9% the previous week. This rate remains above the long-term average of 66.7% but is slightly below the four-quarter average of 78.5%.

During the week of June 3, eight companies from the S&P 500 index are scheduled to present their financial results. The most eagerly awaited earnings reports include:

Global Markets

Global stock markets mostly followed the U.S. market. Meanwhile, developed markets outside the U.S. even showed slight gains, as tracked by IDEV, defying the thesis of a worldwide risk-off.

The ACWX ETF, representing the MSCI All Country World Index excluding the USA, has been fluctuating between its recent maximum and the 50-day moving average support, reflecting investors’ uncertainty about the future direction.

Economic Indicators, Statistics and News

Several important macroeconomic indicators and economic news were published during the week:

Global

·????? Donald Trump has made history as the first former U.S. president to be found guilty in a criminal trial, convicted on all 34 counts of falsifying business records to conceal a hush-money payment to Stormy Daniels. This verdict, reached by a jury in New York after two days of deliberation, comes just five months before the 2024 election and could significantly impact the political landscape. Despite the conviction, Trump, the presumptive Republican nominee, continues to garner strong support from his base, with many rallying around him.

The charges stem from allegations that Trump orchestrated a scheme to influence the 2016 election by using his business records to hide a $130,000 payment to Daniels, meant to silence her about an alleged sexual encounter. Prosecutors argued that this conspiracy deprived voters of crucial information. Trump's sentencing is set for July 11, where he faces up to four years in prison, just days before the Republican National Convention.

Despite this legal setback, Trump remains defiant, claiming the trial was rigged and vowing to fight the verdict. He is almost certain to appeal the decision, although he cannot pardon himself if re-elected because the conviction is on state charges. During the trial, Trump did not testify, and his defense team focused on discrediting key witness Michael Cohen, Trump's former lawyer, who testified that Trump was directly involved in the repayment scheme for the hush money.

The trial also featured testimony from David Pecker, former CEO of the National Enquirer, who detailed how his company helped suppress negative stories about Trump. Despite these testimonies and extensive evidence, including documents and secret recordings, Trump maintained his innocence.

Donald Trump’s historic conviction could significantly impact the upcoming presidential election, with political betting markets already reflecting a sharp shift in his favor. Despite being indicted four times and facing multiple criminal trials, including this recent conviction, Trump’s support has only grown. RealClear Politics' average shows a notable increase in his probability of winning, with betting markets now giving him better than a 50% chance of victory.

The trial, despite its embarrassing revelations, appears to have bolstered Trump’s campaign. This trend is seen in the reaction of political figures and Wall Street executives, who are increasingly swinging behind Trump. Hedge fund manager Bill Ackman and Blackstone’s Stephen Schwarzman are notable examples of financial support, reflecting a broader sentiment that Trump’s policies would benefit industries and potentially increase wealth for investors.

Historically, U.S. elections follow predictable cycles that influence market behavior. Markets tend to prefer incumbents due to reduced political uncertainty and the expectation that they will take measures to boost the economy ahead of elections. This year is proving no different, with the S&P 500 performing well despite the political turmoil. The index is on track for strong gains, similar to the positive market trends seen in previous incumbent re-election years, such as Bill Clinton’s in 1996.

However, Biden’s decline in the polls has started to impact specific sectors. FedEx, a company closely tied to globalization and trade volumes, has seen its share price fall in tandem with Biden’s diminishing chances. Strategas Research Partners suggests that under Trump, European automakers and assets in Mexico might suffer, while India could benefit from escalating trade tensions with China.

US

·????? In the first quarter of 2024, the US economy experienced slower growth than initially estimated, with the Bureau of Economic Analysis revising GDP growth down to an annualized rate of 1.3% from the previous estimate of 1.6%. This deceleration is primarily attributed to weaker consumer spending on goods, which grew by 2.0%, down from the earlier estimate of 2.5%. High interest rates, diminishing pandemic-era savings, and slower income growth are significant factors affecting household and business expenditures. Notably, consumer spending on goods, particularly autos, was softer, and federal government spending also slowed. Imports increased compared to the first estimate, resulting in net exports detracting from growth for the first time in two years.

The revision in consumer spending was partially offset by stronger business and residential investment, with nonresidential investment revised up to 3.3% from 2.9%, and residential investment up to 15.4% from 13.9%. A key measure of domestic demand, final sales to private domestic purchasers, showed a rise of 2.8%, slightly below the initial 3.1% increase. Gross domestic income (GDI), another measure of economic activity, rose by 1.5% in the first quarter, while corporate profits fell by 0.6% before tax. The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred inflation metric, increased at a 3.3% annualized rate, slightly lower than the initial projection, with core PCE rising by 3.6%.

Meanwhile, consumer confidence in the US saw an unexpected rise in May, breaking a four-month declining trend. The Conference Board's sentiment gauge increased to 102 from 97.5 in April, surpassing all estimates in a Bloomberg survey. The index of present conditions climbed for the first time since January, and the measure of expectations saw the largest jump since July. Despite this increase, overall confidence has been trending lower due to persistent inflation, record household debt, and a softening job market. Consumer concerns about a potential recession increased, reflecting the challenging economic environment.

The Federal Reserve's Beige Book survey reported that the US economy expanded at a "slight or modest" pace since early April, with consumers showing increased price sensitivity and discretionary spending remaining flat to slightly up. Employment rose modestly in eight of twelve districts, with wage growth moving toward pre-pandemic levels. Prices increased modestly, and businesses noted consumer resistance to further price hikes. The report, compiled by the Federal Reserve Bank of Dallas, indicates a more pessimistic outlook among businesses, highlighting rising uncertainty and greater downside risks.

·????? The Federal Reserve's preferred measure of underlying US inflation moderated in April, with the core personal consumption expenditures (PCE) price index, which excludes volatile food and energy components, increasing by 0.2% from the prior month. This represents the smallest advance of the year, signaling a potential slowdown in inflation pressures. According to the Bureau of Economic Analysis, the year-over-year increase for the core PCE price index stood at 2.8%, consistent with expectations. The overall PCE price index rose by 0.3% month-on-month and 2.7% year-on-year, aligning with estimates.

However, inflation-adjusted consumer spending fell by 0.1%, a surprising decline influenced by reduced outlays for goods and softer services spending. Wage growth, a key driver of demand, also moderated, with overall incomes rising by 0.3% and wages and salaries increasing by just 0.2%, the smallest gain in five months. Real disposable income, crucial for consumer spending, decreased by 0.1%, marking its second decline in the last three months. The saving rate held steady at 3.6%, the lowest since late 2022.

Bloomberg Economics analysts noted that the details of April's report are favorable for the Federal Reserve, as they indicate waning inflation pressures. However, they anticipate that the Fed will likely maintain current interest rates at its June meeting, awaiting more data to confirm the inflation cooling trend.

Research from the Federal Reserve Bank of Cleveland suggests that US inflation may not return to the central bank's 2% target until mid-2027. Cleveland Fed economist Randal Verbrugge's report indicates that while pandemic-era shocks have largely resolved, the remaining inflationary forces are very persistent. The model used in the research differentiates between extrinsic dynamics, influenced by external shocks, and intrinsic dynamics, which drive inflation in the absence of such shocks.

The normalization of supply chains has contributed to recent progress on inflation, leading to declines in the prices of certain goods. However, this progress appears to have plateaued. Two key measures tied to supply chains—the Federal Reserve Bank of New York’s global supply chain pressure index and the Producer Price Index (PPI) for core intermediate goods—have stabilized, suggesting that the downward pressure from these sources has nearly ended.

Verbrugge's analysis indicates that further reductions in inflation will primarily depend on intrinsic factors, such as wage growth and pricing behaviors of firms, which take longer to influence inflation rates. Consequently, the Cleveland Fed model suggests that inflation will be governed mainly by these intrinsic dynamics moving forward, implying that it could take several years for inflation to return to the Fed's 2% target. This persistence means that the central bank might need to keep interest rates higher for a longer period than previously anticipated to manage inflation effectively.

·????? Home-price growth in 20 major US cities accelerated in March, with the S&P CoreLogic Case-Shiller index showing a 7.4% annual increase, up from 7.3% in February. This increase is adding pressure on buyers during the key selling season, exacerbated by mortgage rates hovering around 7%. Despite a rise in listings, inventory remains historically low, driven by homeowners' reluctance to sell properties with lower locked-in rates. San Diego, New York, and Cleveland saw the largest annual gains among the cities surveyed, reflecting a broader trend where major cities are experiencing higher price growth compared to the national average of 6.5% in March.

In contrast, the Federal Housing Finance Agency (FHFA) reported a significant slowdown in US house price growth in March, with prices edging up only 0.1% from February's 1.2% increase. Year-over-year, prices rose by 6.7% in March, down from 7.1% in February.

The market for existing homes faced additional challenges in April, as indicated by a sharp decline in pending home sales. The National Association of Realtors (NAR) reported that its index of contract signings fell by 7.7% to 72.3, the lowest level since early in the pandemic. All US regions experienced declines, with the steepest monthly drop since February 2021. NAR Chief Economist Lawrence Yun noted that higher mortgage rates dampened home buying, despite an increase in inventory. Yun anticipates that a potential Federal Reserve rate cut later in the year could improve conditions by enhancing affordability and increasing supply. However, the current market remains tight, with only 1.2 million homes available, well below pre-pandemic levels.

Mortgage rates in the US rose for the first time in four weeks, with the average 30-year fixed loan reaching 7.03%, up from 6.94% the previous week, according to Freddie Mac. High borrowing costs, combined with elevated home prices and tight inventory, have significantly impacted demand. The measure of contract signings has plummeted to a four-year low in April. Sam Khater, Freddie Mac’s chief economist, highlighted the need for more evidence of slowing inflation for mortgage rates to decrease significantly. Realtor.com economist Jiayi Xu expects that decelerating inflation and economic growth could bring mortgage rates down to around 6.5% by the end of 2024.

·????? The New York Fed Staff Nowcast model downgraded its U.S. GDP growth forecast for Q2 2024 to 1.76% from 2.04% a week ago, mainly due data revisions and negative surprises from personal consumption data. Similarly, the Atlanta Fed's GDPNow revised its estimate downward to 2.7% from 3.5%.

Europe

·????? Euro-area inflation accelerated more than anticipated, complicating the European Central Bank's (ECB) strategy as it prepares to lower interest rates. Consumer prices in the eurozone rose by 2.6% in May, up from 2.4% in April, surpassing the 2.5% median estimate from analysts. A core measure, excluding volatile items like food and energy, also exceeded expectations, rising to 2.9%. This increase is partly attributed to unfavorable statistical effects, such as last year's introduction of a cheap nationwide transport ticket in Germany and a significant drop in energy costs in 2023 that wasn't repeated.

Germany, the eurozone’s largest economy, saw its inflation rate rise for the second consecutive month. Consumer prices increased by 2.8% in May, up from 2.4% in April, driven largely by the aforementioned transport ticket base effect. Despite this uptick, the general trend in German inflation is expected to decline, with predictions that it will drop below the 2% mark in the latter half of the year. Core and services inflation, however, are likely to remain more persistent but should also see a gradual decrease.

In France, inflation accelerated for the first time this year, with consumer prices rising by 2.7% in May, compared to 2.4% in April. This was slightly above the 2.6% forecast by economists. The increase was driven by a 5.8% rise in energy prices, though services inflation slowed to 2.7% from 3% in April. The expectation is that some energy price pressures will ease in June, leading to a decrease in headline inflation to 2.5%, continuing a downward trend over the coming quarters.

Spain also reported an increase in inflation for the third consecutive month. Consumer prices rose by 3.8% in May, up from 3.4% in April, exceeding the 3.7% median estimate. Core inflation, which excludes energy and some food costs, edged up to 3% from 2.9%. This rise is primarily attributed to the rollback of government support measures aimed at containing the energy crisis. However, the underlying inflation trend in Spain has been smoother and is expected to fall below 2% later in the year, indicating that the risk of persistent inflation is diminishing.

Despite these inflationary pressures, inflation expectations among eurozone consumers edged lower, with prices projected to advance by 2.9% over the next 12 months, down from 3% in March. This marks the lowest level since September 2021. The three-year inflation expectations also fell slightly to 2.4% from 2.5%.

·????? S&P Global Ratings downgraded France's credit rating from AA to AA-, highlighting the French government's failure to meet budget deficit targets after significant spending during the Covid pandemic and energy crisis. Despite reforms and economic recovery efforts, S&P projects that France's budget deficit will remain above 3% of GDP by 2027.

This downgrade tarnishes President Emmanuel Macron’s reputation for debt management, complicating his political situation just before the European elections, where his Renaissance group trails Marine Le Pen’s National Rally.

Le Pen leveraged the downgrade to criticize Macron’s economic policies and called for voters to sanction him in the EU elections. She also urged opposition lawmakers to support a no-confidence motion against his government. Finance Minister Bruno Le Maire defended the government’s strategy, citing the necessity of large-scale spending during the pandemic to save businesses and protect households. He reaffirmed the goal of reducing the deficit to under 3% of GDP by 2027.

S&P’s decision underscores the increasing debt burden, predicting government debt will rise to 112% of GDP by 2027 from 109% in 2023. This places France’s rating on par with the Czech Republic and Estonia, seven notches above junk status, with a stable outlook. Investors are particularly concerned about France's long-term debt sustainability, reflected in the rising yield spread on 10-year bonds over German securities, which has doubled since pre-Covid levels.

·????? Germany's economic outlook is showing signs of gradual improvement, although the recovery process remains sluggish and uneven. The Ifo institute's expectations gauge rose for the fourth consecutive month to 90.4 in May, up from a revised 89.7 in April. Despite this positive trend, the measure of current conditions fell, indicating that while confidence in future growth is building, the present economic situation remains challenging.

In parallel, German consumer sentiment improved for the fourth consecutive month, according to a survey by the GfK institute and the Nuremberg Institute for Market Decisions. The consumer sentiment index rose to -20.9 heading into June, up from a revised -24.0 in May, surpassing analysts' expectations. This improvement is attributed to rising income expectations and a greater willingness to buy, driven by falling inflation rates and respectable wage and salary increases. Despite this progress, there remains a notable level of uncertainty among consumers, inhibiting larger purchases and more significant investments.

Despite these positive signals, the retail sector showed disappointing results in April. Retail sales fell by 1.2% compared with the previous month, a sharper decline than the 0.1% decrease predicted by analysts. Year-on-year, retail sales were down by 0.6% in real terms, underscoring the challenges facing consumer spending in Germany.

·????? In early May, UK retailers experienced the slowest price increases in over two years, signaling an improved economic outlook. The British Retail Consortium reported a rise in shop prices of just 0.6%, down from the previous month’s 0.8% and below the three-month average of 0.9%. Food price inflation also eased to 3.2%, while non-food items saw a deflation of -0.8%, a continuation from April’s -0.6%. Retailers, facing subdued consumer demand for large-ticket items, reduced prices on furniture and audiovisual equipment in preparation for the summer Euro tournament.

In the housing market, UK house prices rose for the first time in three months, indicating stabilization amid high borrowing costs. Nationwide Building Society reported a 0.4% increase in average home prices in May, surpassing economists' expectations of a 0.2% rise. This marks the strongest growth since February. The Bank of England noted that mortgage approvals in April were steady, with 61,140 home loans authorized, aligning with market forecasts and exceeding the six-month average.

The housing market had slumped the previous year as the Bank of England raised interest rates to a 16-year high to combat inflation, exacerbating the cost-of-living crisis. However, with inflation declining and rate cuts anticipated, buyers are cautiously returning. Nationwide’s chief economist, Robert Gardner, highlighted the market's resilience despite ongoing affordability pressures, attributing improved consumer confidence to solid wage gains and lower inflation. Yet, the outlook remains cautious, with no expectation of a significant resurgence in house prices.

The upcoming general election brings housing issues to the forefront, with the Conservative Party trailing in polls. Analysts from Knight Frank and Zoopla noted that while there is a seasonal demand increase, high supply and persistent services inflation are capping price growth. In May, houses for sale hit an eight-year high, indicating seller confidence, although buyer caution persists, with nearly a third of homes listed in 2023 still unsold.

Asia

·????? Japan is witnessing significant inflationary pressures, particularly in the services sector, which is now rising at the fastest rate in over 30 years. According to the BOJ, the services producer price index surged by 2.8% year-on-year, the highest growth rate since September 1991, excluding periods affected by sales tax increases. This increase exceeded the forecasted 2.3%, suggesting that inflation is becoming more entrenched in the economy. The data supports the possibility of the BOJ considering another interest rate hike sooner than previously expected, possibly moving the timeline from October to July.

The rise in service prices is largely driven by wage gains across various sectors, including retail and telecommunications, where workers secured wage increases exceeding 5%. This trend of passing higher labor costs onto customers is expected to maintain the upward momentum in service prices. However, the economy faces mixed signals, with private spending declining for four consecutive quarters, contributing to an economic contraction in the first quarter of the year.

Inflation in Tokyo also accelerated in May, with consumer prices excluding fresh food rising by 1.9%, driven primarily by utility costs related to renewable energy surcharges. These figures typically serve as a leading indicator for national trends, suggesting a similar acceleration in nationwide inflation when those figures are released. The Tokyo inflation rate remains lower than the national average due to local educational support measures, but with tax cuts and the end of government utility subsidies starting in June, the future impact on prices and consumption remains uncertain.

Despite the upward inflation trend, other economic indicators present a more nuanced picture. Industrial output in April was weaker than expected, and while the jobless rate held steady at 2.6%, the proportion of job vacancies to seekers decreased slightly, indicating a tight labor market that may eventually contribute to higher wages and prices. Retail sales showed a positive increase of 1.2% in April, beating the consensus estimate of 0.6% growth, but factory output edged lower by 0.1%, missing the expected 1.5% growth.

Economists are divided on the timing of the BOJ's next interest rate hike. While some suggest that rising prices and a weaker yen may prompt an earlier move, others believe that the BOJ will stick to a cautious approach, potentially delaying the hike until October. The upcoming national inflation data, expected to show core CPI inflation climbing closer to 3% in May, will be crucial in shaping the BOJ's decision.

·????? China's industrial sector experienced a notable upturn in April, driven by government initiatives and a resurgence in export demand, as reported by the National Bureau of Statistics. Industrial profits for large Chinese companies rose by 4% year-on-year, marking a recovery from a decline in March, which had interrupted seven consecutive months of growth. This improvement was largely attributed to the global demand for technology products and the Chinese government’s push for equipment upgrades. Specifically, the earnings of manufacturers of computer, communication, and other electric equipment surged by 76% in the first four months of the year compared to the same period the previous year. Conversely, general equipment manufacturers saw a more modest profit increase of 6%.

The government's efforts included subsidies, investments, and new environmental standards to encourage the replacement of old machinery, fostering growth in emerging industries such as tech. Foreign firms in China also rebounded, with profits rising by 17% in the first four months of the year, while state-owned enterprises saw a 2.8% decline in earnings.

Despite these gains, challenges remain. Domestic demand is still weak, and the external environment remains complex, as highlighted by government statistician Yu Weining. The producer price index continued to decline, falling by 2.5% in April, reflecting ongoing deflation in factory-gate prices since late 2022. Meanwhile, consumer spending growth slowed to its lowest pace since 2022, and key property sector metrics deteriorated.

The official manufacturing PMI unexpectedly fell to 49.5 in May from 50.4 in April, indicating a contraction in factory activity and raising concerns about China’s ability to meet its growth target of around 5% for the year. The sub-index for new export orders also contracted, and input prices rose to an eight-month high due to increased commodity costs. This contraction underscores the vulnerability of the manufacturing-driven recovery, particularly in light of rising trade protectionism from the US and EU.

In response to these challenges, Chinese policymakers are under pressure to bolster the domestic market through further fiscal and monetary stimulus. Economists predict that the central bank may cut interest rates, and the government has already announced a broad rescue package for the property sector, though its effectiveness is uncertain. The International Monetary Fund (IMF) has also raised its growth forecast for China to 5% for this year, up from 4.6%, and to 4.5% from 4.1% for 2025, citing strong early-year performance and anticipated government support. However, the IMF has called for additional measures to resolve the housing crisis and to support unfinished pre-sold homes.

·????? China's recent efforts to stabilize its struggling property market have shown mixed results, impacting both growth projections and financial markets. A rescue package announced on May 17, which includes lower down-payment requirements and 300 billion yuan ($42 billion) in central bank funding for local authorities to buy excess inventory from developers, is expected to boost GDP growth modestly. Economists surveyed by Bloomberg predict an increase of 0.1 to 0.3 percentage points in GDP for this year, with the median growth forecast for 2024 edging up to 4.9%. However, the measures are seen as modest relative to the scale of the issues, with the housing market still facing significant inventory challenges.

Meanwhile, new-home sales by the 100 largest real estate companies in China fell 33.6% year-over-year in May, an improvement from a 45% decline in April. The government's initiative to buy unsold homes and loosen home-buying rules has started to show green shoots, with transactions gaining 3.4% from April. However, the scale of unsold housing remains daunting. China has an equivalent of 60 million unsold apartments, which would take more than four years to sell without government aid. The central bank's provision of 300 billion yuan to address inventory overhang is seen as insufficient to substantially reduce existing stock.

·????? India's economic growth surged past 8% in the fiscal year ending in March, surpassing expectations and providing a significant boost to Prime Minister Narendra Modi’s government just days before the announcement of election results. The nation’s gross domestic product (GDP) rose by 8.2%, exceeding the 7.9% forecast by economists. In the January-March quarter alone, GDP grew by 7.8% year-on-year, although this was a slight deceleration from the revised 8.6% expansion seen in the previous quarter.

This robust growth cements India's position as the world’s fastest-growing major economy, with the Reserve Bank of India (RBI) projecting a 7% growth rate for the current fiscal year, well ahead of the global growth forecast of 3% for 2024. Despite the impressive GDP figures, the divergence between GDP and gross value added (GVA)—which rose 6.3% in the first quarter—highlights underlying distortions primarily due to changes in government subsidies.

The strong economic performance is expected to allow the RBI to maintain its current interest rates, which have been held steady for seven consecutive meetings. This stance is bolstered by a focus on bringing inflation down to the central bank’s 4% target. Economists anticipate that the RBI may revise its growth forecast upwards at its next meeting.

On the fiscal front, India reported a fiscal deficit of 16.54 trillion rupees for the year through March, representing 95.3% of the budgeted estimate. This improved fiscal discipline has led to predictions that the deficit for 2023-24 will be around 5.6%, potentially lowering further to 5% following a record dividend payment from the central bank.

In a related development, S&P Global Ratings upgraded its outlook on India’s BBB- sovereign credit rating to positive from stable, citing the country’s strong economic fundamentals and sustained policy stability. This change reflects confidence in India’s long-term growth prospects, driven by significant infrastructure investments and economic reforms. S&P highlighted that regardless of the election outcome, the continuity in economic policies is expected to support growth in the coming years.

Bonds reacted positively to S&P’s outlook upgrade, with the yield on the benchmark 10-year note falling to 6.99%. Additionally, India's impending inclusion in JPMorgan Chase & Co.’s emerging-market bond index is anticipated to attract substantial foreign inflows, estimated at $20 billion to $25 billion over the next 10 months. This inclusion, along with other expected index additions, will bolster India’s foreign-exchange reserves, enhancing economic resilience.

Furthermore, India's cautious fiscal and monetary policies have been praised for reducing the government's debt and interest burdens while strengthening economic stability. This prudent approach has paved the way for a potential credit rating upgrade over the next 12-18 months, contingent on sustained growth and inflation easing towards target levels.

Foreign Exchange Markets

The Dollar Index, which reflects the value of the US dollar against a basket of major currencies, lost 0.1% over the week.

Commodities and Energy Markets

In the commodities sector, the majority of assets ended the week with mixed movements.

Global temperatures are breaking records, and the situation is expected to worsen significantly, with 2024 poised to become the hottest year in history. This extreme heat is driving up prices for essential commodities such as natural gas, power, and staple crops like wheat and soy. Shipping routes, already disrupted by climate-induced issues, may face further chaos, and the potential for destructive wildfires is increasing. These climate disruptions are exacerbating inflation, raising the costs of energy, food, and fuel, and contributing to devastating economic impacts. In 2023 alone, extreme weather and earthquakes caused global losses of $250 billion.

Natural gas prices in the U.S. could surge by more than 50%, with similar expectations for wheat and coffee markets. The first four months of 2024 were the warmest in 175 years, and there is a 61% chance that 2024 will surpass 2023 as the hottest year on record. Record-high ocean temperatures are likely to fuel intense tropical cyclone activity, while the La Ni?a weather pattern expected in August will amplify hurricanes in the Atlantic and cause dry conditions in the U.S. West and South.

The global economy faces significant risks, with the hurricane season in the Gulf of Mexico posing a major threat. U.S. natural gas futures could reach $4 per million British thermal units if hot weather increases air-conditioning demand, depleting current inventories. In Europe, the competition for liquefied natural gas from exporters like the U.S., Qatar, and Nigeria is intensifying, with funds showing the most bullish stance on European natural gas since the pre-energy crisis period.

Power markets are similarly at risk. Texas, for example, is experiencing surging electricity prices due to high temperatures, with prices for August reaching above $200 per megawatt-hour. In Europe, extreme heat could force French nuclear plants to shut down, exacerbating power supply issues. These high commodity prices complicate the Federal Reserve’s efforts to control inflation and may lead to prolonged higher interest rates, posing a challenge for President Joe Biden ahead of the U.S. presidential election.

The agricultural sector is also facing severe impacts, with wheat futures reaching their highest levels since July. Dry conditions in key exporting regions like Russia and adverse weather in North America are affecting crop yields. Coffee markets are at risk of a 30% price increase due to potential production issues in Brazil and Vietnam. The oil market is vulnerable to disruptions from severe heat, which can affect production, refining, and shipping operations. Wildfires in Canada and potential refinery shutdowns due to heat stress and power outages add to the risks.

Debt and Fixed Income Markets

Market Movements

According to CME data, the implied Fed Funds rate curve for the next 18 months (until November 2025) has shifted downward by an average of 3 basis points.

Meanwhile, the U.S. Treasury yield curve barely moved. The 10-year bond yields increased by 5 basis points to 4.51%, and the 30-year bond yields rose by 8 basis points to 4.65%.

Central Bank Insights

·????? The Bank of Japan (BOJ) is navigating a complex monetary policy landscape as it addresses rising long-term bond yields and prepares for potential interest rate adjustments. Governor Kazuo Ueda emphasized that long-term bond yields should be guided by financial markets, acknowledging that they have reached the highest levels since 2012. Ueda, along with Finance Minister Shunichi Suzuki, underscored the need for Japan to improve its fiscal health, given its debt ratio of about 250% of economic output, the highest among developed economies.

Deputy Governor Shinichi Uchida indicated that there is scope for gradually raising interest rates now that Japan has shifted away from a zero-inflation norm. Uchida highlighted that consumers and companies are no longer expecting static prices, with more firms confident in raising prices and workers less willing to accept low wage increases. This shift in behavior supports the BOJ’s view that inflation expectations are becoming anchored at 2%, although the challenge remains to solidify this target.

Board Member Seiji Adachi noted that yen weakness could spur price gains, potentially prompting an earlier rate hike if prolonged weakness affects inflation. Adachi, known for his dovish stance, highlighted the need for keeping financial conditions easy but acknowledged the possibility of accelerating monetary policy adjustments if inflation exceeds the 2% target sustainably. Adachi’s comments align with Ueda’s cautious approach to the yen’s impact on prices, signaling readiness for policy action if necessary.

Economists and former policymakers like Takatoshi Ito suggest that the BOJ might raise interest rates to 0.25% and possibly 0.5% this year, advocating for a cautious rate hike cycle. Ito, a former advisor and a potential candidate for BOJ leadership, warned against aggressive rate hikes in response to the weak yen, suggesting it could harm the domestic economy. He indicated that gradual yield increases towards 1.5% would be manageable without triggering significant economic problems.

·????? The European Central Bank (ECB) is navigating a critical juncture in its monetary policy as it prepares to initiate interest rate cuts amid a complex economic landscape characterized by inflation dynamics and wage pressures. ECB officials, including Governing Council members and Chief Economist Philip Lane, have indicated that a rate cut is likely at the upcoming June meeting, with potential for further reductions later in the year.

ECB Governing Council member Mario Centeno expressed confidence that the early-year acceleration in workers’ pay in the euro zone does not pose a significant threat to inflation targets. Centeno highlighted that the real-wage recovery, following the consumer price surge due to Russia’s invasion of Ukraine, is compatible with inflation converging to the ECB’s 2% target. He noted that the euro-area economy's revival is expected to continue without jeopardizing the disinflation process.

Executive Board member Piero Cipollone echoed this sentiment, suggesting that recent data supports a reduction in the restrictive stance of the ECB’s monetary policy. Cipollone’s comments align with those of Fabio Panetta, who emphasized the need for a steady descent in borrowing costs to manage macroeconomic volatility effectively.

Chief Economist Philip Lane underscored the importance of maintaining a restrictive policy stance through 2024, while suggesting that the ECB can begin to reduce rates within this restrictive zone. Lane emphasized that the full impact of the ECB’s monetary-tightening campaign has yet to be realized, with substantial pass-through effects on inflation expected to continue.

Governing Council member Francois Villeroy de Galhau advocated for maintaining flexibility in the timing and pace of rate cuts, suggesting that consecutive cuts in June and July should not be ruled out. He stressed the importance of significant room to loosen monetary policy toward a neutral setting, while noting that the US Federal Reserve’s actions would not heavily constrain the ECB’s decisions.

Dutch central bank chief Klaas Knot suggested that the ECB’s key meetings for interest rate decisions could center around quarterly projections, with June, September, and December being critical. Knot highlighted the need for a gradual reduction in policy rates, although he acknowledged that wage growth and productivity remain challenges.

Latvian official Martins Kazaks emphasized the importance of a data-dependent approach, warning against an autopilot mode for rate cuts. Kazaks pointed out the necessity of monitoring wages, productivity, and profit margins closely as recession risks fade.

Bank of Italy Governor Fabio Panetta argued against delaying rate cuts, advocating for prompt and gradual action to prevent excessive economic constriction and inflation undershoot. Panetta’s remarks suggest a preference for regular rate reductions, with an emphasis on maintaining tight monetary conditions even with several cuts.

A Bloomberg survey indicated that economists are scaling back their expectations for the extent of ECB rate cuts. While a majority predict two more reductions in September and December following an expected cut in June, there is considerable debate over the pace and number of cuts. The survey revealed a divergence between economic forecasters and financial markets, with markets pricing in fewer cuts than economists anticipate.

·????? Federal Reserve officials have been expressing varied perspectives on the future of US monetary policy, with a focus on interest rates, inflation, and the central bank's balance sheet. Fed Governor Michelle Bowman suggested a preference for a slower tapering of the Fed’s balance sheet runoff than currently planned, citing the abundant reserves at commercial banks. She emphasized the importance of reducing the balance sheet size to enhance the Fed's future policy flexibility while maintaining that any changes should not be misinterpreted as shifts in monetary policy.

Federal Reserve Bank of Cleveland President Loretta Mester advocated for enhanced communication strategies to improve public understanding of the Fed’s policy decisions. She recommended expanding the policy statements and adding more details to the quarterly summary of policymakers’ forecasts to better link economic conditions with policy decisions. Mester highlighted the need for a clearer narrative and scenario analysis to strengthen the credibility and effectiveness of the Fed's forward guidance.

Minneapolis Fed President Neel Kashkari underscored the need for patience in assessing inflation trends before making further policy changes. He noted the resilience of the US economy and labor market but pointed out that inflation has shown signs of stalling at around 3%. While he does not rule out additional rate hikes, Kashkari suggested that policymakers should wait for more data before deciding on rate cuts.

Atlanta Fed President Raphael Bostic expressed hope that the significant price pressures seen during the pandemic would normalize over the next year. He indicated that if inflation trends continue as expected, rate cuts might be appropriate by the fourth quarter. Bostic stressed the importance of reducing the breadth of inflation to gain the confidence needed for lowering rates.

New York Fed President John Williams projected that inflation would continue to fall in the second half of the year, attributing this to elevated borrowing costs and easing imbalances between supply and demand. Williams emphasized a cautious approach, noting that any decision on rate cuts would depend on incoming economic data. He expected inflation to decrease to about 2.5% by year-end and approach the 2% target in the following year.

Dallas Fed President Lorie Logan raised concerns that current high interest rates might not be as restrictive as anticipated. She emphasized the need for flexibility in policy decisions, considering the potential rise in the neutral interest rate due to increased investment demand. Logan highlighted the uncertainty surrounding the path to achieving the 2% inflation target and the importance of keeping all options open.

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