Week #24 — Market Update for June 10-14, 2024

Executive Summary

The major U.S. stock indexes posted mixed results. For the second week in a row, almost all of the gains for the technology-heavy S&P 500 and Nasdaq Composite came from the “Magnificent 7” stocks, which once again accounted for 92% of the S&P 500 index's weekly increase. Specifically, the trio of AAPL, MSFT, and NVDA drove these indexes to new highs. Apple’s stock rose by 7.9% week over week as the company unveiled its strategy for incorporating artificial intelligence (AI) into its products. Investors are optimistic about the new AI features in iPhones, including an agreement with OpenAI to integrate ChatGPT, which is expected to drive a major upgrade cycle among users. Meanwhile, the AI poster child of the year, Nvidia, surged another 9.1%, with a year-to-date return of 166%. The rally, recently fueled by a 10-for-1 stock split, has shown no signs of slowing down and could position Nvidia for inclusion in the Dow Jones Industrial Average, potentially replacing Intel Corp.

Notably, despite rising indexes, the Fear and Greed index has continued to decline, entering the “fear” zone this week. Such a contradiction could be a sign of underlying market weakness, as evidenced by the mid- and small-cap components of the S&P Composite 1500 Index, which have both already retreated about 5% from their highs.

Globally, stock markets posted mixed movements, with European markets witnessing significant losses amid political turmoil in France. After an unexpected defeat to Marine Le Pen's far-right National Rally, President Emmanuel Macron called for snap parliamentary elections three years ahead of schedule. Financial markets reacted negatively to these developments, with the spread between French and German 10-year yields widening to its highest level since 2017 and a wipeout of about $210 billion off the value of French stocks.

The New York Fed Staff Nowcast model slightly upgraded its U.S. GDP growth forecast for Q2 2024 to 1.91% from 1.90% a week ago as positive surprises from CPI data offset negative surprises from export and import price data. The Atlanta Fed's GDPNow did not publish an update to its model during the week.

Turning to monetary policy, market expectations of the Federal Reserve's actions have evolved. The likelihood of a rate cut in September has surged to 74.3% from 54.4% a week ago. Accordingly, traders have revised their projections for 2024's monetary easing to 37 basis points, up from 27, implying one certain rate cut in September or November and about a 50% probability of a subsequent one in December.

In the bond market, the U.S. Treasury yield curve moved down, with 10-year bond yields falling by 23 basis points to 4.20% and 30-year bond yields decreasing by 21 basis points to 4.34%.

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

US Stock Market

The major U.S. stock indexes posted mixed results. For the second week in a row, almost all of the gains for the technology-heavy S&P 500 and Nasdaq Composite came from the “Magnificent 7” stocks, which once again accounted for 92% of the S&P 500 index's weekly increase. Specifically, the trio of AAPL, MSFT, and NVDA drove these indexes to new highs. Apple’s stock rose by 7.9% week over week as the company unveiled its strategy for incorporating artificial intelligence (AI) into its products. Investors are optimistic about the new AI features in iPhones, including an agreement with OpenAI to integrate ChatGPT, which is expected to drive a major upgrade cycle among users. Meanwhile, the AI poster child of the year, Nvidia, surged another 9.1%, with a year-to-date return of 166%. The rally, recently fueled by a 10-for-1 stock split, has shown no signs of slowing down and could position Nvidia for inclusion in the Dow Jones Industrial Average, potentially replacing Intel Corp.

Notably, despite rising indexes, the Fear and Greed index has continued to decline, entering the “fear” zone this week. Such a contradiction could be a sign of underlying market weakness, as evidenced by the mid- and small-cap components of the S&P Composite 1500 Index, which have both already retreated about 5% from their highs.

In terms of sector performance, seven out of eleven sectors showed negative dynamics.

The Fear & Greed Index, which measures market sentiment, decreased to 38 from 45 a week ago, entering a “fear” zone.

The SPY ETF, which tracks the S&P 500 Index, returned to the ascending trajectory, reaching a new high this week.

Global Markets

Global stock markets posted mixed movements, with European markets witnessing significant losses amid political turmoil in France. After an unexpected defeat to Marine Le Pen's far-right National Rally, President Emmanuel Macron called for snap parliamentary elections three years ahead of schedule. Financial markets reacted negatively to these developments, with the spread between French and German 10-year yields widening to its highest level since 2017 and a wipeout of about $210 billion off the value of French stocks.

The ACWX ETF, representing the MSCI All Country World Index excluding the USA, has sharply left its range, finding support at the 100-day moving average. For now, it’s too early to predict further movements, though the first wave of the selloff seems to have ended.

Economic Indicators, Statistics and News

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

Global

·????? The World Bank has raised its global growth forecast for 2023 to 2.6%, up from the 2.4% projected in January, primarily due to stronger-than-expected US economic performance. The US growth outlook has been upgraded significantly to 2.5%, from the previous estimate of 1.6%. However, growth forecasts for regions such as Sub-Saharan Africa, the Middle East, and North Africa have been downgraded. The 2025 global growth forecast remains unchanged at 2.7%.

The global economy is stabilizing faster than anticipated, largely due to the robust US economy, according to Indermit Gill, the World Bank’s chief economist. However, the overall growth trajectory remains below pre-pandemic levels, and poorer countries face significant challenges. These nations are grappling with issues like attracting private investment, reducing public debt, improving education, health, and infrastructure, and managing conflict and climate shocks. The 75 countries eligible for interest-free loans from the World Bank's International Development Association will require international assistance.

Global inflation is expected to decline to 3.5% this year and 2.9% by 2025, though at a slower pace than previously projected. As a result, many central banks are likely to maintain high interest rates, which are anticipated to average around 4% between 2025 and 2026, compared to pre-pandemic levels.

The report also highlights the lackluster outlook for global trade, which is expected to experience the weakest half-decade of growth since the 1990s by 2024. Although trade growth will slightly improve from last year's standstill, it remains subdued due to the proliferation of trade-restrictive measures and heightened trade policy uncertainty.

US

·????? Federal Reserve officials unanimously decided to maintain the benchmark federal funds rate within the range of 5.25% to 5.5%, the highest level in two decades, initially set in July 2023, for the seventh straight meeting. Despite this, policymakers signaled a shift in their rate cut expectations, indicating just one reduction this year compared to three predicted in March. They now foresee four cuts in 2025, an increase from the previously anticipated three.

Chair Jerome Powell noted the recent favorable inflation readings and acknowledged modest progress toward the Fed's 2% inflation target. However, he emphasized the need for additional positive data to confirm that inflation is moving sustainably toward this goal. The Fed's "dot plot" revealed differing opinions among officials regarding the future path of borrowing costs: four officials saw no cuts this year, seven anticipated one reduction, and eight expected two cuts.

The Federal Open Market Committee (FOMC) adjusted its post-meeting statement to reflect this modest progress, shifting from a previous assertion of a "lack" of progress. This change aligns with recent data showing a slowdown in price growth in April and May. Powell welcomed these figures, which bolster the Fed's confidence in the inflation trajectory, but stated that they are not sufficient to justify rate cuts at this time.

The Fed also updated its inflation forecast, raising the projection for underlying inflation to 2.8% from 2.6% in March, while maintaining its economic growth and unemployment rate forecasts at 2.1% and 4%, respectively. The unemployment rate rose to 4% in May, indicating a gradually cooling labor market.

Powell compared the current labor market to its state at the onset of the pandemic, noting its strength but gradual cooling. He acknowledged that any unexpected weakening could prompt a Fed response. Additionally, the Fed raised its long-term interest rate projections to 2.8% from 2.6% in March, suggesting an expectation that higher interest rates will persist.

The market reaction to these developments was subdued – the S&P 500 index only slightly pared early gains of 1% after an unexpectedly soft inflation print, closing at 0.85%. This was largely because market participants forecasted almost the same rate dynamics as policymakers revealed – according to CME data for the last Friday, expected easing for 2024 was projected at 27 basis points versus 25 basis points as the median dot plot, and for 2025 – 80 basis points against 100 basis points (four rate cuts).

·????? Recent economic data from the US shows encouraging signs for inflation control, suggesting potential rate cuts by the Federal Reserve later this year. The core consumer price index (CPI), which excludes volatile food and energy prices, rose just 0.2% in May, the softest month-on-month increase since August 2021, and below the 0.3% forecasted. This reduction in core CPI, combined with a broader cooling in services inflation and a decrease in producer prices, indicates easing inflationary pressures.

The overall consumer price index remained flat from the prior month, marking the tamest reading in almost two years, largely due to cheaper gasoline. Year-over-year, the CPI increased by 3.3%, and the core CPI by 3.4%, both slightly below expectations. Key metrics such as the supercore services index, which excludes shelter, saw prices fall slightly for the first time in nearly three years, indicating a broader decline in service-related inflation.

Additionally, the trimmed mean inflation rate, which excludes the most extreme price changes, slowed to an annualized rate of less than 2% in May, marking a return below the Federal Reserve's target for the first time in three years. The sticky price inflation rate, covering goods with prices that are hardest to change, also showed a slowdown to 4.0% from 4.5% in April.

Moreover, the producer price index (PPI) for final demand fell by 0.2% in May, the most significant decline in seven months, against expectations of a 0.1% increase. Year-over-year, the PPI rose by 2.2%, again below forecasts. Nearly 60% of the monthly decline in the PPI for goods was due to falling gasoline prices, with decreases also seen in diesel fuel, commercial electric power, and jet fuel. Service costs remained unchanged.

These developments bolster expectations that the Federal Reserve’s preferred inflation measure, the personal consumption expenditures (PCE) price index, will show minimal gains when May data is released. Analysts forecast the core PCE, which excludes food and energy, to increase by only 0.1% for the month.

·????? Consumer expectations for inflation in the US showed little change, according to recent surveys. The Federal Reserve Bank of New York reported that consumers anticipate prices to rise at an annual rate of 3.2% over the next year, down slightly from 3.3% the previous month. Expectations for inflation three years ahead remained steady at 2.8%, while the five-year outlook increased to 3.0% from 2.8%.

Meanwhile, US consumer sentiment dropped to a seven-month low in early June, reflecting ongoing concerns over high prices impacting personal finances. The University of Michigan's sentiment index fell to 65.6 from 69.1 in May, contrary to economists' expectations of a rise to 72. Consumers expect prices to climb at an annual rate of 3.1% over the next five to 10 years, a slight increase from the 3% expected in May. For the next year, they see costs rising by 3.3%, consistent with the previous month's expectations.

Additionally, the Cleveland Fed's estimate for 10-year expected inflation in June decreased to 2.37% from 2.45% in April. This estimate is based on a model that includes Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations. This decline suggests a moderate long-term outlook for inflation despite the recent concerns reflected in consumer sentiment surveys.

·????? Recent data indicates a positive shift in the US mortgage market as mortgage applications for home purchases rose for the first time in five weeks, thanks to a slight decrease in mortgage rates. According to the Mortgage Bankers Association (MBA), the index of mortgage applications to buy a home increased by 8.6% in the week ending June 7, reaching a level of 143.7, the highest since early May. This rise follows the Memorial Day holiday and marks a notable change in the market trends.

Refinancing applications also saw a significant jump, with the MBA's refinancing gauge soaring by 28.4%, the largest weekly increase since January 2023. The overall index of mortgage applications, which includes both home purchases and refinancing, jumped 15.6% last week, the biggest advance in early 2023.

Mortgage rates fell for the second consecutive week, providing some relief for homebuyers. The average rate for a 30-year fixed mortgage decreased to 6.95%, down from 6.99% the previous week, as reported by Freddie Mac. Similarly, the rate for a 15-year mortgage dropped by 15 basis points to 6.6%. Despite these reductions, mortgage rates remain high, which is a key factor that the Federal Reserve continues to monitor as it assesses inflation trends.

Looking ahead, Morgan Stanley projects that the average 30-year fixed mortgage rate will stabilize around 6.25% by mid-2025, down from nearly 7.8% in late 2023. This anticipated decrease is tied to expected Fed rate cuts starting in September 2024, with three 25-basis-point reductions. However, affordability challenges persist as home prices have surged 54% since 2019 and are expected to continue rising through 2025. The potential decline in mortgage rates may offer some relief but is unlikely to return to pre-pandemic affordability levels.

The housing market remains influenced by various factors, including the "lock-in effect," where homeowners with low mortgage rates are less inclined to sell, thereby limiting housing inventory and sustaining price pressures. Morgan Stanley strategists predict home price growth will slow to 2% this year and increase to 3% by 2025, reflecting ongoing demand and limited supply.

·????? In a recent meeting with House Republicans, former President Donald Trump proposed increasing tariffs as a means to offset the cost of extending and enhancing his 2017 tax cuts, which are set to expire next year. Trump's suggestions include implementing a new tax exemption for tipped wages and potentially significant cuts to personal income taxes, financed by tariff hikes, particularly on imports from adversarial nations like China.

Trump's proposal to use tariff increases to fund income tax cuts faces significant challenges. Federal revenue from tariffs, although tripled over the past decade due to Trump's trade policies, constitutes only 2% of federal revenues. In contrast, individual income taxes account for nearly half of federal receipts. Thus, a substantial increase in tariffs would be required to make a meaningful impact, which could lead to higher consumer prices. For instance, a proposed 10% across-the-board tariff could cost the typical American household $1,500 annually, according to the Center for American Progress.

Trump's tariff hike proposal has received mixed reactions from lawmakers. While some Republican representatives expressed support, emphasizing the potential for reduced taxes on American workers, others remain cautious. Representative Nicole Malliotakis highlighted Trump's aim to balance lower income taxes with higher tariffs. However, significant skepticism persists due to the potential economic repercussions.

Former Treasury Secretary Lawrence Summers strongly criticized Trump's tariff-based revenue model, warning of severe economic consequences. Summers labeled the proposal as "immensely damaging," predicting it could lead to "the mother of all stagflations" and trigger "worldwide economic warfare." He argued that increased tariffs would escalate the cost of imports and domestic goods, reducing consumer spending and potentially causing an economic downturn.

Summers also drew parallels to George McGovern's 1972 presidential campaign, suggesting that Trump's proposals represent one of the most inflationary policy platforms in recent history. He cautioned that such policies could lead to a 10% mortgage rate and increased wage inflation pressures due to stricter labor supply constraints.

In response to Summers' criticisms, Trump campaign spokesperson Karoline Leavitt defended the former president's economic record, citing the success of his first-term policies in achieving low mortgage, interest, and unemployment rates, and minimal inflation. Leavitt assured that Trump's second-term agenda would similarly address inflation and benefit working families.

The debate over Trump's tariff proposal underscores the broader political and economic challenges facing the U.S. as it approaches the expiration of key tax cuts from the 2017 legislation. Extending these cuts, estimated to cost $4.6 trillion over a decade, will require careful consideration of funding mechanisms and potential impacts on the economy.

·????? The New York Fed Staff Nowcast model slightly upgraded its U.S. GDP growth forecast for Q2 2024 to 1.91% from 1.90% a week ago as positive surprises from CPI data offset negative surprises from export and import price data. The Atlanta Fed's GDPNow did not publish an update to its model during the week.

Europe

·????? The French political landscape has been significantly shaken by recent events, with President Emmanuel Macron's centrist Renaissance party suffering a severe defeat to Marine Le Pen's far-right National Rally in the European Parliament elections. This unexpected outcome has led Macron to call for snap parliamentary elections, three years ahead of schedule, an unprecedented move aimed at reasserting his party's dominance. However, this strategy carries substantial risks, both politically and economically.

Le Pen's National Rally secured approximately 34% of voter intentions in the first round of the upcoming legislative elections, compared to 19% for Macron's party, according to a Toluna Harris Interactive poll. The left-leaning coalition, including France Unbowed, the Communists, Socialists, and Greens, garnered 22%. This political shift highlights a growing dissatisfaction with Macron's government, driven by issues such as inflation, security, and immigration.

Financial markets reacted negatively to the announcement of snap elections, with French bonds experiencing significant selloffs. The spread between French and German 10-year yields widened to its highest level since 2017, reflecting investor concerns about fiscal instability. French equities also tumbled, with the CAC 40 Index falling 6.2%—the most since March 2022. Major banks like BNP Paribas and Société Générale suffered substantial losses of 12% and 15% respectively. Overall, the selloff wiped about $210 billion off the value of French stocks.

Macron's decision has been met with widespread criticism and warnings from financial experts. Bank of France Governor Fran?ois Villeroy de Galhau emphasized the need for a clear economic policy to stabilize investor confidence. Finance Minister Bruno Le Maire warned that victory for either the far-right or the newly formed left-wing alliance could lead to severe economic consequences, including a potential debt crisis similar to the one the UK faced under Liz Truss.

The snap elections are not just a political gamble but a test of Macron's ability to unify centrist and moderate forces against the growing influence of extremist parties. His administration has been criticized for failing to enact sufficient fiscal reforms, leading to credit downgrades by Fitch and S&P Global Ratings. The budget deficit remains a significant concern, projected to stay above 3% of GDP through 2027.

Despite these concerns, some market experts see potential opportunities amid the turbulence.

Andromeda Capital Management co-founder Alberto Gallo noted that markets often overreact to the election of populist leaders. He highlighted Italy under Premier Giorgia Meloni as an example where initial market fears proved unfounded, with the spread between Italian and German bonds narrowing to a two-year low earlier in 2024. Gallo suggested that the rise of populists might lead to increased government spending, as middle-ground parties will need to continue spending to counterbalance extreme political wings.

Investors at Vanguard Group Inc. and Jefferies International view the widening French spreads as a buying opportunity for periphery European bonds. Vanguard's Ales Koutny and Jefferies' Mohit Kumar believe the risk is specific to France and not indicative of a broader euro-wide issue. Spain and Greece, in particular, have shown resilience, with Spain's yield gap over France narrowing to less than 20 basis points, the lowest since the global financial crisis, and Greece planning to repay its bailout loans ahead of schedule. BlackRock’s Wei Li pointed out that Europe’s overall fiscal trajectory is better than that of the US. Pimco’s founder Bill Gross suggested that European bonds could outperform US Treasuries due to uncertainty around the upcoming US presidential elections. However, not all are convinced; David Roberts of Nedgroup Investments warned of potential risks and volatility, suggesting that holding French, Italian, or Spanish debt could be precarious in the coming weeks.

Meanwhile, European Central Bank officials have not considered using crisis tools in response to the current market turbulence. The ECB remains focused on its mandate to control inflation, and Executive Board member Isabel Schnabel emphasized that the Transmission Protection Instrument would only be used in countries pursuing sound fiscal policies. ECB President Christine Lagarde refrained from commenting on domestic political situations but reaffirmed the ECB's commitment to its mandate.

·????? Euro-zone industrial production fell unexpectedly at the beginning of the second quarter, raising concerns about the region’s economic recovery in 2024. Output decreased by 0.1% in April compared to the previous month, which was revised lower to a 0.5% gain. This decline contradicted economists' expectations of a 0.2% increase, based on the median of 29 estimates.

This setback suggests the euro-zone economy will need to rely more on its service sector to maintain its recovery trajectory following a growth spurt in the first quarter. The European Commission has projected an expansion of 0.8% for 2024, which is double the growth rate of the previous year.

Despite the overall decline, the report highlighted some positive developments. Excluding intermediate goods, all other categories showed improvement. Notably, capital goods saw a 0.7% increase, marking the third consecutive month of gains in this category.

Geographically, the decline in industrial production was concentrated in smaller countries within the euro zone, with Luxembourg, Latvia, and Ireland experiencing the largest drops. Among the four largest economies in the region, only Italy recorded a decline in industrial output.

·????? UK unemployment rate unexpectedly rose to 4.4% in the three months through April, the highest in over two and a half years. This increase in joblessness coincided with a slowdown in wage growth, with private sector average weekly earnings rising by 5.8%, the slowest pace in two years. Despite a nearly 10% hike in the minimum wage, the data suggests underlying inflationary pressures are easing, potentially allowing the Bank of England to consider cutting interest rates later this year.

Meanwhile, Britain's economic recovery seemed to stall in April, with GDP remaining flat compared to the previous month’s 0.4% growth. This stagnation, occurring in the lead-up to the general election, poses a challenge for Prime Minister Rishi Sunak, who has promoted the idea that the economy is improving. Factors such as wet weather dampening retail sales, a 1.4% decline in manufacturing output, and continued high interest rates have contributed to this economic halt.

The Office for National Statistics highlighted specific areas of growth within services, which saw a 0.2% increase, driven by sectors like computer programming, consulting, publishing, and arts and entertainment. However, consumer-facing services experienced a 0.7% decline, significantly impacted by the unusually wet weather in April, which was 155% of the long-term average.

The outlook for the rest of the year remains one of relative stagnation, with private sector economists predicting a modest 0.6% expansion for 2024, up from just 0.1% last year. Bloomberg Economics forecasts a slowdown to 0.4% growth in the second quarter, down from 0.6% in the first quarter.

Asia

·????? The Bank of Japan (BOJ) maintained its current interest rate policy and deferred detailed plans on reducing bond purchases to its July meeting, leaving the yen vulnerable to further declines. Despite expectations from more than half of surveyed economists that the BOJ would begin cutting its bond purchases in June, the announcement indicated a delay in normalizing policy, crucial for the yen's recovery. The yen fell to its lowest level since April but regained some ground as Governor Kazuo Ueda indicated that both substantial bond purchase reductions and a potential interest rate hike could occur in July.

Ueda emphasized the need for more time to carefully consider the reductions, suggesting they would be significant. Despite this delay, he did not rule out a rate hike in July, stating it could coincide with adjustments in monetary easing.

Analysts remain divided on the impact of the BOJ's decisions. Some believe the delayed announcement will prevent a rate hike in July, while others see it as buying time to ensure a smoother transition.

Pacific Investment Management Co. (Pimco) expects the BOJ to raise interest rates twice more this year, projecting the policy rate to reach 0.25% by July or September and 0.5% by December or January. By 2025, the rate could rise to 1%. This shift is expected to make Japanese government bonds (JGBs) more attractive to investors, with yields on five-year and 10-year JGBs projected to reach 0.9% and 1.25%, respectively, by the end of 2024.

·????? Japan’s economy exhibited limited signs of recovery, as reflected in the slightly narrower-than-expected contraction of its GDP. The revised data showed an annualized GDP shrinkage of 1.8% for the first quarter of the year, compared to the preliminary estimate of 2%. This adjustment came as both consumers and companies scaled back on spending amidst the strongest inflation trend in decades, leading to an accumulation of unsold inventories.

Personal consumption remained unchanged at a decline of 0.7%, marking the fourth consecutive quarter of reduced spending. Business spending saw a slight improvement in the revised figures, shrinking by 0.4% instead of the initially reported 0.8%. Inventory buildup contributed 0.3 percentage points to GDP growth, while net exports showed a slightly greater negative impact on the economy than previously estimated.

A rebound in economic growth is expected in the current quarter as Japan recovers from temporary setbacks, including a New Year’s Day earthquake and an auto production halt due to a certification scandal. However, new scandals and rising utility costs, as government subsidies phase out, present risks to this outlook. Households have been coping with over two years of declining real wages, exacerbated by inflation at or above the BOJ’s 2% target and higher import costs due to the yen's depreciation.

In response, the government plans to provide one-off tax rebates starting in June, aiming to mitigate the deflationary mindset. Additionally, analysts expect real wages to turn positive in the coming months following significant wage increase commitments from large companies. The weak yen, while contributing to higher import prices, also benefits corporate earnings from abroad and boosts inbound tourism.

Adding to the complexity, Japan's producer prices rose at their fastest pace in nine months in May, with a year-on-year increase of 2.4%, surpassing economists’ expectations of a 2% rise. The monthly gain was 0.7%, the highest in 18 months. This increase was driven by higher renewable energy surcharges and a significant 6.9% rise in yen-denominated costs for imported materials, indicating the impact of the yen’s depreciation on inflation after the currency hit a 34-year low against the dollar in late April.

·????? China's consumer prices rose less than expected in May, with the CPI increasing by just 0.3% year-over-year, slightly below the 0.4% forecasted by economists. This marks the fourth consecutive month of minimal CPI growth, signaling persistently weak domestic demand. Core inflation, which excludes food and energy prices, rose 0.6%. Factory-gate prices, measured by the PPI, fell 1.4% in May, extending a deflation streak that began in late 2022. These figures have prompted calls for more aggressive government action to boost demand, with suggestions for comprehensive policies encompassing fiscal, monetary, and property sectors.

The Chinese government has struggled to stimulate household spending amidst a prolonged real estate slump and a weak job market, leading to the longest deflation period since the Global Financial Crisis. Falling producer prices are squeezing corporate profits and dampening investment, exacerbating economic challenges. There is concern that consumer reluctance to spend could deepen if they expect further price declines.

The People’s Bank of China (PBOC) is expected to start its 2024 rate cuts with a 10-basis point reduction on June 17, according to Bloomberg Economics. In response to overcapacity issues and foreign complaints, Beijing might take measures to curb excess capacity, which could alleviate producer price deflation. However, the key to addressing downward price pressure remains reviving domestic demand, particularly in the property sector, which continues to struggle.

China’s weak demand has broader implications. The 20-month deflation in producer prices, the longest since 2012-2016, has led to lower export prices, which have fallen about 14% since the start of 2023. While this trend benefits emerging markets by helping control inflation, it also heightens trade tensions with the US and Europe. For instance, the US has imposed tariffs on some Chinese electric vehicles and solar panels, and the EU is considering similar actions.

China's exports to advanced economies have decreased, now constituting about 56% of total shipments, down from 63% a decade ago. The share of exports to the US has dropped to about 13% from 20% over the same period. Emerging markets such as Russia, Indonesia, and Kazakhstan are benefiting from cheaper Chinese imports, which are helping to control inflation. For example, Indonesia is importing more affordable machinery, and Vietnam is buying cheaper Chinese glass.

·????? India's inflation rate eased only slightly in May, staying above the central bank's target, which justifies the need for continued caution among policymakers. The CPI rose 4.75% year-over-year, slightly down from 4.83% in April, and below the median forecast of 4.85% predicted by economists in a Bloomberg survey. The Reserve Bank of India (RBI) struggles to bring inflation down to its 4% target due to persistent food price pressures. Despite the timely arrival of monsoon rains providing some relief, a severe heatwave has renewed fears of a price spike. Food prices, which account for about half of the CPI basket, remained steady at 8.69% from a year ago, compared to 8.7% in April. Excluding food and fuel, core inflation eased to 3.12% in May from 3.25% in April.

Inflation control is crucial for Prime Minister Narendra Modi, whose party faced an electoral setback partly due to the high cost of living. Maintaining economic stability is essential as the country navigates these inflationary pressures.

India's trade deficit widened in May due to expanding imports driven by strong domestic demand. The trade gap stood at $23.8 billion, higher than the $19.5 billion forecasted by economists. Exports grew 9.1% to $38.1 billion, while imports climbed 7.7% to $61.9 billion. Despite the economy's more than 8% expansion in the fiscal year ending in March, the fastest pace among major nations, global trade conditions remain uncertain. The World Bank projects 2024 to cap the worst half-decade of trade growth since the 1990s. A widening trade deficit could pressure India's current account and the rupee, which has decreased by 0.4% against the dollar this year, remaining one of Asia's best performers.

Foreign Exchange Markets

The Dollar Index, which reflects the value of the US dollar against a basket of major currencies, gained 0.6% over the week, mostly due to the euro's depreciation amidst political turmoil in Europe.

Commodities and Energy Markets

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

Oil prices experienced their largest weekly gain since April. This surge followed a dip last week due to OPEC+'s announcement about possibly restoring supply later this year. However, OPEC+ clarified that it might pause or reverse these production changes, if necessary, which bolstered market confidence.

Despite these gains, the overall outlook for crude remains cautious. The International Energy Agency (IEA) has curbed forecasts for consumption growth this year and warned of a "major surplus" this decade as the shift away from fossil fuels causes demand to plateau. World consumption is expected to level off at 105.6 million barrels per day by 2029, just 4% higher than last year's level, amid increasing sales of electric vehicles and improved fuel efficiency. Meanwhile, oil production capacity, led by the US, is projected to exceed demand by a staggering 8 million barrels per day by the end of the decade.

Oil companies are advised to ensure their business strategies are prepared for these changes. Some major companies, such as BP and Shell, have tempered their plans to diversify into renewable energy, while others like Exxon Mobil remain focused on oil and gas.

The IEA's forecasts are highly regarded but have not always been accurate. For instance, a decade ago, the agency warned of a looming oil supply crunch that did not materialize due to America's shale boom. In 2022, it incorrectly forecasted an immediate collapse in Russian output. Recently, the IEA has revised its demand projections for 2024 multiple times.

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 17 basis points as soft inflation data provide more support for anticipated easing.

Meanwhile, the U.S. Treasury yield curve moved down, with 10-year bond yields falling by 23 basis points to 4.20% and 30-year bond yields decreasing by 21 basis points to 4.34%.

Central Bank Insights

·????? The European Central Bank (ECB) remains cautious in its approach to reducing interest rates following last week's cut, with President Christine Lagarde emphasizing that further rapid reductions are not guaranteed. In interviews and public statements, Lagarde and other ECB officials underscored the importance of data-driven decisions and highlighted ongoing uncertainties in the economic landscape.

Lagarde indicated that while the recent rate cut was deemed appropriate due to sufficient progress in disinflation, the ECB is not committed to a linear path of rate reductions. She pointed out that inflation is expected to return to 2% by the end of next year, but acknowledged that the journey will have its "bumps on the road." The ECB's policy adjustments will be reassessed regularly, considering new economic projections and data.

In Dubrovnik, Croatia, Lagarde reiterated the ECB's confidence in the disinflationary path but noted potential challenges from wage growth, geopolitical tensions, and structural forces such as climate change. She also dismissed speculation about immediate further cuts, aligning with the market's expectation of one more cut this year.

Martins Kazaks, a member of the ECB's Governing Council, supported this cautious stance, emphasizing that while last week's rate cut signaled a shift away from tight monetary policy, any further reductions will depend on continued favorable inflation data. Kazaks highlighted the need for vigilance, as inflation has a tendency to return, and expressed comfort with market expectations of one to two more cuts this year.

Governing Council member Peter Kazimir echoed this sentiment, stating that the September policy meeting will be crucial for determining the next steps. He suggested that the ECB can afford to wait until then to reassess the economic situation and decide on further rate adjustments.

Joachim Nagel, head of Germany's Bundesbank, also stressed the importance of a cautious approach, noting the persistent stickiness of core inflation. Nagel argued that future rate cuts should be based on comprehensive economic data and warned against complacency.

Similarly, ECB Vice President Luis de Guindos highlighted the high level of uncertainty in the economic outlook, reinforcing the need for a data-dependent approach to policy decisions. He expressed optimism about the ongoing disinflation process but cautioned that external shocks could still impact the eurozone economy.

Bostjan Vasle, another ECB official, indicated that more rate cuts are likely if inflation continues to slow as expected. However, he acknowledged the risks that could slow down the disinflation process, including strong wage growth and geopolitical factors.

The ECB's cautious stance is also reflected in comments from other Governing Council members. Olli Rehn emphasized that the ECB is not pre-committing to any rate path and will base its decisions on inflation outlook, underlying inflation dynamics, and the strength of monetary transmission. Christodoulos Patsalides reiterated the importance of data in determining future policy actions, while Mario Centeno suggested that the ECB will take time to assess the economic impact of recent rate cuts before making further adjustments.

·????? Federal Reserve Bank of Cleveland President Loretta Mester expressed continued concern over inflation risks, even as recent data shows some easing in price pressures. In interviews at Bloomberg’s New York office, Mester highlighted that the risks to inflation remain tilted to the upside and emphasized the need for more consistent data before considering rate cuts.

Mester noted that the median projection of policymakers, which indicates just one interest-rate cut this year, aligns closely with her economic outlook. The latest CP) data, excluding food and energy, showed a 0.2% rise in May, and a year-on-year increase of 3.4%—the slowest pace in over three years. While she acknowledged this as a positive development, she stressed the necessity of seeing similar trends in subsequent reports to gain confidence that inflation is on a sustainable downward trajectory towards the Fed’s 2% target.

“We’ve made pretty good progress on inflation in the last two years. It’s still too high,” Mester said. “There’s more to do on inflation to gain confidence that it is on that downward trajectory to 2%.”

Mester also shared her projection for the long-term interest rate, setting it at 3%. This is slightly above the median estimate of 2.8% marked by policymakers in June, following a slight increase in March. This suggests that the Fed does not anticipate a return to pre-pandemic interest rate levels in the foreseeable future.

Echoing Mester’s cautious stance, Chicago Fed President Austan Goolsbee described the May CPI data as “very good,” but emphasized the importance of consistent monthly improvements to confidently achieve the 2% inflation target. Speaking at the Iowa Farm Bureau Economic Summit, Goolsbee remarked, “If we got a lot of months like this, we would be feeling so much better” about reaching the central bank’s inflation goal.

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