Weekly market insights

Machine Learning Intelligence

发布日期: 2023年8月12日

Institutional opinions

class="font-[700]">Potential Market Correction: The analysis suggests that the recent pullback in the markets might be indicative of a larger correction in the coming months. Given the historical data and the current market conditions, a correction in the range of 5% - 10% is anticipated. However, the analysis also indicates that this correction is not expected to derail the overall bull market, which is believed to be in its early stages.

: August and September are historically more volatile months in the markets. This suggests that investors should be prepared for increased market fluctuations and potentially higher levels of uncertainty during this period.

: The analysis highlights that the rally in the market has been supported by better fundamentals, including improving inflation trends, a potential pause in Federal Reserve rate hikes, and positive economic growth. These factors have contributed to the market's upward momentum.

: Despite negative earnings growth in the near term, the analysis predicts a gradual improvement in earnings growth in the second half of the year and through 2024. This anticipated recovery in earnings could be a positive driver for market performance.

: The Federal Reserve's actions are expected to play a role in the market's future trajectory. While the Fed is likely to remain on hold through 2023, it might signal potential rate cuts in 2024 if inflation approaches the 2.0% target. The Fed's decisions could influence market sentiment and direction.

: If a market pullback or correction occurs, it could present an opportunity for investors who didn't fully participate in the earlier rally to enter the market at potentially lower prices. The analysis suggests that both equities and longer-duration bonds could offer compelling investment opportunities.

: The analysis identifies potential sectors that could lead the market higher. These include small-cap stocks, cyclical sectors like industrials and materials, consumer discretionary, and international equities. Additionally, artificial intelligence (AI) and technology sectors are also expected to remain strong.

: Historical data indicates that while pullbacks are common after strong rallies, markets tend to recover within about six months on average. The recovery time could be even shorter if the extreme highs are excluded.

: Overall, the analysis suggests a sense of cautious optimism. While a correction might be imminent, the long-term outlook for the market remains positive due to favorable fundamentals and potential catalysts.

: The analysis suggests that emerging markets (EMs) are better positioned to withstand volatility and benefit from the rewiring of global supply chains. As nations prioritize security and resiliency over maximum efficiency, many EMs are expected to benefit from the shift in supply chain dynamics, bringing production closer to home.

: The data indicates that globalization is under pressure, and a world of fragmentation is emerging with competing defense and economic blocs. The rise of multi-aligned nations and the changing priorities of countries and companies are expected to accelerate the rewiring of supply chains. Selected EMs are seen as beneficiaries of this trend.

: The analysis suggests that, in the short term, emerging markets may be better positioned to withstand volatility compared to developed markets (DMs). EM central banks are nearing the end of their rate hiking cycles, which could provide some stability. However, EMs are not immune to risks.

: The analysis indicates a preference for hard currency EM debt over local currency debt. EM hard currency debt is considered more attractive due to its diversification and the potential impact of supply chain rewiring on the currency. This shift in preference is expected to be implemented on a six- to 12-month tactical horizon.

: The analysis highlights specific sectors within EMs that are expected to benefit from the rewiring of supply chains. These sectors include commodities like oil, chemicals, industrial manufacturing, battery and memory supply chains, nickel, cobalt, and lithium. The push to reshore production closer to home, particularly in areas like semiconductors, is also seen as an opportunity.

: The concept of "mega forces," which are structural changes with the potential to reshape economies and sectors, is introduced. These forces include digital disruption (AI), geopolitical-driven rewiring of globalization, transition to a low-carbon economy, aging populations, and changes in the financial system. Identifying catalysts and beneficiaries of these mega forces is crucial.

: The analysis emphasizes that the current environment is characterized by greater volatility and a departure from the past four decades of steady growth and inflation known as the Great Moderation. Central banks are expected to keep policies tight to counter inflationary pressures.

: The data indicates that wage pressures are persistently high, despite hopes of inflation falling back to target levels. The labor market is tightening due to factors like aging populations, which could contribute to sustained wage growth and potential challenges in achieving inflation targets.

: The analysis highlights the importance of granularity and security selection in the current market environment. With increased volatility and divergent security performance, opportunities can be found through more targeted approaches and uncorrelated exposures.

: The analysis suggests an overweight position in artificial intelligence (AI) investments. AI is considered a significant structural change that could impact various sectors and industries, and the potential benefits of AI adoption may be more pronounced within developed markets.

: The analysis anticipates a rise in long-term government bond yields due to fiscal challenges and increased U.S. Treasury bond issuance. The downgrade of the U.S. credit rating and borrowing needs could lead investors to demand higher term premiums.

The U.S. is experiencing a manufacturing supercycle, driven by mega-legislative programs and investments in areas like solar panels, electrical vehicles, semiconductors, and charging stations. The manufacturing boom has exposed weaknesses, such as a lack of skilled labor, shortages of critical metals and minerals, and global industrial subsidy races. Investment implications: Investors could consider exposure to infrastructure-related industrial companies, leaders in renewable energy, electrical vehicles, batteries, and charging stations, as well as low-carbon technologies and transmission technologies.

El Nino, a cyclical warming of the Pacific Ocean, is predicted to impact global markets by increasing agricultural commodity price inflation, affecting interest rates, and potentially leading to fiscal and external imbalances in import-dependent countries. Agricultural resource scarcity remains a long-term trend, and the onset of El Nino could accelerate the effects of higher food prices. Investment implications: Investors may see higher prices for agricultural commodities, increased demand for products that boost agricultural yields, and potential benefits for equities along the agribusiness supply chain.

The equity market has shown resilience and a broadening of participation, with various sectors like Materials, Industrials, Energy, and Financials leading the advance. Weaker seasonality, elevated valuations, bullish sentiment, and the lagged effects of monetary policy tightening could pose challenges for the equity market. Investment implications: Investors could consider a balanced approach to portfolio construction, staying attentive to potential headwinds, and using periods of market weakness to rebalance portfolios.

While reshoring in the U.S. has led to investments and growth, it faces challenges such as a shortage of skilled labor, lack of secure domestic supply for critical metals and minerals, global subsidy races, and the potential negative consequences of concentrating production. The reshoring strategy could lead to delayed projects, rising wages, and supply chain vulnerabilities. Investment implications: Investors should be aware of potential pitfalls and consider diversification strategies that align with long-term economic growth and adaptability.

Reshoring could inadvertently lead to economic inefficiencies, lower profit margins due to excess capacity, and greater risks of supply disruptions. A diversified supply source across countries may offer better resilience to shocks and promote more sustainable economic growth. Investment implications: Investors might consider diversifying supply chains and investment portfolios to mitigate the risks associated with potential unintended consequences of reshoring efforts.

The recent downgrade of the U.S. credit rating by Fitch due to expected fiscal deterioration, high government debt, and governance issues may have consequences for investors. The 2011 downgrade by S&P had a significant market impact, resulting in stock market declines and falling Treasury yields. The initial reaction to the Fitch downgrade has been less volatile, but investors should remain cautious.

Rising interest costs to service the U.S. debt are becoming challenging, and higher interest rates could further accelerate these costs. Investors tend to demand higher yields to offset increased risk as debt service costs become harder to sustain. This can lead to higher borrowing costs for the U.S. government.

The U.S. Treasury is expected to issue around $1 trillion worth of Treasury securities, which could reduce market liquidity. This increase in issuance coincides with the Federal Reserve reducing its balance sheet, potentially impacting market dynamics.

Increased federal debt issuance could redirect private investment spending and consumption towards Treasury debt, limiting capital available for private investment. This redirection of capital could result in lower economic output, incomes, investment of capital, and investment returns.

As the U.S. government's debt load grows, policymakers may have less flexibility to respond to future economic shocks and unexpected events. This reduced flexibility could lead to more significant negative economic impacts from future shocks due to limitations in fiscal responses.

Despite fiscal concerns, the U.S. benefits from structural strengths, including the dollar's reserve currency status and a diversified and advanced economy. Current economic performance is above expectations, but the potential for recessionary conditions could complicate the near-term fiscal outlook.

While the immediate impact of the Fitch downgrade has been modest, investors should monitor the U.S. fiscal challenges over the medium- to long-term. If these challenges persist, investors could face higher interest rates and borrowing costs, especially for longer-maturity securities. Increased volatility in equity markets could occur as rising interest rates compete with equities for investor attention, and policymakers might lack tools to buffer unexpected economic events.

The employment report showed a nuanced picture of the labor market, with job openings and payroll gains coming in below expectations. Wage growth surprised slightly on the upside, which prompts the question of whether this trend will continue or revert to its previous easing pattern.

The 2Q23 earnings season revealed that more than 70% of companies beat earnings estimates despite softer revenues. In the face of input cost inflation, companies had been raising prices to protect margins. However, as inflation eases further, pricing power is likely to diminish.

The landscape is shifting as inflation eases, causing companies to experience reduced pricing power. To defend margins, companies may be compelled to embrace layoffs and cost-cutting measures. This could lead to softer wage growth and moderation in the labor market overall.

Certain sectors, like IT and other service-related industries, have already experienced moderation in wage growth due to layoffs in the previous year. Goods-producing industries and trade, transport, and utilities might experience a lag in the impact on wage growth due to sustained high job opening rates and unionization.

Chairman Powell's recent comment suggests that the Federal Open Market Committee (FOMC) might not need to wait for inflation to return to 2% before considering rate cuts. A less robust wage growth environment should provide the Fed with room to pause and eventually cut rates in the coming year.

The data indicates that a soft landing for the economy is becoming increasingly visible. However, historical precedent shows that soft landings are rare occurrences. The timeline to add duration (investing in longer-term fixed income securities) has been extended due to recent increases in interest rates.

Investors should consider taking advantage of the extended timeline to add duration to their investment portfolios, given the recent rise in interest rates. Embracing higher-quality sectors within the fixed income universe is recommended as preparation for lower inflation and softer economic growth in the upcoming year.

The U.S. stock market ended the week mixed, with value stocks outperforming growth stocks. Concerns about rising long-term interest rates and conflicting inflation signals contributed to this mixed performance.

Corporate Earnings Season:

The quarterly earnings reporting season is winding down, contributing to lighter trading volumes. Health care stocks received a boost from positive developments in diabetes drug efficacy, while information technology stocks underperformed due to worries about rising rates.

Interest Rates and Federal Reserve:

Inflation data and statements from Federal Reserve officials suggest a mixed outlook on interest rates. The Federal Reserve may consider rate cuts in the coming year if wage growth remains weak. The bond market saw increased activity, and the yield on the 10-year Treasury note rose due to producer price inflation.

European stocks showed little change overall. Sentiment was affected by concerns about a potential economic slowdown in China and a windfall tax on bank profits announced by the Italian government.

European Bond Yields:

European government bond yields rebounded, driven by the possibility of sustained inflationary pressures. Expectations for the European Central Bank (ECB) to maintain an ultra-accommodative stance increased due to uncertainty in the economic outlook.

Japanese stock markets saw gains, with positive earnings forecasts from major companies and the resumption of Japan-bound group tours for Chinese citizens contributing to the positive sentiment.

Monetary Policy:

The Bank of Japan (BoJ) is likely to maintain its ultra-accommodative stance due to signs of easing inflationary pressure and slowing wage growth. The BoJ's commitment to yield curve control with flexibility remains in place.

Chinese stocks faced a retreat as evidence suggested that the country's economic recovery might have peaked. Concerns about deflationary pressures offset optimism about stimulus measures to boost consumer spending.

Inflation Data:

China's inflation data indicated a decline in both consumer and producer prices, raising concerns about weak demand in the economy. Trade and lending data also came in below expectations, indicating a loss of momentum in the recovery.

Property Sector:

China's property sector continues to face challenges, as evidenced by property developers struggling with liquidity issues. The sector has been affected by slowing sales and high debt levels.

Both Colombia and Mexico reported inflation data. While both countries experienced month-over-month increases, disinflation is evident in sequential inflation data, indicating some stability in price growth.

Monetary Policy:

Central banks in Colombia and Mexico are likely to maintain cautious stances on monetary policy, with potential interest rate adjustments in response to inflation trends and economic conditions.

The recent market momentum has slowed down, partly due to the U.S. debt downgrade by Fitch. This suggests that the odds of a pullback in the market have increased. There are indications of weakness beneath the surface, with new lows expanding even during market upside. Additionally, key stocks have experienced breakdowns, and the S&P 500 has fallen below its 20-day moving average for the first time since May.

Despite the recent pullback, the "buy the pullback" investor mentality is likely to come into play, potentially finding support around the 50-day moving average (DMA) of the S&P 500 at 4427. The degree of investor conviction and price action in the coming days and weeks will provide insights into the market's future direction. If a minor bounce occurs and is followed by a decline below the recent low, there's a higher likelihood of an extended back-and-forth period.

The Q2 earnings season is nearing its end, with positive surprises from 79% of S&P 500 companies reporting. However, despite solid results, price reactions have been relatively muted, possibly due to stocks being priced for perfection leading up to the earnings season. Stocks that reported beat and raise results have shown positive post-results price changes, while others have seen negative reactions, contributing to the view that valuations may have priced in a lot of good news.

The Technology sector, which has been a market leader, is showing signs of consolidating its strength from the first half of the year. The sector's index has broken its 50-day moving average, and relative strength is declining. This consolidation might indicate a temporary breather. The semiconductor subsector is also showing signs of fatigue, as it moves below its 50 DMA for the first time since June. Earnings reports from semiconductor companies may influence the sector's performance.

Oil prices have exhibited renewed strength, with WTI crude oil trading above its 200-day moving average. This improvement has positively impacted the Energy sector, which has seen relative strength breaking above downtrend resistance. This improvement might attract investor attention to the out-of-favor sector. However, the Energy sector's relative performance has historically moved counter to the S&P 500, potentially indicating uncertainties in the market, inflation expectations, and economic activity.

The technical analysis of the S&P 500 suggests that the recent slowdown in momentum and the breach of moving averages might signal a potential pullback or consolidation period. The market's behavior around support levels and the overall trend of the average stock's relative strength could provide insights into the health of the market.

Upcoming economic data releases, including July CPI, PPI, Retail Sales, Industrial Production, and Leading Economic Indicators, will play a significant role in determining the degree of weakness or the market's ability to recover from the current slowdown. Positive data could potentially support equities, while weaker data might contribute to further market challenges.

Despite economic resilience in the services sector, the risk of higher inflation remains due to elevated wage growth. This could keep the Federal Reserve cautious and alert. Economic variables, such as interest rates and weak bank lending, may weigh on economic activity in the coming months.

Equity markets are currently testing their first support levels and are likely to experience a bounce in the short term due to becoming oversold from a trading perspective. However, despite the short-term bounce, the overall view is that equity markets are peaking intermediate-term after a significant surge from Q4 2022 lows. The current weakness is consistent with a pullback into the seasonally weak period extending into September. While a bounce is expected, it's likely to be relatively short-lived, followed by further choppy sideways trading rather than the beginning of another multi-month advance.

The S&P 500 is currently at first support around 4,500, near its blue 50-day moving average and Q2-Q3 uptrend line. There is additional support at 4,448, and if that doesn't hold, next support is at 4,325. The view is that the S&P 4,300 and Nasdaq 13,150 are important support levels that are unlikely to be broken if markets remain weak through Q3. The current pullback is seen as a normal and healthy pause within the early stages of a new market cycle that began in Q4 2022.

The US 10-year yield tested and then stalled below its next key technical band between 4.24% and 4.33%. While there was concern about rates accelerating higher, short-term indicators becoming overbought suggested a stall, which has been reinforced by this week's pullback. The expectation is that 10-year yields will not surge above the 4.24-4.33% range. Key downside levels for yields are identified at 3.85 and 3.67%.

Natural Gas has broken out above its June-July trading range highs, part of the broader improvement seen in the energy sector. Short-term pullbacks in the energy sector are expected to be short-lived, and the breakout in natural gas supports the idea of a broader bottoming pattern with potential for further upside.

The Healthcare sector has been trading sideways since April 2022 and underperforming the S&P 500 in relative performance. However, there's evidence of improvement developing in the Healthcare sector, which is seen as part of normal sector rotation into a seasonally weak period moving into September.

Previous update:

Institutional Opinions

U.S. Credit Downgrade Impact: The recent credit downgrade of U.S. government debt by Fitch is not expected to have a significant impact on the fundamental drivers of the economy and markets. While the downgrade raises concerns about the growing federal debt burden, U.S. Treasuries are still considered the world's premier safe asset due to their liquidity and market depth.
Stock Market Outlook: The data suggests that the evolution of growth and inflation provides a solid foundation for stocks to continue in a sustainable uptrend. Despite the credit downgrade and potential downside risks, the economy has been growing above-trend, unemployment is near historic lows, and credit spreads are narrow, which supports the stock market.
Positive 12+ Month Outlook: The equity market is currently riding a wave of soft-landing optimism, and the trend is favorable. The S&P 500 has been posting consecutive months of positive performance, and historical data suggest solid returns over the next 3, 6, and 12 months. The overall market message is that strength often begets strength, supporting a positive 12-month stance on equities.
Q2 Earnings Season: Q2 earnings season has been strong, with a significant percentage of S&P 500 companies beating bottom-line estimates. Forward estimates are also improving, indicating that fundamentals are holding up better than previously believed. Market leaders in sectors like Consumer Discretionary, Technology, Industrials, and Communication Services have delivered notable results.
Economic Soft-Landing: The economy has performed well so far, buoyed by excess savings from Covid stimulus. However, there are concerns over the path of inflation, which could impact the Federal Reserve's efforts to lower it. Additionally, rapid Fed tightening since last year may lead to credit conditions tightening and indicators pointing to economic weakness ahead. The market consensus is leaning towards an economic soft-landing, but potential disruptions could create doubt among investors.
Technical Analysis: From a technical perspective, the S&P 500 has broken out in early June and has been trading above its 20-day moving average. Barring a significantly negative shock, the index is likely to hold above support levels on a pullback. The 20-day moving average (~4515) is the first level of support to monitor on the downside.
Credit Conditions and Defensive Sectors: The Senior Loan Officer Survey indicates increasingly tight lending standards, which could precede economic contraction. Tight credit conditions may impact equity prices from current levels. For investors looking to add defensive attributes to portfolios, Health Care and Utilities sectors are highlighted as low-beta options.
U.S. Equities: The major U.S. equity benchmarks started August with a down week, driven by rising Treasury yields and an unexpected downgrade to the U.S. government's credit rating. While some mega-cap names like Amazon performed well and beat expectations, others like Apple traded down due to mixed results, especially in its iPhone sales. The U.S. government's credit downgrade and the slowdown in hiring from the faster pace at the start of the year might have contributed to the decline in equities.
Interest Rates: The yield on the benchmark 10-year U.S. Treasury note increased from the previous week, reaching almost 4.20%. Expectations of higher issuance by the Treasury Department pushed yields higher. In contrast, the Bank of England raised its key interest rate by a quarter of a percentage point to 5.25%, indicating that rates are likely to stay high for some time to return inflation to the 2% target. The UK housing market remains weak amid high mortgage rates.
European Equities: European equities declined as higher U.S. bond yields and disappointing earnings reports affected investor sentiment. The UK's housing market showed a significant decline in house prices, and Eurozone inflation remained well above the ECB's target. However, the Eurozone economy rebounded in the second quarter, though forward-looking indicators suggest a weaker start to the third quarter.
Japanese Markets: Despite strong corporate earnings, Japanese stock markets fell as global investor risk appetite was dampened by the U.S. sovereign credit rating downgrade. The Bank of Japan's monetary policy adjustment led to a rise in the 10-year Japanese government bond yield to a nine-year high.
Chinese Stocks: Chinese stocks rose as Beijing announced new measures to revive consumption and the People's Bank of China pledged to support the real estate market. The official manufacturing Purchasing Managers' Index rose to 49.3, just below the growth threshold for the fourth consecutive month. The property sector, however, continued to decline for a second month with a significant drop in new home sales.
Brazil's Central Bank: The Central Bank of Brazil kicked off an easing cycle by lowering its benchmark interest rate by 50 basis points, becoming one of the first global central banks to ease monetary policy after aggressive tightening during the post-pandemic inflationary surge.
Peru's Inflation: Peru's consumer price index for July increased at a slower pace compared to June, indicating well-behaved inflation and the potential for the central bank to introduce an easing bias or cut rates in the future.
Bond Market Outlook: Bonds may experience some pressure but could rally into 2024 as the end of Federal Reserve tightening becomes clear. The recent rise in bond yields could be attributed to economic strength, Bank of Japan policy changes, and an uptick in commodity prices. However, the pullback in bonds is seen as a culmination of several factors, and yields are expected to stay range-bound before potentially dropping in 2024.
Labor Market and Wage Growth: The July jobs report provided mixed takeaways, indicating that the labor market is cooling but only slowly. Wage growth remains a concern for the Federal Reserve as it aims to manage inflation. The unemployment rate is at its lowest since the 1960s, and wages grew at a faster-than-expected pace.
Short-term Market Volatility: The recent credit downgrade and other economic factors could lead to higher volatility in the second half of the year. While stocks are expected to remain in an uptrend, short-term investors may take profits, leading to market fluctuations.
Investment Recommendations: Investors may consider diversifying into lagging segments of the equity market with lower valuations. Dollar-cost averaging can be employed to take advantage of market swings. Properly laddering fixed-income holdings is recommended to benefit from potential lower yields in 2024.
Near-Term Pause in Equities: The equity markets are expected to experience a near-term pause as Q3 seasonality becomes a headwind. Evidence of peaking short-term is visible, and key support levels are being tested. Further weakness in the coming weeks is anticipated.
Technical Levels for S&P and Nasdaq: The S&P and Nasdaq are challenging/breaking the rising 20-day moving averages near key support levels. A break below these levels could lead to further downside movement towards the next support levels.
US 10-Year Yields: The US 10-year yields are challenging important upside levels between 4.0-4.9%. A close above 4.09% could signal further upside movement, but interest rates are expected to stall at the 4.24-4.33 range due to short-term momentum likely becoming overbought.
Seasonality Impact: Seasonality studies suggest that September has often been a period of weakness for equities. Given the current view of the equity markets, the balance of Q3 is expected to remain volatile as markets consolidate gains from Q1 to Q3.
Sentiment Surveys: Sentiment surveys indicate positive sentiment among investors, but it is expected to become less of a tailwind tactically. Bullish sentiment may decline during a market pullback, acting as a healthy check on overly bullish investors.
Long-Term Perspective: Despite the near-term pause and potential weakness, the longer-term cycle backdrop is viewed as positive. Pullbacks are seen as a healthy technical development and an opportunity to continue building equity exposure in secular and cycle growth stocks through the Fall.
U.S. Equities vs. International Developed Markets: The past decade has seen a significant outperformance of U.S. equities compared to international developed market stocks. However, historical patterns suggest that market leadership tends to rotate over the long term. Therefore, it is possible that international markets could experience a period of outperformance in the future, especially given their relatively lower valuations and potential benefits from the shift away from globalization.
U.S. Dollar and Currency Headwinds: The persistently strong U.S. dollar has curtailed returns for USD-denominated investments. However, according to RBC Global Asset Management's fair value model, the U.S. dollar remains overvalued by more than 20 percent based on purchasing power parity. This suggests that the U.S. dollar could enter a multiyear weakening cycle, which would likely improve currency-adjusted returns for international equities in the years ahead.
Geopolitics and Trade Relations: Ongoing geopolitical tensions and the shift away from globalization may create opportunities in international equity markets. Companies in Europe and Japan could serve as useful ways to position for a wider range of potential economic outcomes in an era where protectionist policies are likely to become increasingly common.
Interest Rates and Economic Conditions: Interest rates in the U.S. and Canada have been trending upward, with central banks engaging in rate hikes to combat inflationary pressures. The trajectory of inflation and economic data will play a crucial role in determining future rate decisions and market expectations.
Market Leadership Cycles: While U.S. equities have been dominant in recent years, history shows that market leadership tends to rotate between different regions over the long run. As the U.S. equity market becomes top-heavy, opportunities in international markets could provide compelling ways to broaden sector and company exposures at relatively less demanding valuations.
Investor Sentiment: Investor sentiment towards U.S. equities has been favorable, but it may become less of a tailwind for stocks as pullbacks and uncertainties occur. Investors are advised to maintain a strategic allocation to international equity markets to diversify risk and returns, benefit from income streams, and gain exposure to broader geopolitical trends.
Stock Market Outlook: The analysis suggests that the stock market may struggle to move much higher in the near term. Valuations are stretched, and the risk-versus-reward tradeoff is not attractive. The recommendation is for investors to exercise patience and wait for better opportunities to put money to work in the stock market over the coming quarters.
Vulnerability of Technology Sectors: If inflation starts to rise again and interest rates continue to increase, the technology sectors that have driven the recent rally could be vulnerable to sharp pullbacks. The recommendation is to be cautious in these sectors and to focus on overweighting quality sectors that have underperformed during the rally and have good long-term revenue-generation prospects.
Emphasizing Capital Preservation: The view is to emphasize capital preservation while the sentiment-driven market becomes more overextended. This involves securing dividend streams for income and positioning for potential long-term capital gains through a disciplined and incremental approach like dollar-cost averaging.
Long-Term Perspective: For investors looking at a longer time horizon of two, four, or more years, equities are still considered one of the best ways to build wealth over time. Putting money into the stock market in a systematic way over time has historically paid off in the long run, and this trend is expected to continue in the decades ahead.
Fear of Missing Out: The analysis suggests that the fear of missing out on a nearer-term tech-sector rally should not drive investment decisions. Waiting for the earnings outlook to improve and avoiding risking savings in a sentiment-driven rally is advised.
Federal Reserve Policy: The Federal Reserve hiked rates by 25 basis points at their July meeting to a range of 5.25%-5.50%. Despite the rate hike, the messaging from Chairman Powell was somewhat dovish, emphasizing continued data dependency in policy decisions. The Fed is likely to closely monitor inflation data, particularly the July and August CPI reports, to make decisions on further rate hikes in their September meeting. If there is mounting evidence of a sustained disinflation trend, the Fed may consider pausing rate hikes.
Economic Growth: The first estimate of 2Q23 GDP showed that the economy grew at a better-than-expected annualized rate of 2.4%. This growth was driven by strength in consumption and business fixed investment, indicating resiliency in economic growth.
Labor Markets: Unemployment claims remain low, indicating a strong labor market. Additionally, the Employment Cost Index (ECI) rose 1.0% in the second quarter, suggesting moderate wage gains. The Fed is likely to closely monitor wage growth relative to inflation trends.
Inflation: The data showed progress on disinflation, with the core services ex-housing PCE rising at a modest rate of 0.24% in June, down from the previous three months' average of 0.44%. If disinflation trends continue, it may influence the Fed's rate hike decisions.
Market Sentiment: Despite the Fed rate hike and messaging, markets appear relatively unfazed. Investors seem to be looking beyond incremental Fed tightening, suggesting that they may be more focused on other factors influencing market sentiment.
Rising Global Yields: The tightening of policy by major central banks, including the Bank of Japan's shift to relax its yield curve control, may lead to rising Japanese bond yields. This could also pull global yields higher due to the strong gravitational pull between developed market (DM) bond yields. There is potential for further tweaks to the Bank of Japan's policy, contributing to an increase in developed market bond yields.
U.S. Jobs Data: The upcoming U.S. jobs data is likely to show still-low unemployment, confirming a tight labor market. However, it is noted that the low unemployment rate may be a result of structural worker shortages rather than a sign of a buoyant economy. The Federal Reserve may be misreading the economy's strength based on this indicator, and there is a possibility that the Fed may hike more than markets expect and then cut rates later.
Disinflation Trend: Inflation data in the euro area and Japan suggests a cooling trend. The European Central Bank (ECB) has already signaled an end to its tightening bias and is moving towards data-dependency. If disinflation trends continue, it could influence central bank policies and global yields.
Market Sentiment: Markets seem to have come around to the view that central banks will keep policy tight to lean against inflationary pressures. This is not a friendly backdrop for broad asset class returns, and central banks may be forced to hold policy tight in a world shaped by supply constraints.
Investment Themes: Given the potential for rising global yields and central banks being forced to keep policy tight, there is an overweight preference for short-dated U.S. Treasuries and quality in both equities and fixed income. Investors are advised to consider opportunities for security selection, relative value, and exposure to mega forces, such as artificial intelligence (AI), geopolitical shifts, low-carbon economy transition, aging populations, and changes in the financial system.
Thematic Exposure in Portfolios: The post-pandemic world has accelerated certain megathemes while some were exaggerated. Investors should consider thematic exposure in portfolios, especially in areas like generative artificial intelligence (AI), which is seeing a significant opportunity.
Bullish Catalysts for Equities: The equity market has rallied into the second half of the year, but uncertainty remains due to the macroeconomic backdrop. Investors should watch for signals such as corporate earnings rebound, Fed funds rate peaking, a potential recession as a "reset," increased capital expenditures, a weakening U.S. dollar, realignment of volatility gauges, and improvements in the fundamental backdrop to support a sustainable, broad-based recovery.
Entrepreneurial Spirit in the U.S.: Despite challenges like a potential recession, rising costs, and tight labor markets, the entrepreneurial spirit in the U.S. remains strong. The number of business applications filed in the first half of the year has surged, indicating confidence in the economy and supporting the bias toward U.S. assets in portfolio construction.
Portfolio Considerations: Given the level of portfolio drift in certain areas, investors should actively rebalance portfolios. Transitioning to a new macroeconomic regime with elevated risks requires building diversified portfolios across and within asset classes, including alternatives. The current conditions warrant a neutral view on equities and fixed income relative to strategic benchmarks, with emphasis on balance and diversification.

Previous update:

Institutional Opinions

The Federal Reserve may have completed its rate hike cycle, and rate cuts are unlikely this year. However, rate cuts may be signaled early next year if inflation moves toward a 2% target, and the Fed may remain on an extended rate pause through the beginning of 2024.
The European Central Bank (ECB) and Bank of Japan (BoJ) have enacted monetary policy decisions, raising rates and making policy tweaks respectively. Global push higher in interest rates may incrementally raise borrowing costs for consumers and corporations, while supporting easing inflation trends worldwide.
The US economy is experiencing resilient growth, with GDP growth coming in above-trend speed for the second quarter. Despite some areas of easing, there are no signs of an imminent recession or downturn, and the probability of an outright recession has declined.
Inflation continues to moderate even as growth accelerates, which is a positive signal for the Fed and markets. Price pressures can ease even if growth remains solid.
Market sentiment seems to be optimistic, embracing a goldilocks-type scenario, as better macro trends, including potential rate hike pauses, moderating inflation, and resilient growth, contribute to a broadening of market leadership.
Despite the strong rally, there are still compelling opportunities in both the equity and bond markets. Some bouts of volatility may still occur, but there are prospects for adding quality positions at lower prices.
In equities, positioning for a further broadening of market leadership, including small-cap stocks and cyclical sectors, may be favorable. Complementing growth stocks with these sectors and some international exposure could yield better performance.
In bond markets, longer-duration bonds, particularly in the investment-grade space, present an attractive opportunity to complement shorter-duration and cash-like assets. Extending duration ahead of potential rate cuts could provide better yields and potential price appreciation.
Central banks are expected to hike policy rates this week, and markets anticipate rate cuts due to cooling inflation. However, central banks are likely to hold tight on rates, leading to a continuation of the inflation fight.
U.S. stocks rose last week on initial earnings updates, but earnings are expected to contract in the second half of 2023 due to wage gains impacting profit margins.
The Federal Reserve and the European Central Bank (ECB) are likely to raise interest rates again this week. The Bank of Japan may opt for loose policy to sustain above-target inflation, given fewer supply constraints.
Soft June U.S. core CPI inflation has revived hopes for rate cuts in 2024, which may fuel a bull run across assets for some time. However, this optimism could be challenged as the disconnect between fast-falling inflation and stronger-than-expected economic activity becomes apparent.
Core inflation across developed markets is falling from last year's highs, but the journey back to central banks' 2% policy target remains bumpy. Spending shifting back towards services is causing goods inflation to fall, but persistent services inflation driven by wage pressures may keep core inflation above 2%.
Central banks, including the Fed, ECB, and Bank of England, are facing the challenge of dealing with lower goods prices and persistent services inflation. They are expected to push ahead with their inflation fight, even though growth is weaker in the euro area and the UK.
In this environment, holding tight on monetary policy is likely to be the prevailing approach, with central banks forced to keep policy tight to lean against inflationary pressures.
Given the challenges in the macro environment, investors are advised to look beyond broad asset classes and focus on specific investment themes, such as income generation through short-dated U.S. Treasuries, quality investments in equities and fixed income, and opportunities arising from mega forces like artificial intelligence (AI) in multi-country, multi-sector investment cycles.
Maintain a neutral weight on small-cap stocks: Despite the recent strength in the Russell 2000 Index, the absence of several macro factors that typically support sustained outperformance for small-cap stocks calls for a cautious approach. It is important to monitor the pickup in cyclical momentum and the economywide profits cycle before considering an upgrade.
Focus on quality bias across equities, including small-caps: Given the headwinds for small-caps due to the profits cycle and contracting margins, a quality bias is recommended in equity investments. Companies with strong fundamentals and lower leverage may be better positioned in the current environment.
Favor hard assets and hard power in the portfolio: The risks associated with China's dominance as the "refinery to the world" for critical metals and minerals suggest a focus on hard assets (such as energy, metals, and minerals) and hard power (including defense) in investment strategies. This is important in light of geopolitical tensions and the potential disruptions in the supply chain.
Monitor liquidity conditions and Federal Reserve actions: The concerns over liquidity and volatility resulting from increased Treasury bill issuance have been addressed by the Federal Reserve's borrowing program. Investors should closely watch liquidity conditions, bank reserves, and the interplay of the TGA, RRP, and Quantitative Tightening (QT) for potential impacts on risk asset sentiment.
Consider extending duration in fixed income: With the economy transitioning to a new macroeconomic regime and risks still elevated, investors may consider lengthening duration in fixed income investments. This should be based on the shape of the yield curve, real rates, and the potential for a recession in the next six to 12 months.
Diversify portfolios across and within asset classes: As the macroeconomic environment undergoes a transition, building diversified portfolios becomes imperative. Qualified investors should carefully assess their portfolio drift and make adjustments as needed to align with their risk tolerance and investment objectives.
Real Estate Investment Trusts (REITs) may continue to underperform other S&P 500 sectors: The historical pattern, where REIT relative strength has moved in two-year cycles of positive and weak performance, suggests that REITs could remain weak relative to other sectors into 2024. The unfavorable rating on REITs is based on late-economic-cycle performance, rising delinquencies, tightening lending standards, and other negative real estate indicators.
Real Estate Valuations may impact REIT relative strength: REITs currently trade at a 5.4% discount to their underlying real estate holdings, which historically is considered decent. However, historical patterns indicate that relative strength peaks in REITs often align with periods when real estate becomes relatively expensive, and troughs align with cheaper real estate periods. A reversal in relative strength could be triggered by changes in real estate valuations, though the exact threshold for this shift is uncertain.
Equities may face headwinds in the second half of 2023: The market's recent rise has been supported by factors such as monetary policy, liquidity-related factors, economic growth, and prospects for artificial intelligence. However, many of the positive factors are now priced into the market, leading to richer valuations. The expectation of additional interest rate hikes, declining liquidity, and weakening economic indicators may lead to headwinds for equities in the second half of 2023.
Residential Mortgage-Backed Securities (RMBS) offer potential opportunities: RMBS is currently rated neutral and provides relatively attractive yields compared to investment-grade corporate bonds. The sector is well-positioned to offer risk-adjusted excess returns in the second half of 2023, especially if Treasury yields remain in a tight range. RMBS has historically shown higher credit quality and better liquidity during economic slowdowns, making it a potential hedge against uncertainty.
Commercial Real Estate Market faces loan maturities and investment opportunities: The commercial real estate market is facing a significant wall of loan maturities, with almost $1 trillion in aggregate loans maturing by year-end 2024. This situation could create problems for property owners who may struggle to find reasonable financing in today's tight credit market. However, it could also present an investment opportunity for private real estate debt managers, as private investors may be needed to provide debt financing in the current lending market conditions.
S&P 500 Equal Weight, Russell 2000 Small-cap & MSCI Emerging Market indices may face resistance: Despite improving technical profiles and higher lows established in March, these indices are currently testing resistance levels at their February highs. A brief pause is likely in the short term, but beyond that, they are expected to continue strengthening through 2023, indicating participation broadening across equity markets.
Cyclical sectors, particularly Industrial and Energy, are expected to continue strengthening: The S&P Industrial sector has rallied above its 2022-2023 high, and the S&P 500 E&P index is showing signs of bottoming and turning higher from important support. This technical behavior suggests that cyclical sectors may continue to strengthen through 2023 into 2024, indicating potential economic strength during that period.
US 10-year yields are within a narrow trading range, remaining a net positive for equities: The US 10-year yields are still in a sideways trading pattern, which is viewed as neutral for equities and supportive of the overall market. However, a move above 4.09% would signal potential inflation pressures, which could be a yellow flag for equities. On the other hand, a decline below certain levels, particularly 3.6% and 3.24%, could indicate concerns about economic weakness.
The Federal Reserve's rate hike cycle is likely over: The data suggests that the rate hike cycle has likely come to an end, with little indication of further rate increases in the near term. The strong economic growth without significant inflationary pressures supports the idea that the Fed may not proceed with further rate hikes.
Fixed income investors can benefit from the current environment: The outlook for fixed income investors remains positive, with short-term yields at their highest levels in nearly 20 years, and longer-term yields still above average. With the Fed on hold, investors have time to put money to work, and it is suggested to consider gradually rolling maturing short-dated bonds into longer-dated bonds to lock in yields for longer and potentially benefit from capital appreciation if yields fall.
US stocks and economic growth remain resilient: Despite concerns about higher interest rates and leading economic indicators flashing cautionary signals, US stocks have posted new 15-month highs, and corporate results have surprised to the upside. The strong showing of the US economy, with GDP growth outpacing expectations, has reduced the likelihood of a recession this year.
The European Central Bank's interest rate hike may see a policy pause: While the ECB has delivered on its interest rate hike promise, the near-term outlook for the eurozone economy has deteriorated. Economic activity indicators have fallen below expectations, and credit supply and demand continue to decline. The ECB remains data-dependent, and there's a possibility of another hike, but not necessarily at the September meeting.
Investor sentiment towards Asian equities has been boosted by China's dovish tone: China's top leadership acknowledges economic recovery challenges and plans to announce more countercyclical policies to boost demand and support economic development. Investors are particularly interested in property market policies and specific announcements of easing measures in H2 2023 to sustain the rally in Chinese equities.
S&P 500 Uptrend: The S&P 500 remains in a notable uptrend since the October 2022 lows, and the market message has improved over the past week. Momentum is overshadowing concerns about further economic softening, leading to a positive tone in the market.
Market Rotation: There has been rotation in the market during earnings season, with a preference towards out-of-favor areas such as Health Care, driven by low expectations and attractive valuations. On the other hand, in-favor areas like Communication Services, with elevated expectations and stretched valuations, are seeing some relative performance give-back.
Federal Reserve (FOMC) Decision: The Fed raised the target rate by 25 bps, and the market seems to have taken it in stride. The market's implied expectation suggests that this rate hike might be the last before the Fed starts to loosen monetary policy, supporting the belief in a potential "soft landing" as inflation data continues to moderate.
Broadening in Breadth: There are signals of better participation in the market as divergences continue to wane. The breadth has improved for the S&P 500, and the Transports sector is showing strong performance following a recent breakout, supporting a more bullish posture.
Actionable Sectors: The Energy sector looks actionable in the short-term, with a recent technical breakout. While relative performance has been lagging, the breakout in absolute price could lead to catch-up in relative performance for the sector.
U.S. Dollar and Emerging Markets: The U.S. dollar is bouncing back to resistance in the short-term. If this is a short-term bounce and not a sustainable move, investors may use it as an opportunity to accumulate Emerging Markets (excluding China), as historically, there has been an inverse correlation between the U.S. Dollar and the relative performance of Emerging Markets.
End of Fed Hiking Cycle: The end of the Fed's hiking cycle appears to be nearing, and the market does not expect any further rate hikes for the remainder of the year, assuming a hike occurs this week. This suggests that the Fed may pause or halt its rate increase campaign in response to economic conditions.
Market Outlook for Rate Cuts: The market seems pessimistic about the outlook for rate cuts, with only one full cut expected in 1Q24 and a cumulative 125 bps of cuts for the year. However, history shows that when the Fed starts cutting rates, it often does so more aggressively, with rates falling on average 275 bps within the first year of cuts. This could mean that the market's expectations for rate cuts may be too conservative.
Investment Climate and Fixed Income Duration: As rates move lower, the investment climate becomes more appealing for all long-term asset classes. Investors may want to consider extending fixed income duration, anticipating that policy rates in 2024 and 2025 may not be as high as currently expected due to a softening in growth momentum and a rapid decline in inflation.
U.S.: Dow Jones Industrial Average: The Dow recorded its longest winning streak since 1987, indicating a positive sentiment in the market. However, trading was relatively subdued during the week due to the summer vacation season diverting attention from important data releases, the Federal Reserve policy meeting, and corporate earnings reports. The week's data also suggests that the U.S. economy might manage a soft landing and avoid a recession despite increasing borrowing costs. Positive economic readings, particularly on inflation, and growth in various sectors indicate a favorable economic environment. The Federal Reserve raised the target rate by 0.25% and signaled a relatively benign tone in its official statement, leading to expectations that the Fed might be done raising rates for the year. Futures markets are pricing in a low probability of further rate hikes by the end of the year.
Europe: European Central Bank (ECB) Interest Rate Increase: The ECB raised interest rates to a record-equaling high of 3.75%, but policymakers hinted at a potential pause in monetary tightening, considering future rate decisions. Spain faces a period of near-term uncertainty due to an inconclusive election outcome, leading to parties jockeying to form a majority coalition government or face another election. Eurozone business activity showed a slowdown, with the Flash Eurozone Composite PMI falling to an eight-month low. Germany's IFO business climate index also fell for the third straight month. In Hungary, the National Bank of Hungary reduced its depo rate and overnight collateralized lending rate, signaling a possible trend of rate cuts.
Asia: In Japan, the BoJ decided to keep its key short-term interest rate unchanged and announced greater flexibility in its yield curve control (YCC) target. The central bank also revised up its forecast for consumer price inflation in fiscal 2023. In China, chinese equities rallied after Beijing signaled it would provide more stimulus to support the economy. The Communist Party's Politburo pledged to boost domestic consumption and enhance support for the real estate sector. Profits at industrial firms in China declined, but at a slower pace than the previous month, indicating ongoing economic challenges and potential deflation risks.
Americas: Inflation in Brazil continues to show modest disinflationary surprises, potentially leading policymakers to consider cutting the Selic rate by 50 basis points rather than 25 basis points.

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Previous update:

Institutional Opinions

Market Volatility: As the economy faces slower growth, the equity markets may experience increased volatility. While the base-case view is that stocks are not likely to return to the 2022 bottom, the steady ascent for stocks, up 12% since early May, may be overly optimistic. Investors should expect greater fluctuations in the market than what has been experienced in recent months.
Economic Slowdown: The data indicates that there are signs of emerging fatigue in the economy, and trends in jobless claims, labor turnover, and hourly earnings suggest a deceleration in the second half of the year. The predicted slowdown may take the form of a "rolling recession," with various areas of the economy slowing and rebounding at different times.
Small-Cap Stocks as a Signal: The performance of small-cap stocks can offer insights into the cyclical outlook. Smaller companies tend to be more sensitive to domestic economic conditions. The recent rise in small-cap stocks may be a positive indicator for economic resiliency.
Labor Market's Impact: The labor market has been a strong pillar of support for the current phase of the economic cycle. While there are early signals of softness, the abnormally strong state of the labor market is expected to play a role in softening any economic slowdown.
Interest Rates and Fed Policy: The Federal Reserve's aggressive tightening cycle may have lagged impacts on the economy. The slowdown in the economy may lead to a silver lining for the markets, as it could prompt the Fed to back away from restrictive interest-rate policy, potentially leading to rate cuts next year.
Longer-Term Rates and Yield Curve: Longer-term rates, like the 10-year Treasury yield, have typically risen ahead of recessions, influenced by tighter Fed policy. The current experience with rates reflects uncertainty in the market's outlook for growth and Fed policy.
Forward-Looking Markets: Markets are forward-looking, and historical bear markets have started before recessions occurred. Stocks have begun their recovery before the economy rebounded in the past. Investors should consider the earnings season as corporate earnings are a powerful driver of the market's direction.
Residential Real Estate: The residential real estate market has experienced significant price increases, with the median price for existing homes in the U.S. reaching a record high. However, higher mortgage rates and other headwinds, such as low inventory, reluctance to switch to higher interest rate loans, and declining affordability for borrowers, are likely to impact demand. Tighter credit and job concerns are also expected to contribute to a cautious outlook for residential markets. Overall, the residential real estate sector is facing challenges, and further deterioration of the underlying fundamentals is anticipated.
Commercial Real Estate: The commercial real estate market, particularly in larger U.S. cities, is facing challenges due to the impact of the pandemic and the work-from-home migration. High office-vacancy rates in many major cities are putting pressure on small businesses that rely on foot traffic from downtown workers. As office leases roll over, new lease rates are falling, leading to an increase in delinquency rates for office-backed commercial mortgage-backed securities. The office subsector of the NAREIT All Equity REIT Index has underperformed, and commercial real estate is expected to continue underperforming in the near-to-intermediate term.
Overall Real Estate Sector Rating: The analysis suggests an unfavorable rating for the Real Estate sector as a whole. The combination of numerous headwinds impacting both residential and commercial real estate makes investment in the sector unattractive at present. Further deterioration of the underlying fundamentals is likely.
Inflation Expectations: The market is currently not worried about inflation, with 1-year and 2-year inflation expectations dropping to cycle lows at 1.3% and 1.9%, respectively. 5- and 10-year inflation expectations also remain anchored at around 2.2%. The view is that inflation is set to move lower, supported by numerous inflation leading indicators. However, the path may not be easy, and investors should not get complacent on inflation as solid consumer spending, higher equities, and a lower US dollar could still have inflationary effects.
Economic Outlook: The market is giving the economy the benefit of the doubt at current levels, and the timeline for economic normalization has been pushed out due to excess savings being worked down from the Covid era. However, leading economic indicators point to weakness ahead, and there are concerns that could upset the market's current mood over the coming months. Some of these concerns include the path of inflation, the lagged effects of rapid Fed tightening on the economy, and the market's pricing in of a soft landing. The overall economic outlook suggests that there may still be a mild recession in the future.
Earnings Season: Q2 earnings season has supported the market's trend thus far, with solid numbers and positive reactions from some out-of-favor sectors, such as banks and health care. However, there is an underlying tone of mean-reversion, where companies that have been trading well are facing higher bars for results, while those in weaker trends are experiencing lower bars for positive reactions.
Market Momentum: The tug-of-war between economic indicators and market momentum currently favors momentum. Good inflation data, economic results, and earnings have provided fuel to the soft-landing narrative, and the trend remains positive. However, investors should be aware of potential concerns that could disrupt the market's current mood and lead to choppiness in the coming months.
Technical Analysis: The first level to monitor the S&P 500 for technical resistance in the short-term is at 4600. Technical support levels include the 20 DMA (4440), the 50 DMA (4325), and 4200.
U.S. Equity Market: Most of the major U.S. equity indexes are advancing on hopes that the tight labor market and moderating inflation will help the economy avoid a hard landing. However, the tech-heavy Nasdaq Composite is suffering a modest pullback. Value stocks are outperforming their growth counterparts in the large-cap Russell 1000 Index.
Retail Sales and Jobless Claims: Retail sales in the U.S. increased modestly in June, but the growth rate was slower than the consensus estimate. However, upward revisions to May data raised the growth rate for that month. Additionally, new filings for unemployment benefits fell for a second consecutive week and reached their lowest level since May, indicating a positive development in the job market.
Economic Outlook: U.S. Treasury Secretary Janet Yellen downplayed the risk of a recession, citing the labor market's resilience and slowing inflation. However, the Conference Board's Leading Economic Index, a forward-looking gauge of U.S. economic activity, has been decreasing for 15 consecutive months, indicating potential economic weakness in the future.
Bond Market: Bond investors are pricing in a near certainty of another Federal Reserve rate hike at the central bank's July policy meeting. The yield curve has further inverted, with the yield on the benchmark 10-year U.S. Treasury note little changed while two-year U.S. Treasury note yields increased.
Europe: European government bond yields have ticked lower as cooling inflation in the U.S. and the UK raised expectations that major central banks could be close to the end of tightening monetary policy. The eurozone economy avoided a recession in the first quarter of this year, and two leading hawks in the European Central Bank (ECB) have appeared to moderate their stance on future interest rate increases.
Japan: Japan's stock markets registered mixed performance for the week, with the Nikkei 225 Index falling while the broader TOPIX Index gained. The Bank of Japan's monetary policy meeting and June core consumer price inflation data are impacting investor sentiment.
China: Chinese equities retreated as the latest economic data pointed to faltering growth. China's real estate sector has started showing signs of weakness amid poor consumer sentiment and persistent deflationary pressures.
Turkey: The Turkish central bank raised its key policy rate to anchor inflation expectations and control inflation pressures driven by domestic demand, cost pressures, and exchange rates.
Peru: The Peruvian central bank kept its key policy rate unchanged, but its post-meeting statement was viewed as dovish, indicating that the beginning of a policy-easing cycle could be near due to falling inflation and weak economic growth.
Global Disinflation Trend: The data indicates a global disinflation trend, with headline CPI rising at a slower pace in major economies compared to the peak inflation seen a year ago. The OECD reported softening inflation in most major economies, reaching the lowest level for global inflation since December 2021. This overall softening of prices is a positive development.
Progress Among Countries: Progress in reducing inflation remains uneven among countries. Emerging markets, where some central banks have taken early action, have been more successful in bringing down core inflation and may see rate cuts this year. On the other hand, some countries in developed markets, particularly Italy, are still facing challenges with food inflation, while others are waiting for further drops in core inflation.
Impact of Tight Labor Market: Core services prices have been slower to ease due to tight labor market conditions globally. Labor-intensive services, like medical care and education, may see some softening through further monetary tightening. However, others, like transportation, may remain elevated with higher rates.
Diverging Global Monetary Policy: Some central banks have reached the end of their hiking cycles, while others are just beginning to tighten monetary policy. The divergence in global monetary policy can have significant effects on currency dynamics and international returns.
Currency Impact: Investors should pay attention to how diverging global monetary policy can affect currency dynamics. Central bank actions, interest rate differentials, and economic conditions in different countries can lead to fluctuations in currency values, which can impact investment returns for international investors.
Structural Challenges: Some countries, like the U.K., are facing very sticky inflation, and others, like China, are potentially facing deflation. Countries with structural challenges may need to implement appropriate measures to address inflation and deflation concerns.
Preference for EM Assets: The macro backdrop favors emerging market (EM) assets over developed market (DM) assets. EM stocks and bonds have shown a stealth rally, and the macro assessment suggests that EM assets have an edge over DM peers.
EM Debt Outlook: EM local currency debt was tactically overweighted in March due to higher yields for carry and a weaker U.S. dollar. However, tightening spreads with Treasuries may lead to a switch to EM hard currency debt issued in U.S. dollars. Nevertheless, peaking DM policy rates should support EM currencies, bolstering EM local debt for the time being.
EM Macro and Policy Picture: EM central banks are closer to rate cuts as inflation falls. Many EM central banks had already hiked rates aggressively to combat inflation, and some countries, like Brazil, have seen policy rates rise significantly. EM economies are benefiting from a brighter policy outlook.
Rally in EM Equities: EM equities have staged a stealth rally, with double-digit gains across Latin America and other parts of Asia, despite China's economic slowdown. The policy picture and improved EM economic growth prospects, along with attractive valuations relative to DM economies, are contributing to the rally.
Granular Approach: The investment playbook involves getting granular and focusing on specific countries and sectors within EM to find the brightest macro backdrops and attractive valuations. This approach allows for better positioning to capture returns in specific areas.
Harnessing Mega Forces: The playbook also involves harnessing mega forces, such as digital disruption and artificial intelligence (AI), geopolitical fragmentation, the low-carbon transition, aging populations, and the future of finance. These structural changes are expected to create significant shifts in profitability across economies and sectors.
Importance of Security Selection: Greater volatility and dispersion within and across asset classes require careful security selection and expertise to achieve above benchmark returns. Relative value opportunities from potential market mispricings are likely to be more abundant.
Macro Strategy and the Possibility of a Recession: The data suggests that the economy is experiencing slower nominal GDP growth but is still running above pre-pandemic rates. However, leading indicators indicate that momentum is fading due to the effect of higher interest rates squeezing demand. The main force for slowing growth is the increasing mismatch between company pricing power and lagging wage pressures, which is likely to continue until the labor market weakens significantly. As a result, a recession is still likely.
Market View and Investment Implications: The equity rally has been fueled by multiple expansion, but further upside may be more limited. Expectations for a recession have been pushed out, but the case for an economic slowdown persists, creating a gap between the market and macro outlooks. Volatility sentiment measures for equities and fixed income are telling different stories, indicating risks of increased periods of volatility.
Student Loan Repayments: The three-year hiatus on federal student loan repayments is ending, and borrowers will resume making average monthly payments of $383 in October. This could strain consumers who have been spending that money elsewhere, leading to slower spending and potentially dampening retail sales. However, several factors, such as excess savings and available credit, may soften the economic impact.
Portfolio Considerations: Given the level of portfolio drift in certain areas, the recommendation is to actively rebalance portfolios. As the transition to a new macroeconomic regime takes hold with elevated overall risk amid slowing earnings, higher interest rates, and geopolitical uncertainty, it is essential to build diversified portfolios across and within asset classes, including alternatives. The current stance is to remain neutral on equities and fixed income relative to strategic benchmarks.
USD Weakening: The US dollar (USD) is expected to weaken due to a slowdown in US inflation, deceleration in the US labor markets, and tighter credit conditions. The Federal Reserve (Fed) is not expected to implement much more tightening in monetary policy. The narrowing growth and interest rate differentials between the US and other countries contribute to the USD-negative outlook over the next few months.
EUR and GBP Strengthening: European central banks, including the European Central Bank (ECB), are persisting with interest rate hikes to combat resilient core inflation. This is likely to lead to a stronger euro (EUR) against the USD. The Bank of England (BoE) is also expected to tighten monetary policy, leading to a stronger British pound (GBP) supported by healthy yield spreads.
CAD Moderately Strengthening: The Canadian dollar (CAD) has strengthened modestly against the USD due to outperformance in the domestic economy and tightening monetary policy by the Bank of Canada (BoC). Some modest improvement in the CAD versus the USD is anticipated over the second half of the year, with a target of USDCAD easing to 1.30 by year-end.
JPY Weakening: The Japanese yen (JPY) is expected to remain the weakest major currency due to wider yield spreads versus the rest of the world. Lower US yields have allowed the JPY to recover somewhat, but the year-end forecast for USDJPY is adjusted to 135.
MXN Bull Run: The Mexican peso (MXN) has been on a bull run and is expected to maintain its strength against the USD. Positive inflows from remittances and local policymakers' wide interest rate cushion over rising US interest rates are supporting the MXN. However, concerns about competitiveness among local exporters and the possibility of rate cuts may slow MXN losses versus the USD.
Banks' Performance and Interest Rate Changes: Historically, banks tend to perform well when interest rates rise, as they can increase their net interest margins. However, the delay in passing on higher returns to savers could affect their profitability. The profitability of banks could improve if the lending cycle remains benign and loan loss provisions are restrained.
US Banking Sector: The US banking sector's earnings season is expected to be subdued overall due to the regional bank crisis, affecting the traditional expansion in net interest margin. Credit quality is anticipated to remain strong, except for the commercial real estate sector, leading to a potential increase in loan loss provisions in the future. Despite this, large US banks are expected to maintain a strong capital base, allowing for compelling dividend payouts.
Canadian Banking Sector: Canadian banks' valuations are nearing stressed levels, reflecting slowing loan growth, higher deposit costs, and loan losses, while the regulatory environment is becoming less favorable. The state of the economy remains a key short-term concern for the sector's performance.
UK Banking Sector: The UK banking sector's capital position is expected to be resilient even in severe economic scenarios. Positive economic momentum is likely needed for UK bank shares to re-rate materially higher.
European Banking Sector: European banks have enjoyed earnings upgrades due to the benefit of higher interest rates on their net interest margin. However, a selective approach is advised, focusing on high-quality banks, given the current subdued economic environment.
Global Economic Outlook: The US economy has shown resilience, but weakness in economic data is emerging in the eurozone and China. Economic slowdowns in these regions are worth monitoring, considering the interconnected nature of the global economy.
Inflation and Interest Rates: Inflationary pressure remains broad in nature, and consumer spending has been relatively resilient in Canada. As a result, interest rates are expected to remain high in the short term, with a potential rate hike by the Bank of Canada. In the UK, long-awaited signs of disinflation have appeared, potentially reducing expectations for interest rate hikes by the Bank of England.
Chinese Economic Recovery: China's economic recovery showed signs of losing momentum in Q2, raising concerns about potential slowdowns in the global economy. Deflation is now a major risk, with prices declining across the board for the first time since 2020. Calls for further economic stimulus and policy support are growing.
US-China Investment Restrictions: The Biden administration's proposed restrictions on investments in China will focus on cutting-edge technology and will apply only to new investments. Implementation is likely to be delayed until early 2024.

Previous update:

Institutional Opinions

Disinflation theme: The data indicates a trend of slowing inflation across various categories, which lessens the pressure on central banks to continue hiking interest rates. This suggests that the disinflation theme is likely to continue in the near future.
Diversification into lagging equity segments: The recommendation to diversify into lagging segments of the equity market that carry lower valuations indicates that there may be opportunities for investment in undervalued sectors or companies. This suggests that investors may find potential gains by reallocating their investments to these areas.
Dollar-cost averaging to take advantage of volatility: The anticipation of higher volatility in the market suggests that investors can benefit from a dollar-cost averaging strategy. By investing systematically at regular intervals, investors can take advantage of potential market fluctuations and potentially achieve better long-term returns.
Extending duration within fixed-income portfolios: With the expectation that inflation will continue to decrease and central banks may eventually cut rates, there is an opportunity to extend the duration of fixed-income portfolios. Longer-term bonds with historically high yields may provide income generation and potential capital appreciation if yields start to move lower.
Market reaction to inflation and central bank actions: The market reaction to the sharp deceleration in U.S. inflation and the slight shift in expectations regarding central bank tightening suggests that investors are responding positively to these developments. This reaction could continue if inflation continues to cool and central banks pivot towards a pause or rate cuts.
Earnings season and market gains: The upcoming earnings season is expected to mark the end of the earnings downturn, with positive growth anticipated in the third quarter and beyond. Positive earnings results could drive further gains in the equity market, although the market's hefty gains in the first half of the year may already be largely priced in.
Opportunities in broadening market participation: The recommendation to rebalance and diversify into lagging segments of the equity market suggests that there may be opportunities beyond the dominant mega-cap technology stocks. Value-style investments, small-cap companies, traditional cyclical and defensive sectors, and international stocks are mentioned as potential areas for investment.
Impact of higher interest rates and potential economic slowdown: The data suggests that the impact of higher interest rates and a potential economic slowdown may lead to increased volatility in the market. However, historically, strong first halves of the year have been associated with further gains in the remainder of the year. Dollar-cost averaging and diversification strategies are recommended to navigate these potential market conditions.
Earnings Outlook: The data suggests that there is pressure building under the surface of higher expected corporate earnings. Profit margins are shrinking, and there is a divergence in earnings forecasts, with tech firms experiencing growth while other sectors stagnate. The outlook indicates that there may be more earnings pain ahead, particularly in the second half of the year.
Tight Labor Markets and Profit Margins: The data highlights the tight labor markets in the U.S. and Europe, which could squeeze corporate profit margins. Companies may face pressure to increase wages to attract workers, leading to a potential decline in profit margins. This could result in a challenging macro environment for broad asset class exposures.
Central Banks Holding Tight: The data suggests that central banks, such as the Fed, will be forced to keep policy tight to curb inflationary pressures. The market is adjusting to this new regime, and the expectation is that central banks will not quickly ease policy. This indicates a break from the previous era of steady growth and inflation known as the Great Moderation.
Granularity and Selective Preferences: The data emphasizes the importance of getting more granular and identifying selective preferences within developed market stocks. Divergence within and across asset classes is expected to be higher in the new regime, offering opportunities for security selection and relative value plays. The focus should be on areas where the macro view is priced in and where mega forces, such as AI, geopolitical changes, low-carbon transition, and financial system evolution, can create shifts in profitability.
Impact on Investments: Based on recent data, some investment implications include overweighting short-dated U.S. Treasuries as income becomes a priority, favoring quality in both equities and fixed income, overweighting AI as a multi-country, multi-sector investment cycle unfolds, and considering sectors like healthcare and industrial (particularly automakers) that may be better positioned to navigate the changing macro environment.
Market Juncture and Potential Volatility: The surge in government bond yields and the dip in stocks indicate an important market juncture. The data suggests that markets are adjusting to the view that central banks will keep policy tight, and this may lead to increased volatility. The focus will be on whether corporate earnings can meet market expectations during the Q2 reporting season to avoid additional pressure on equities.
Full Employment Recessions: The data points to the unusual possibility of "full employment recessions" in the U.S. and Europe, where tight labor markets and worker shortages could result in economic downturns despite low unemployment rates. This unique scenario could have a significant impact on corporate profit margins and the overall macro environment.
Yield Curve and Economic Strains: The yield curve has steepened, indicating that the market is pricing in more Federal Reserve tightening and an extended period of higher interest rates. This is likely to keep the yield curve inverted for longer, which could strain the economy and increase the odds of a "hard landing" as inflation proves more challenging to control than anticipated.
Forces Shaping Market Direction: As the second half of 2023 begins, several key forces could determine market direction globally. These include the potential for a U.S. recession, additional stimulus measures in China, higher inflation in Europe, a shift in monetary policy in Japan, and a potential breakout in the value of the U.S. dollar.
Job Market Outlook: The job gains in the first half of the year were driven by small and medium-sized businesses in the leisure and hospitality industries, as well as strong hiring in the construction sector. However, larger firms, information, and financial services industries have been shedding workers. It is expected that job growth will slow in the second half of the year as firms implement cost-cutting measures to support margins. The Federal Reserve remains concerned about wage growth reinforcing inflation that is still above the 2% target.
Investment Implications: Given the outlook for tighter monetary policy, the risk is that the stock market rally in 2023 could fizzle out. As a result, high-quality assets are considered preferable for investors looking to maintain portfolio gains. Valuations in equities have deteriorated since the start of the year, but stronger growth continues to favor U.S. equities. A more cautious view is warranted for international markets, and a focus on diversification, balance, and higher-quality investments is recommended.
Yield Curve and Macroeconomic Impact: The shape of the yield curve is seen as an important leading indicator of the economy's direction. An inverted yield curve, where short-term rates are higher than long-term rates, suggests that monetary policy is in a restrictive phase. The longer the yield curve remains inverted, the higher the likelihood of a "hard landing" for the economy. The current deep inversion of the yield curve is a cause for concern, as it has preceded previous recessions.
Earnings and Nominal GDP Growth: The data suggests that earnings recession is already underway and is likely to worsen in the coming months. Slowing nominal GDP growth is expected to impact corporate revenue growth, causing earnings to grow less than revenues. The slowdown in nominal GDP growth is attributed to the tightening of monetary policy and the fall in inflation. The earnings recession is expected to be more significant due to the previous stimulus that pushed revenues and margins above their underlying trends.
Market Outlook and Valuations: While equity markets had a strong start to the year, valuations have deteriorated compared to a year ago. Expectations for growth have been upgraded, and the U.S. economic activity has not fallen into a recession as initially feared. However, there is a preference for the U.S. market over the rest of the world. Key determinants of market direction in the second half of 2023 include economic and policy developments in the U.S., China, Europe, and Japan.
Labor Market Outlook: The labor market has been resilient, with job gains in certain sectors and smaller businesses. However, a weaker labor market is expected to emerge in the second half of the year. Rising layoffs and declining job openings suggest that the unemployment rate will increase. The slowdown in nominal economic growth is expected to drive a continuation of the profit recession and lead to more aggressive cost-cutting initiatives, including labor. This could be a headwind for equity investors in the second half of the year.
Equity Market Outlook: The S&P 500 Index has experienced a strong rally in 2023 but is still below its January 2022 peak. The market rally seems extended, with factors such as a deteriorating macro and earnings environment, full valuations, and lack of breadth of gains across the index. A sustainable and broad-based equity rally is expected to take time to develop, and a bumpy and range-bound ride is anticipated in the near term.
Commercial Mortgage-Backed Securities (CMBS): The conditions in the commercial real estate space are expected to continue deteriorating, despite resilient economic growth. The Federal Reserve's plan to raise interest rates and keep them higher for longer is likely to contribute to this trend. Credit spreads on CMBS have widened, and rating agencies have started downgrading credit ratings. Higher-quality and short-to-intermediate duration in AAA CMBS sectors are preferred for investors willing to bear the risk.
Oil Prices and Russian Supply: Despite political turmoil in Russia, oil prices have remained relatively muted, indicating that the market is shrugging off the risk of a potential supply disruption. Russian oil production has historically been resilient to political and military conflicts. Previous sanctions imposed on Russia's oil industry did not result in a significant decline in oil production. Therefore, a major supply disruption is deemed unlikely in response to the recent military uprising.
Private Equity Exit Environment: The economic slowdown and macro headwinds have created a challenging exit environment for private equity funds. The number and value of exits have declined below the long-term trend line. Factors contributing to this decline include a less favorable fundraising environment, declining confidence among corporate leaders, and a tepid IPO market. Private equity managers may opt to extend hold times instead of selling positions below perceived values. This could lead to limited partners selling fund stakes on the secondary market to generate liquidity. However, the slowdown may also present attractive buying opportunities for funds with cash to deploy, particularly in small/mid-cap buyout and growth equity strategies.
Equity Market Outlook: The S&P and Nasdaq have reaccelerated their rally following a brief pause. The uptrends for both indexes remain intact, with resistance levels at 14,534 for the Nasdaq and 4,637 for the S&P. A decline below the June lows would be needed to signal a reversal in the uptrends. Participation in the market is broadening beyond mega-cap growth stocks, with cyclicals showing improvement. Industrial, financial, materials, and energy sectors are exhibiting signs of bottoming after pullbacks. As earnings for Q2 are reported, pullbacks are expected to be relatively short-lived, presenting buying opportunities within both secular and cyclical growth groups.
US 10-Year Yield: The US 10-year yield reversed from an important upside level of 4.09%, alleviating concerns of a surge in rates. The next important support is at 3.6-3.7%, and a break below that level would suggest further weakness toward the 3.25-3.3% range. This suggests a potential decline in interest rates, which could be a tailwind for equity markets.
US Dollar Index (DXY): The US Dollar Index experienced an important technical breakdown, collapsing below a key level at 100.8. The weakness in the US dollar confirms a downtrend that started in Q4 2022. The next support level is near the 62% retracement level at 98.9. A weaker US dollar is seen as a tailwind for equity markets.
Broadening Participation: The S&P 500 Equal Weighted, Russell 2000, and MSCI Emerging Market indices are showing signs of broadening participation beyond mega-cap technology stocks. These indices established cycle lows in Q4 2022 and higher lows in March 2023, indicating a positive trend reversal. To confirm a new uptrend, a move above the February highs is needed. The levels to watch are 6,321 for the S&P Equal Weighted index, 2,007 for the Russell 2000 Small-cap Index, and 1,057 for the MSCI Emerging Market index. It is expected that these indices will rally to their February highs and potentially push higher, supported by declining interest rates and a weak US dollar throughout the rest of 2023.
Earnings Outlook: The consensus forecast for S&P 500 Q2 earnings is a decline of 7.0% year over year. However, it is anticipated that the actual results will be better than feared, with an estimated decline of around 3.4% after factoring in earnings beats. Sectors such as Energy and Materials are expected to be significant drags on Q2 results due to tough year-over-year comparisons. Excluding these sectors, the consensus forecast projects 1.4% growth, with the potential for higher growth if earnings beats materialize. Technology-oriented stocks and the Industrials sector face higher hurdles to maintain their recent gains, and their performance will be closely monitored for indications of U.S. and global economic trends.
Market Stance and Valuation: A Market Weight stance in U.S. equities is deemed appropriate due to economic and earnings growth uncertainties in the near future. Recession risks are still a concern, and the stretched valuation of the S&P 500, with a high P/E ratio and elevated PEG ratio, suggests limited room for economic disappointments. It is prudent to maintain U.S. equity exposure at the long-term recommended level in portfolios.
Economic Factors: The Consumer Price Index (CPI) in the United States showed a smaller annual increase, indicating progress on price stability. The data led to a positive reaction in Treasury yields, with a higher probability of a more benign policy stance from the Federal Reserve. However, policymakers may be reluctant to cut rates without multiple months of acceptable core inflation. In Canada, the Bank of Canada (BoC) raised interest rates for a second consecutive time, showing growing concern about inflation risks. The BoC expects excess demand to persist into 2024, leaving the possibility of another rate increase in September.
Regional Outlook: In the UK, private sector pay growth remained strong, driven by higher inflation expectations and a tight labor market. The Bank of England (BoE) may opt for another interest rate increase in August, considering high wage growth. European equities have underperformed global equities, but earnings trends have been more resilient. However, there have been divergences in earnings expectations for different sectors, with notable downgrades for the European chemicals sub-sector and continued upgrades for European banks. In Asia Pacific, there has been a risk-on mood toward Asian equities, particularly Chinese stocks, due to improved investor sentiment following regulatory developments. Chinese exports declined significantly, suggesting weak external demand and potential challenges to China's recovery in the second half of the year.
Market Momentum: The recent wave of market momentum continues, with equities pushing to year-to-date highs. The wider participation of lagging areas driving performance, rather than just a handful of Tech heavyweights, is a positive sign. Better-than-expected economic data is supporting the recent strength.
Economic Outlook: The economy has held up better than expected this year, leading to increased talk of a non-recessionary or soft-landing scenario. The timeline for economic contraction has been pushed out, but there is still a likelihood of a mild recession occurring within the next 6-12 months.
Equity Market Outlook: Overall, a positive outlook is maintained, with expectations that equities will reach their prior highs by the end of next year. The bear market that started 18 months ago is following a historical pattern, and leading indicators suggest a decline in inflation ahead. As inflation comes down and/or employment weakens, the Fed may pivot, and equities will begin pricing in the eventual economic recovery.
Earnings Season: Some data also suggests that the Q2 earnings season is anticipated to have a higher bar for positive surprises compared to the previous quarter. Economic concerns have eased, and earnings revision trends have slowed their pace of decline. Valuations have extended despite rising bond yields. However, the potential for upside surprises may be lower in Q2, given the higher expectations.
Technical Analysis: The S&P 500 index has been riding above its 20-day moving average and broke above resistance levels. The 20-day moving average will be the first level of support to monitor. The MACD is close to rolling over, and stochastics are at overbought levels, indicating a potential consolidation or pullback in the near future. The upcoming earnings season will be an important catalyst to monitor.
Participation and Opportunities: Better participation has been observed beneath the surface, indicating a broadening out of market participation. Lagging areas present opportunities for investment. The US dollar's decline following the CPI report could have a positive influence on commodities, Materials, and Energy sectors. Energy remains in an overall downtrend, but its performance may improve if WTI crude oil breaks its downtrend and the US dollar continues to weaken.
U.S. Stocks: Stocks in the U.S. recorded strong gains during the week, driven by cooling inflation signals. The S&P 500 and Nasdaq Composite both saw positive performance, with standout performers in sectors such as casino operators, regional banks, and asset managers. The unofficial start of earnings season with major banks reporting second-quarter results also contributed to the positive sentiment.
Inflation Data: The release of consumer price index (CPI) inflation data showed a continued cooldown in inflation. Both headline and core inflation rose 0.2% in June, slightly below expectations. The annual increase in headline inflation slowed to 3.0%, its slowest pace since March 2021, while core inflation slowed to 4.8%, the slowest since October 2021. Producer price index (PPI) inflation data was also encouraging, with headline producer prices nearing deflation territory and core producer prices at their slowest pace since January 2021.
Consumer Sentiment: The University of Michigan's gauge of current consumer sentiment showed its largest monthly gain since 2006. Consumers reported improved optimism due to better labor market conditions and falling inflation. This data suggests that the economy might be able to avoid a recession and experience a "soft landing" as inflation cools.
U.S. Treasury Yields: U.S. Treasury prices rose as longer-term yields retreated following the positive inflation data. The yield on the benchmark 10-year note fell below 4%. Supportive technical conditions remained in the municipal bond market, leading to strong demand for munis.
European Stocks: European stocks experienced their biggest weekly gain in about three-and-a-half months. Cooling inflation in the U.S. raised expectations that interest rates may soon peak. China's extension of support measures to the property sector also contributed to optimism. Major stock indexes in France, Germany, Italy, and the UK advanced.
ECB Monetary Policy: The minutes of the European Central Bank's (ECB) June meeting showed support for further rate increases amid concerns about persistently high inflation. Policymakers discussed the need to communicate that monetary policy still has more ground to cover to bring inflation back to target. The possibility of interest rate increases beyond July was considered. However, a meeting-by-meeting approach was favored, especially as rates approached a possible peak level.
UK Economic Outlook: The UK economy contracted less than expected in May, and wage growth hit a record level. GDP grew on a rolling three-month basis, and wages grew at a record annual pace in the three months through May. However, the labor market showed signs of easing with a slight increase in the jobless rate.
UK Housing Market: Surging mortgage rates affected the UK housing market, with homebuyers pulling back at the sharpest pace in eight months. Higher borrowing costs were seen as weighing on affordability.
China's Economy: Chinese equities rallied after Beijing announced measures to support the country's economy. The extension of policies to defer property development loans and support project delivery raised hopes for additional economic stimulus. Inflation data showed unchanged CPI and decreasing core inflation, indicating increasing deflation risks and a weakening post-lockdown recovery.
Japan's Equities and Monetary Policy: Japanese equities lagged behind other Asian markets. Expectations that the Bank of Japan (BoJ) may adjust its yield curve control framework exerted upward pressure on domestic yields. The yen strengthened against the U.S. dollar, anticipating monetary policy normalization. The 10-year Japanese government bond (JGB) yield rose, nearing the BoJ's cap level.
EU-Japan Summit: Japan and the European Union agreed to boost strategic cooperation on digital and critical raw materials supply chains. Restrictions on food imports from Fukushima were lifted, providing support for the affected area's reconstruction.
Brazil and Colombia: In Brazil, inflation remained below the central bank's key policy rate, and there were signs of cooling in core goods price pressures. The central bank is expected to start reducing the policy rate in the next couple of months. In Colombia, inflation showed a slight decrease, mainly led by food prices. Core inflation and services inflation also showed signs of easing, but the central bank is not yet expected to begin an easing cycle.
Labor Market Momentum: The labor market in the U.S. has shown resilience in the first half of 2023, supported by strength in the labor market and consumption. However, the labor market momentum appears to be cooling, as indicated by various key indicators. This suggests that the pace of growth in the labor market may slow down.
JOLTS Job Openings: JOLTS job openings fell to 9.8 million, bringing the ratio of openings to unemployed workers to its lowest level since October 2021. This indicates a decline in the number of available job opportunities, which may contribute to a slowdown in the labor market.
Quits-to-Layoffs Ratio: The quits-to-layoffs ratio rose, driven by increasing quits. Although still elevated, it is 23% below last year's peak. This suggests that workers are more confident in leaving their current jobs, potentially seeking better opportunities. However, a higher quits-to-layoffs ratio also indicates potential challenges for employers in retaining talent.
Nonfarm Payrolls: Nonfarm payrolls rose by 209,000 in June, falling short of expectations and showing a slowdown compared to May. This slower pace of job growth, along with downward revisions to job growth in previous months, confirms the fading momentum in the labor market.
Unemployment Rate and Wage Growth: The unemployment rate ticked down to 3.6%, indicating continued strength in the labor market. Wage growth also ticked up to 4.4%, highlighting the ongoing strength in wages. However, slower job growth may lead to slower wage growth in the future as labor demand cools.
Impact on Fed Policy: The increasingly balanced labor market, with slower wage growth, may reduce pressure on the Federal Reserve (Fed) to maintain its hawkish messaging and tighten monetary policy aggressively. Slower wage growth should also allow inflation to drift lower, aligning with the Fed's goal of maintaining price stability.
Expectations for the July FOMC Meeting: The data did not significantly change expectations for the July Federal Open Market Committee (FOMC) meeting. The Fed may take note of the cooling labor market momentum but could maintain its current stance on monetary policy.

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