Although data and comments from Federal Reserve officials may suggest otherwise, the big picture still shows that global fundamentals are trending positively, with the global cycle and earnings revisions inflecting higher, UBS strategists said Monday.
The latest Federal Open Market Committee (FOMC) saw the median forecast for rate cuts in 2024 drop from three to one, which initially raised concerns among investors about the investment outlook. However, “the totality of market performance last week suggests that investors actually took the Fed news in stride,” the UBS team noted.
The S&P 500 surged to a new all-time high on Thursday as strong May payroll growth and better-than-expected CPI data have bolstered confidence in a soft landing for the economy. However, the week's performance showed a clear distinction between winners—tech, large-cap quality, and momentum stocks—and losers, such as value, cyclicals, and small-caps, UBS noted.
Rates fell by about 20 basis points across the Treasury curve in response to the inflation news, but the USD rallied 0.6% last week and 1.4% since the payrolls report, contrary to expectations following favorable jobs and inflation data.
“This performance collectively looks “risk off” as much as “risk on” despite the equity gains,” UBS highlighted.
The unexpected French election contributed to this risk-off sentiment, the bank said, particularly affecting European equities. Political uncertainty from snap elections in France, Mexico, and India likely triggered a mild safe-haven bid for US assets, strengthening the USD.
A bigger driver of cross-asset price action may be investor skepticism about a soft landing, despite it being the consensus view. Concerns over slowing growth, not persistent inflation, are predominant.
After a period of high inflation, the last two months of data have renewed confidence in disinflation. However, recent growth data is mixed. While May payrolls exceeded expectations at 272,000, other labor market indicators show cooling. Initial jobless claims rose to their highest level since August, and the University of Michigan Consumer Sentiment Index declined, raising concerns about consumer spending resiliency.
“The underperformance of value, cyclical, and small-cap stocks is the market’s way of saying that doubts persist over whether economic growth will remain solid,” UBS wrote in a note.
Looking ahead, upcoming May retail sales and personal consumption expenditure data are crucial. Positive credit card spending data for the month provides cautious optimism, potentially easing growth concerns similar to how May CPI alleviated inflation fears.
Regarding the Fed dots, investors may wonder why the FOMC didn't opt for two rate cuts to maintain flexibility. However, the one-cut median hasn't significantly impacted market pricing, which still anticipates two cuts by December. Fed Chair Jay Powell downplayed the projections, saying that “these projections are not a committee plan or any kind of decision.”
“Perhaps most important is that the Fed is data-dependent, and if inflation over the summer remains modest, then the Fed will have a valid case for making an “insurance” cut in September. That thinking is why we still expect two cuts this year,” UBS said.