Central bank actions impacting market sentiment

US Federal Reserve (Fed) pushes pause on interest rate hikes
ECB staying the course
China's Central Bank's unexpected move
Earnings trends will be key to watch for equity direction

As we assess the current market landscape, several key factors have influenced the recent market upswing, including a notable Q1 earnings season, decelerating inflation, growing optimism about a soft, non‑recessionary landing, the AI (Artificial Intelligence)‑powered tech rally, and the Fed approaching the end of its tightening cycle. These factors have played significant roles in driving the positive momentum. However, it is important to acknowledge that with much of the positive news already priced into the equity market, there is an increased vulnerability to potential disappointments. During June the developed markets stocks’ index MSCI World (EUR) has risen by 3.63% and the emerging markets stocks’ index MSCI Emerging Markets (EUR) has added 1.43%.

The US Federal Reserve introduces the idea of a "skip" meeting

The US Federal Reserve paused its interest‑rate‑hiking cycle, keeping the Fed funds rate at 5.0%–5.25%, after 10 consecutive rate hikes. However, it indicated in its updated projections that a peak Fed funds rate could be around 5.6%, which implied perhaps two more 0.25% rate hikes ahead. This comes even as CPI and PPI (Consumer price index and Producer price index) inflation readings surprised to the downside. Nonetheless, in his comments Jerome Powell acknowledged that the Fed tightening thus far has put some downward pressure on growth and inflation, pointing to the tightening in bank‑lending conditions as well. Meanwhile, bond yields climbed higher after the Fed meeting, as markets priced in the potential for additional Fed rate hikes. The 2‑year Treasury yield moved higher by 0.10% to 4.68%, now nearly 1.0% above its recent lows in May.

U.S. Treasury yields climb higher as the Federal Reserve points to more rate hikes ahead

Source: Bloomberg L.P.

ECB tackles inflation with rate hike

Monetary policy was also in the spotlight on this side of the Atlantic, with the European Central Bank (ECB) announcing a 0.25% rate hike during its June meeting, bringing its main rate to a 22‑year high of 3.5%. This marked the eighth consecutive rate hike, despite the bloc entering a recession in early 2023, with both headline and core inflation rates persistently exceeding the ECB's 2% target. Additionally, the central bank has revised its inflation forecasts upwards while slightly reducing growth projections, particularly for the current and upcoming years. Meanwhile, during a news conference, President Lagarde stated that the ECB had more ground to cover and would likely continue raising rates in July. ECB officials have already implemented an unprecedented 400 basis point increase in rates over the past year, marking the fastest tightening pace in the history of the bank.

Surprise rate cut by China Central Bank to stimulate economy

China's central bank surprised economists and market participants by reducing a short‑term policy interest rate. This unexpected action reflects the increasing worry among officials about the country's slowing economic growth. “Policymakers are finally acknowledging the economic weakness,” said Michelle Lam, Greater China economist at Societe Generale. The reduction in interest rates was modest – a tenth of a percentage point for the country’s benchmark one‑year and five‑year interest rates for loans. However, since the majority of corporate lending and mortgages in the country are tied to these rates, the cuts could potentially impact the overall rate of economic growth to some extent. While the reduction in interest rates may provide a temporary boost to sentiment, economists say more needs to be done to boost confidence for businesses to invest.

Will earnings face a downturn or a steady course ahead?

The earnings recession that negatively affected the market for a significant period of the past year has started to stabilize, indicating that analysts were overly pessimistic. Factors such as the economy's resilience, cost‑cutting measures like layoffs, and disinflationary trends that improved profit margins, along with increasing enthusiasm surrounding AI, have helped prevent further decline in earnings. As a result, the S&P 500's projected earnings estimates, which had reached a low point of $226, have rebounded to approximately $232, reflecting an improved corporate profit outlook. This positive development has contributed to the broader trend of increased risk appetite in the markets observed over the month of June. Within a matter of weeks, we will enter the second‑quarter earnings season and closely observe whether companies can maintain these positive trends in the wake of more challenging consumer and economic headwinds.

“House view” update

Our investment team remains committed to a neutral risk allocation considering the current market dynamics. We consider a range of both positive and negative factors in our decision‑making process. Factors such as decelerating inflation, the AI‑powered tech rally, and growing optimism about a soft, non‑recessionary landing contribute to the positive outlook. On the other hand, the restrictive monetary policy and macroeconomic uncertainty continue to rank high on our list of concerns. Taking all these factors into account, we believe maintaining a neutral risk allocation is justified.

Luminor House View

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