Welcome to H2
After a Q1 that was positive across the board, Q2 was more mixed for financial markets. Some assets did really well, with tech stocks seeing a strong outperformance thanks to excitement around AI. That extended to other risk assets, and volatility continued to fall as there were no signs of broader financial contagion after the issues in March. However, sovereign bonds lost ground after inflation remained sticky and central banks kept taking rates higher. Commodities also struggled across the board, with Brent crude oil prices down for a 4th consecutive quarter. On the equity side, the S&P 500, Dow Jones and Nasdaq Composite indexes all notched gains for the week, month, quarter and first half of the year. For June, the S&P and Nasdaq both added about 6.5%, and the Dow's 4.6% gain was the best showing since November. For the second quarter, the S&P's 8.3% jump was its best quarter since Q4 2021, while the Nasdaq surged nearly 13% and the Dow added 3.4%. Finally, for the first six months of 2023, the Nasdaq exploded 31.7% higher for its best first half since 1983, and the S&P soared 15.9% for its best first half since 2019, while the Dow added a more modest 3.8%.
Welcome to H2
The S&P 500 closed the week at 4,450.38, +2.35% higher. The Dow Jones closed at 34,407.60, +2.02%, with the Nasdaq higher by +2.19%. The volatility index VIX closed the week at 13.59 up from 13.44. The Euro Stoxx 600 surged +2.24%.
The 10-year UST closed at 3.84% up from 3.73% a week before. The yield curve is inverted with the yield spread between the 3-month and 10-year UST at -148bps. US Corporate Bond spreads: Investment Grade tightened 1bp at 198bps and High Yield tightened 9bps at 445bps. German 10-year Bunds yield closed at +2.39% up from +2.35% a week before. In Europe, Corporate Investment Grade spreads widened 2bps at 176bps and High Yield spreads widened 4bps at 460bps.
The US Dollar Index (DXY) appreciated +0.01% last week and closed at 102.91. The Euro closed at 1.0909 (+0.14%); the Yen depreciated -0.42%, closing at 144.31 and the Swiss Franc appreciated +0.16%, closing at 0.8956. Gold closed at $1,919.35 depreciating -0.10%. Oil was higher, Brent closed at $74.90 (+1.42%) and WTI at $70.64 (+2.14%).
May US PCE (Personal Consumption Expenditure Index) was in line with expectations, at 0.1% m-o-m, and 3.8% y-o-y. US core inflation softened in y-o-y terms, at 4.6% (vs 4.7% expected), and m-o-m met expectations at 0.3%. However, it was US core services inflation, excluding housing, that caught the market’s attention, which posted its smallest advance since June 2022, rising 0.23% m-o-m, and up 4.53% y-o-y. Consumer spending for May was also soft at 0.1% (vs 0.2% expected). This story was echoed in Europe, as y-o-y CPI came in a touch below expectations at 5.4% (vs 5.5% expected).
Euro area inflation
Eurostat's flash estimate showed that euro area headline inflation slowed in June to 5.5% y-o-y from 6.1% in May, while core inflation rose to 5.4% y-o-y from 5.3% the previous month, less than expected. In terms of core inflation, the rise in services inflation (from 5.0% to 5.4%) was expected - mainly due to base effects in Germany. By contrast, goods inflation continued to ease (by 30bps to 5.5% in June). Country wise, data mostly surprised to the downside except for Germany. Looking ahead, headline inflation should continue to slow progressively, but core inflation could remain stickier and volatile throughout the summer due to services. Beyond the noise, inflation momentum is gradually easing. Euro area bank credit data showed a slowdown in credit growth for both households and non-financial corporations in the euro area. More specifically, annual growth in loans to corporates fell by 0.6pps to 4.0% in May, while growth in lending to households dropped 0.4pps to 2.1%. Meanwhile, narrow money growth (M1) continued to contract in May, posting the sharpest drop in history (-6.4% y-o-y and -12.5% y-o-y in real terms). This reflects bank clients shifting savings from low or noninterest-paying bank deposits into longer term deposits. In all, data confirm that monetary policy transmission remains fast at work in the euro area.
Despite their differences, central bankers gathering in Sintra this year appeared to share the same concerns over inflation being more persistent than expected. The implication for monetary policy remains unchanged – higher rates for (much) longer. But between the lines and behind the scenes, the message was often more nuanced. Opinions seemed to diverge in terms of the appropriate policy stance, balance sheet normalization, or the catalyst for a pause. Some dissenting opinions have started to emerge, with hawkish members hinting at more tightening to come. The US and the UK face transmission problems that the euro area doesn’t. Yield curves are inverted in both cases, but the transmission of higher policy rates looks faster and more efficient in the euro area, including via higher bank deposit and lending rates. Major central banks have recently signaled that their tightening campaigns are not yet complete. For example, the European Central Bank, Reserve Bank of Australia, and Bank of Canada have all hiked rates in recent weeks. The Federal Reserve, in contrast, opted to pause at its June meeting, the first time in 11 meetings since March 2022, after 500bps of tightening. Even so, Jay Powell indicated that two additional rate hikes were likely, a more hawkish outcome than markets had contemplated. Analysts expect the central bank to deliver another 25bps hike at its next meeting on July 25-26. Despite the aggressive rate hikes by the Fed, Q1 in the US grew at a stronger pace. The revised data showed that US GDP grew by 2% in Q1 instead of the previously reported 1.3%. Analysts had been calling for GDP growth of 1.4% in the previous quarter, according to a Reuters poll. The US economy grew by 2.6% in the second quarter of 2022.
The Fed announced results of its 2023 DFAST stress tests on 23 of the largest banks in the country. In a nutshell, all 23 banks tested remained above their minimum capital requirements during the hypothetical recession. The focus on commercial real estate showed that while large banks would experience heavy losses in the hypothetical scenario, they would still be able to continue lending. The results showed that the largest banks' trading books were resilient to the rising rate environment tested. In terms of CET1 (common equity tier 1 capital ratio) the average minimum CET1 ratio was 10.1%.
What to watch
- Monday: US ISM manuf. index (Apr.)
- Tuesday: Australia RBA decision (May); Euro area: final PMIs, M3 (Mar.), Bank Lending Survey (Q1), flash HICP (Apr.); US durable goods (Mar.)
- Wednesday: US FOMC decision (May); US ISM non-manufacturing index (Apr.)
- Thursday: Norway Norges Bank decision (May); Euro area ECB decision (May); US trade balance (Mar.)
- Friday: Germany factory orders (Mar.); US: nonfarm payrolls (Apr.)