Good morning. Lots of developments over the past fortnight. The FED's dot plot projections now indicate that rate cuts have been pushed from 2024 to 2025, albeit with higher forecasted dispersion. Recent economic data shows some signs of softness, such as the latest slowdown in retail sales and the collapse in residential transactions given current home prices and mortgage rates. It seems the market is accurately forecasting one rate cut this year and three more in 2025, not primarily to target inflation, but to address the significant increase in US Treasury expenses and a cooling labor market. The announcement of an increased US fiscal deficit to $2 trillion for 2024 was expected by economists and will be covered through increased borrowing.
A significant yet underreported event was Senator Elizabeth Warren's letter to Fed Chair Jerome Powell, urging him to cut rates, thereby bypassing the convention of Central Bank independence. If such an event had occurred under a Republican administration or in Europe, it would have sparked loud debates. Fiscal dominance is gaining ground globally and should be considered as a risk factor for long-term investments.
Europe faced a major setback in risk following the surprise announcement of French elections after the center coalition government’s poor election results. Macron's risky political gamble might not succeed, especially with the formation of the New Popular Front. As both major contenders (FN and NPF) are untested in governing and favor more social spending, the market quickly priced in the uncertainty, causing spreads to widen and the CAC 40 to lose its gains for the year. I believe higher spreads will persist over the next quarter, but selected equities could present attractive opportunities post-elections as FN moderates its fiscal plans and focuses more on immigration, with less negative economic impact. The broader European picture shows voters increasingly concerned about inflation's erosion of purchasing power and immigration policies, driving the rise of populist and nationalist parties.
Global equity performance remains marked by US exceptionalism, in a narrow rally led by tech names tied to AI capex. The past month has been unusual in terms of performance, with deeply negative market breadth but the S&P 500 reaching all-time highs due to euphoric rises in companies like NVIDIA. As funds rotate away from Europe and some emerging markets (Mexico, Brazil), they seek shelter in popular momentum strategies concentrated in highly liquid US stocks. The key question is whether lower long-term US rates will trigger another significant rotation to mid and small caps in Q3 or if the dominant quality mega-caps will continue to attract all available risk liquidity. Personally, I'm in a wait-and-see mode.
Alexandros Tavlaridis
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