A Growing Divergence

Market sentiment was once again very different on both sides of the Atlantic. The European markets remained under the pressure of tense political environment in France and a 3% slump in April manufacturing production across the Eurozone. The CAC40 dropped 2%, the Stoxx 600 fell 1.30%, the EU bonds were sold off, as well, after MSCI said that it won’t add them to it government indices, the spread between the German and French 10-year papers widened past 70bp – the highest since 2017, and the EURUSD retraced back below its 50, 100 and 200-DMA – after spending just one session above these levels.

And even a softer-than-expected PPI read from the US couldn’t prevent the EURUSD’s decline yesterday. But on the other side of the Atlantic Ocean, the producer prices fell on a monthly basis – the first monthly decline since January and the yearly figure eased to 2.2% while analysts were prepared for a rebound to 2.5%. Cherry on top, the jobless claims jumped to the highest levels in 9 months. Both data played in favour of the Fed doves a day after the Federal Reserve (Fed) hinted that they see little progress regarding inflation instead of ‘none’ at their previous communication and should’ve pulled the US dollar lower – in theory, but the selloff in the euro against the greenback weighed heavier, and the Bank of Japan (BoJ) decided not to reduce its JGB holdings until the July meeting – and that also fueled a yen selloff and sent the USDJPY toward the 158 this morning. In summary, the US dollar bears couldn’t take advantage of softer data yesterday due to contradictory dynamics elsewhere.

But the US yields eased, the US 2-year yield tipped a toe below the 4.70% for the second consecutive session and the 10-year yield fell all the way down to 4.22%. Both yields rebounded since then, but this week’s softer-than-expected inflation updates maintained the expectation of a rate cut alive for the end of the year. The probability of a September rate cut rose to 65%, the probability of a November cut stands at around 80%, while a December cut is now given around 95% chance. Many investors are still skeptical regarding the feasibility of a 2024 cut – and inflation figures haven’t been appetizing so far this year, but the latest figures are encouraging. Yesterday’s PPI for example also hint that declines in some categories in the PPI like airfare and prices for portfolio management services which also feed into the Fed’s favourite gauge of inflation – the PCE index – hint that we could see the PCE index show the slowest advance since November when released later this month.

As such, sentiment in the US equities remains quite cheery. The stock rally slowed yesterday, but the S&P500 eked out a small gain near its ATH level, while Nasdaq advanced to a fresh record. Apple advanced another 0.55%, Super Micro Computer jumped 12% and Tesla advanced nearly 3% after shareholders’ backed Elon Musk’s $56 billion pay deal and his proposal to move the company’s jurisdiction to Texas. Adobe jumped nearly 15% in the afterhours trading after giving a strong outlook for its products as its customers adopt new AI-based tools.

Zooming out, we started seeing a clear divergence between sentiment regarding the European and the US stocks this week and the latter has room to widen. While dark clouds are gathering near the peaks of the Stoxx 600, appetite for the US stocks remains solid – especially for the technology stocks. This positive divergence in favour of the US stocks will likely continue but for this rally to sit on a solid ground, we need gains to widen toward the non-technology names – which is not yet the case; the S&P500’s equal weight index is sitting still and watching the normal-weight index – heavy in tech stocks – travel through uncharted territories. The softening Fed expectations is supportive of such widening of the rally, but investors should show a minimum envy. For now, that’s not necessarily the case. The energy stocks for example continue to be sold off; the SPDR’s energy fund is down by more than 10% since the April peak, financials and utilities are down nearly 5% since May while industrials are down by 3%. Only technology is carrying the rally higher and the rally, there, looks overstretched.

In energy, US crude eased after failure to clear a major Fibonacci resistance at $78.30pb level. That’s the major 38.2% Fibonacci retracement and clearing this resistance should in theory allow the price of a barrel to step into a medium-term bullish consolidation zone. And that’s certainly why we see a solid resistance. The softer Fed expectations as a result of soft inflation reads remains supportive of a further rise, but the rise should be soft and sweet to not awaken the inflation worries, otherwise it would jeopardize the soft Fed expectations.

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