This week we adjusted our Fed call and expect the next policy changes to be hikes rather than cuts, see Fed update. We look for 25bp rate hikes in December 2026 and March 2027. Previously, we expected the Fed to cut rates down to 3.00-3.25%. US nominal growth outlook has improved more than we expected previously as AI driven investment demand continues to fuel both growth and increasingly also inflation. Importantly, our change in call has not been driven by just the war in Iran. Instead, we think that demand-factors are fuelling more structural inflation. US weekly ADP job data this week confirmed the robust trend in the labour market with an average weekly change over the past four weeks of 42.25k up from 33k last week. US PMI manufacturing was solid rising to 55.3 from 54.5 while service PMI declined further from 51.0 to 50.9.
In the euro zone PMIs disappointed with the composite PMI falling to from 48.8 to 47.5, the lowest level since October 2023. The main reason was the services sector that fell to 46.4, a five-year low. Manufacturing PMI also dropped but is still around the average level of the past year. China’s monthly data batch for April also showed the first signs of a negative impact from the Iran war with weakness in both retail sales and investments, see China Flash. It followed a strong start to the year with 5% growth in Q1. PPI inflation has increased sharply in recent months, so China has now become an inflationary force in the global economy after years of being a deflationary force.
The news rollercoaster on the Iran war continued over the past week. One day we are close to a deal; the next day we are not. We are still concerned that the closure of the Strait of Hormuz may drag out and keep oil prices elevated for longer. Bond markets cooled down after last week’s sharp rise that continued into the beginning of this week. The factors driving the increase are a cocktail of strong US data, high inflation prints and fiscal worries across countries, not least UK, US and Japan. The move in expectations for the Fed towards tightening has been a key driver in the US bond market and as we now look for two hikes by the Fed, we have lifted our projection for 10-year treasury yields to 5.0% in 12 months.
We also changed our view on the USD as we believe the USD debasement story is fading and renewed Fed tightening will support the USD. We now see EUR/USD heading lower to 1.12 in 12 months vs a rise to 1.22 previously. Stock markets had a bumpy ride over the past week swinging with the ebbs and flows in bond markets and news out of the Middle East. We are still constructive on stocks on the back of robust nominal growth and strong earnings.
In the coming week focus continues to be on the Middle East, but US spending and PCE inflation data Thursday will also be in the spotlight. Friday focus turns to the first inflation data for May from Germany, France and Spain.
