This week brought the initiation of the second phase of the political agenda where the House passed President Trump’s signature tax bill, which will avert a year-end tax increase.
Questions remain if the nature of the tax bill will add to the US debt burden, but the US administration is adamant that this is a neutral policy as the refinancing need will be offset from the additional growth kick the tax cuts will bring over time. The measure now heads to the Senate for approval, and it includes various provisions, such as spending cuts, tax increases on certain targets, and boosts to military spending and immigration enforcement. Groups of Republicans are pressing for extensive changes and law makers are planning to vote on approval by August. It includes a 4 trillion increase in the US debt ceiling which will derail the US Treasury from a technical default. The US rates market added to the volatility this week as 30yr bonds traded as wide as 5.15% in terms of absolute yield, a level we haven’t seen for the last 2 years. (see graph below)
Something to note is that current US 30yr mortgages are in the context of 7%, again a rate which is quite penalizing as refinance costs keep increasing. On the equity side, we retraced around 1-3% from the recent highs but still holding in the gains which equate to 18% on the S&P from the April lows. The market is a bit more complacent to see another leg higher as we now expect to see a bit more progress on the trade agreements. In terms of fundamentals, S&P earnings surprised to the upside for the last quarter as the implied earnings growth was at 6% with realized at 12%, a surprise of 6% to the upside.
Across the pond, we saw a series of PMI data arising from European countries. Manufacturing came better than expected with Services and Composite data surprising to the downside. This recent data cements the 25bps expected ECB rate cut in June which will bring the ECB deposit rate to 2%. Markets across US, UK and ECB rates dialed back rate cut expectations in the last 2 weeks as the recent equity rally and more dovish tariff narrative has decreased the probability of a global recession. On the tariff side, the European Union’s trade chief, Maros Sefcovic, is planning to have a call with his US counterpart some time this week to discuss the revised proposal that was recently sent to the US administration. The recent proposal covers areas such as labor rights, environmental standards and tariffs for specific goods. The US is expected to reject it with the EU also preparing retaliatory measures on $95bn of US exports if negotiations fail to achieve a satisfactory outcome.
In terms of market moves, we saw a bit of profit taking in US equities this week, trading around 1.5-3% lower with small caps underperforming. European equities are unchanged throughout the week. Gold was the winner trading at $3327 per ounce, up 3.85% on the week and 26.77% year to date. The EURUSD is trading in the 1.134 context up 1.38% on the week and with more renewed momentum of dollar weakness.
Looking ahead…
Next week we have an array of data from both sides of the pond related to inflation. European CPI data is taking place with all focus on Germany and France. In the US we expect PCE Price Index numbers on Friday, the FED’s favorite inflation gauge. At this juncture, the market has priced out any potential global recession due to tariffs. We have agreed with this view for the last month and have raised our allocation weights in Equity and Credit in our Athlos Balanced Strategy AMC. What we expect now is further announcements of trade deals which will take in our view the equity market another leg higher. Nevertheless, we respect the technical of the market due to the increased liquidity premium in the summer months and we plan to take some profit going into the end of June.
Written by: Michael Konstantinou, Senior Portfolio Manager
Source: Bloomberg
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