Julien Lafargue: Welcome to a new edition of Barclays’ Market Weekly podcast. My name is Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and I will be your host this week.
A few things to cover, but, first, let me express my commiserations to all the English football team’s fans out there. Tough battle yesterday. Unfortunately, football is not yet coming home, but I’m sure it’s going to do so very soon, and hopefully in two years’ time at the World Cup.
Now, beyond football, a lot happened in markets last week and we’re going to debrief that in a second. Maybe the first point to discuss is US inflation. That was the key data release from last week, and US inflation came in cooler than anticipated in June, with the headline print falling 0.1% month on month, when the consensus was looking for a gain of 0.1%. On a year-over-year basis, the headline number fell three basis points to 3%. The consensus was looking for 3.1%, and core inflation dropped 10 basis points to 3.3%.
But beyond all those numbers, I think the main development, and what markets may have focused on, was super-core inflation, which is basically core services less housing related costs, and it tends to be the stickier part of the inflation basket. And that super-core inflation dropped 0.1% month on month, which was a very strong sign that maybe the battle against inflation has been won, or at least we’re on track to win it.
Now, we also had the US PPI, the producer price index, on Friday and that was hotter than expected, meaning that input costs are seemingly reaccelerating. So, we need to bear that in mind, as a future consumer price reading might be higher than expected, based on this higher momentum, from an input core perspective as well as the fact that, as we know, once you get a few lower-than-expected readings, economists tend to revise their forecasts a bit lower, leaving room for disappointment, so to speak, or at least a surprise on the upside. So, it’s not going to be a smooth ride to get to 2%, but the underlying trend seems to be one of disinflation in the US.
The other slightly dovish development that we had last week, was Fed chair Powell’s testimony in front of the US Congress. It was a fairly balanced speech and discussion, but I think what markets really focused on was one single sentence that Powell mentioned during this testimony. He noted that inflation is not the only risk we face. And that was really the latest indication that Fed officials are growing more worried about employment headwinds in the US.
As you know, they have this double mandate of job growth, as well as price stability. That means basically inflation of around 2%. And with inflation, as we discussed, trending towards this target of 2%, the focus of the Fed seems to be shifting away from inflation and more towards growth. And, as we know, job data is a leading indicator, but it has been on the softer side as well, which means that when you take into consideration this shift in how the Fed is thinking about its dual mandate, if you think about the slightly softer-than-expected inflation print for a couple of months now, markets are now pricing in a 100% chance of a Fed cut in September. So, almost guaranteed, at least that’s what markets are telling us, and it looks like, bar a major surprise, the Fed is on track to cut interest rates by 25 basis points in September.
Now, the second point I wanted to cover is around earnings. I mean it’s very early in the earnings season, it just kicked off last week, on Friday, with several major US banks publishing their results. Those included JP Morgan, Citigroup or Wells Fargo, and I think it was a relatively mixed bag.
A positive surprise on trading activity and on merger and acquisitions (M&A) activity. That wasn’t too difficult, since M&A had been basically dead for the past year or so. So, a slight revival there.
What was more mixed is probably on the net-interest margin, the difference between what banks lend at and how much they pay on deposits. People were expecting some improvement, or at least no deterioration, and the picture was really mixed between banks. Probably too early again to make any sort of conclusions. We’re going to get other banks reporting this week, so we may get a better, clearer picture.
But I would probably spend more time looking at the management team commentary about the outlook. And, clearly, there was a sense of caution, not necessarily saying that things are going to slow meaningfully, but, clearly, people seem to be aware of the risks and the uncertainty surrounding the macroeconomic landscape in the US, the political uncertainty as well.
Unfortunately, those mixed results were not enough to support the stocks in this industry. The US banking sector as a whole has done very well. On a year-to-date basis, it was up some 20% going into Friday and, obviously, having performed so well, expectations were quite high. And, with no real strong positive surprise, we saw some profit taking. So, let’s see if that continues this week as we get more earnings.
Finally, the big news of the weekend, of course, was the assassination attempt against the former president, Donald Trump. From a market perspective, I don’t think this has a lot of implications and, looking at our screens this morning, very limited reaction. What it means, though, is, at least in the eyes of bookmakers, Trump, specifically given his reaction after this assassination attempt, seems to be edging it, or edging towards victory in November. The odds of seeing him being re-elected have gone up following that event, and that’s probably the main takeaway.
Now, if you look at history, there’s been several assassination attempts on presidents, or former presidents, in the United States and, unfortunately, some of them have been successful, some have failed, like the one that targeted Donald Trump. In terms of those that have failed, history suggests that if you’re subject to an assassination attempt, you don’t necessarily secure your re-election. It worked for Reagan, but other examples in history suggest that it might not be always the case. So, we’ll see.
As we’ve said all along, this is going to be a long campaign and a lot can change. We’re still unsure if President Biden is going to be on the ticket for November. We almost had to pick a new Republican candidate after what happened this weekend, so we’ll see. But clearly the tone of the campaign is likely to change, at least in the short term, with candidates likely to tone down their attacks against their opponent, and promoting unity in what has been a quite tense campaign so far.
Now, one thing that I would say, and we’re receiving some questions from clients around what is the trade if Trump gets elected, or what is the trade if Biden is elected? And I think although it was much more clear-cut back four years ago in the previous election cycle, this time around it’s very difficult to figure out how markets could react, one way of the other.
One trade that seems to be generating some kind of consensus around a Trump re-election is a steepening of the US yield curve, meaning that the two-year rate, or the shorter end of the curve, should come down as the Fed is, as we discussed, likely to start cutting interest rates, and the former president has said many times in the past that he would like to see the Fed cutting interest rates.
So, interest rates in the short end are likely to come down, whereas, at the same time, the former president, Donald Trump, is known for his desire to promote a rather expansionary fiscal policy, which would, potentially, keep long-end rates elevated, as they are today, or potentially even higher. So, the curve would steepen, and that has become one of the cleanest and most consensus ways, I would say, to express a view that Trump would be re-elected.
Now, what this all means for investors. Well, a greater expectation around lower interest rates have helped to reignite some form of rotation towards the end of last week, from large-cap and technology companies into smaller cap and value. That has happened several times in the past, and was relatively short-lived every time, and I think it’s a good occasion to remind investors that if lower rates are coming, it’s because the US economy is slowing, which might not be such good news.
In fact, it may cause earnings to disappoint down the line, especially for those companies that are most exposed to the cycle, more sensitive to the macroeconomic momentum in the US. So, we would be mindful of chasing this rotation. We welcome some broadening of the market action, especially in the US, but we would be careful not to get too carried away by that, and we continue to favour higher-quality and higher-growth companies in general, especially if your investment horizon is longer than a few months.
Now, to wrap up, what to look for this week. Well, it’s a relatively busy agenda. In the US, we’re going to have the GOP Convention for the next three days. At the same time, in China, the Third Plenum will take place, and investors will be keen to hear if Chinese authorities are announcing any new measures or stimulus in order to support the economy, which is still failing to reaccelerate. I wouldn’t recommend you to hold your breath for that, but we might hear more piecemeal measures being announced here and there.
We’re also going to hear again from chair Powell, in an interview at the Economic Club of Washington, and also we’re going to have the US retail sales for June. Closer to home, in the UK, the inflation data for June will be released on Wednesday, followed by the ECB decision on Thursday. Here, we expect the European Central Bank to keep interest rates unchanged this month, preparing markets for a potential further lowering of interest rates come September.
Now, that’s it for this week. Again, a lot to be discussed next week when we’re back. But, in the meantime, as always, we wish you all the very best in the trading week ahead.
