Risks build for stocks, as the Riksbank takes the plunge

The risk rally that sent stock soaring around the world is taking a breather in the middle of the week. On Tuesday the S&P 500 eked out a small 0.13% gain, while the Nasdaq fell by 0.1%. The driver is fear about earnings reports and some pushing back on the ‘dovish Fed’ narrative. However, European stocks have opened slightly higher even though S&P 500 futures are pointing to a lower open, as the focus shifts to rate cuts in Europe after Sweden’s Riskbank cut rates on Wednesday.

Are US economic growth forecasts too high?

There are two things that have the potential to disrupt the stock market rally that has seen the Nasdaq rise by more than 4% over the past week and the FTSE 100 move 2% higher. The first is US economic growth and the second is earnings. The Citi economic surprise indicator for the US is now in negative territory, as the balance of economic data in the US has surprised to the downside. This was aided by the weaker than expected payrolls figures released last Friday. The Citi economic surprise index is now at its lowest level since early 2023. The risk is that too much US economic optimism has been priced in by global financial markets, and now there are growing signs of an economic slowdown. Q1 GDP slowed to a 1.6% annual rate in the US, the fact that the data has not picked up in Q2 could make the OECD’s 2.6% forecast for US economic growth this year look too optimistic.

Thus, investors might start to ponder just how exceptional American growth really is, combined with building political risk, could we see investors ‘sell in May and go away?’

Earnings – No unifying theme

The other factor that could act as a brake on stocks is earnings. Disney’s share price fell by nearly 10% on Monday, and it was one of the weakest stocks on the S&P 500. The market punished Disney for their lackluster forward guidance, even though EPS and net income were above expectations. Overall, 80% of S&P 500 members have reported earnings so far, and 77% of them have reported earnings above estimates, which is equal to the 5-year average and above the 10-year average. Thus, on paper, the Q1 earnings season has been good, however, there has been no unifying factor to the market response when it comes to earnings. For example, Disney’s share price has moved +5% on average in the 1 day after an earnings release in the last 8 quarters, yet the stock fell sharply on Tuesday. Likewise, the tech giants have not moved as a unified block, with Meta underperforming after it failed to convince the market that it can monetize AI.

Riksbank takes the plunge

This makes it hard to predict what the markets will do next. For now, our focus will be on the Bank of England on Thursday and the UK and US economic data that is due at the end of this week. The BOE could lay the groundwork for a summer rate cut on Thursday. The Riksbank took the plunge and cut interest rates on Wednesday, the first time it has cut rates since 2016. The cut to 3.75% from 4% was widely expected, and the Bank said that it expected to cut rates two more times this year. However, the bank also acknowledged that this is a tricky time for monetary policy and said that there are risks to both the upside and the downside. The question now is, will the Bank of England follow the Riskbank (with a lag) and signal that a rate cut is coming for the UK? The ECB is expected to follow the Riksbank by cutting rates next month. The market impact is fairly muted in the immediate aftermath as the rate cut was well signaled. USD/SEK is close to its highest level since November last year, and the Riksbank’s move seems to have given the dollar a boost. EUR/USD is back below 1.0750 on the news, and GBP/USD has also slipped below the 1.25 mark.

As Europe looks like it is going to start cutting rates, the dollar could get a boost, which may put more pressure on the yen. USD/JPY is back above 155, and the BOJ governor has delivered another stern warning to the forex market not to push the yen too far. Thus, FX volatility could be back as we move through this week.