Sentiment lifts, conviction lags

US equities kicked off the holiday-shortened week with another dip on Tuesday, but this time dip buyers stepped in and staged a rebound. The S&P500 found support around its 100-DMA, while the Nasdaq 100 rebounded after briefly dipping below the 24’400 mark. Some software companies released earnings ahead of schedule to ease concerns that AI will completely erode their revenues, arguing instead that integrating AI into their products will increase demand. In vain. The iShares Expanded Tech Software ETF was hit by another 2% selloff on Tuesday, extending the AI-fear driven decline.

On the other side of the trade, the AI enablers — the companies making the AI disruption possible — remain under pressure due to their massive investment plans, increasingly financed by debt. Roundhill’s Magnificent 7 Index is now down more than 11% from its October peak, gently entering the 10–20% drawdown zone that typically starts to look interesting for investors seeking discounted entry levels. Meta’s PE ratio has eased to around 27 — below its 2023 peak of 38. Alphabet’s is around 28, down from above 30 a few weeks ago, while Nvidia trades at roughly 45 times earnings — high, but the lowest since the AI boom began and falling, as earnings growth continues to catch up with price gains.

Still, valuations remain elevated, and the scale of debt-financed investment plans is unsettling some investors. CDS tied to Big Tech names are changing hands, suggesting need to hedge against credit risks.

But the credit risk remains low for now: Big Tech high-grade bonds continue to see strong demand and offer yields only slightly above US Treasuries. This means that despite equity market frustration and increased hedging activity, investors still view these companies as extremely high-quality borrowers with very low default risk. In other words, while not technically risk-free, their bonds are priced close to US sovereign risk in practical credit terms — and that could help put a floor under the equity selloff.

That said, the US Big Tech correction may have further to run before appetite fully returns. Each leg lower from here will increasingly raise the question: is it over? Judging by the 2% slide in SoftBank in Japan today, perhaps not yet. Next week, Nvidia closes the earnings season for the group. Whether it can restore broader appetite remains to be seen.

Meanwhile, the so-called rotation trade remains in play, with European indices benefiting from capital flows. The FTSE 100 hit a fresh record high yesterday despite weakness in energy and mining stocks on softer commodity prices. The sharp decline in sterling following a weak jobs report likely provided support to the index, given that roughly 75–80% of FTSE 100 revenues are generated outside the UK.

On the data front, the UK unemployment rate rose to its highest level since the pandemic, while wage growth slowed to its weakest pace in more than five years. The data is difficult for households, but very much supportive for Bank of England (BoE) doves. The ‘sweet’ combination of rising unemployment and easing inflation strengthens the case for rate cuts and has boosted appetite for UK assets. A sufficiently soft inflation report this morning should cement the expectation that the BoE will cut rates in March and again in June to support an economy strained by harsh fiscal stance.

In the FX, a softer BoE outlook is weighing on sterling against the euro — where the European Central Bank (ECB) is expected to remain on hold for now — and against the US dollar, where Federal Reserve (Fed) expectations have stabilized enough to allow the greenback to regain some ground versus sterling. Technically, Cable tested the major 38.2% Fibonacci retracement of the October-to-February rebound for the third time yesterday. A sustained break below that level would open the door to a deeper bearish consolidation.

Of course, much depends on the dollar leg. Fed minutes due later today may provide further insight into policymakers’ rate outlook. Markets currently price around two rate cuts this year, though views remain divided. Meanwhile, confidence in US data and policy motivation is increasingly debated, keeping the dollar’s broader trajectory uncertain.

The US dollar is attempting a second day of gains, while the kiwi is under pressure after the Reserve Bank of New Zealand (RBNZ) kept rates unchanged and signaled that the policy would remain accommodative as inflation is expected to return toward the 2% target on the coming year. Whether this marks the end of the NZDUSD’s year-to-date rebound near the 0.60 level remains to be seen.

For now, overall dollar appetite remains too fragile to suggest a sustained USD rebound. Let’s see whether the Fed minutes change that narrative – which I doubt.