Soft US CPI reinforces rotation trade

Last week was a week of sweet economic data from the US – or almost.

The jobs market rebounded with 130K new jobs added in January – after a morose 2025 during which the US economy added around 181K jobs for the entire year. That makes roughly 15K job additions per month – and that is weak.

Retail sales were weaker than expected and pointed to a widening spending gap between wealthy and lower-income Americans.

But then Friday’s inflation data showed that headline inflation eased to 2.4% – the slowest since last June – while core inflation fell back to 2.5%, a level last seen in 2021.

The data was mixed but gave some breathing room to markets, as dovish Federal Reserve (Fed) expectations counterbalanced AI-related fears.

The US 2-year yield fell to 3.40% – the lowest since October – as the probability of a Fed rate cut rose to 70%. The US dollar remained under downside pressure on Friday. The greenback is better bid this morning in Asia, but the dovish Fed outlook should keep the dollar under pressure. It’s just that softer-than-expected growth data from Japan this morning is weighing on the Japanese yen after a five-session winning streak, which in turn makes the US dollar look stronger.

Gold, on the other hand, kicks off the week with a move below the $5’000 level. Part of it is due to a marginally stronger US dollar; some argue that softer US inflation is taking pressure off the yellow metal – traditionally seen as a hedge against inflation – but I believe that, given gold’s high correlation with risky assets over the past few weeks, a retreat in gold could be a sign that appetite across risk assets remains weak this Monday morning.

The Nikkei is down 1%, the Kospi is consolidating gains near a record high, while US and European equity futures trade slightly higher, with FTSE futures leading gains at the time of writing.

This week, I expect further capital inflows into the European defence sector, as the weekend’s security talks among Western allies were marked by two notable points:

1. The highest US representative was not present.
2. The German Chancellor stated that Germany and France are not in talks on nuclear deterrence.

Given how strongly Europeans have relied on the US for the continent’s security, the gap left by US disengagement must be filled, and quickly. Hence, European defence stocks will likely continue to benefit from solid inflows.

What is less clear is what will happen across technology stocks.

One of the most notable moves following Friday’s US inflation data was the divergence between tech and the rest of the market. Falling yields helped lift sentiment in many sectors but failed to cheer up Big Tech.

The Magnificent 7 extended losses by almost 1%. The S&P500 was flat, but the equal-weighted version of the index – where all companies carry the same weight – rebounded 1%. In simpler terms: rising dovish Fed expectations reinforced the rotation trade.

Elsewhere, software stocks took a breather after a catastrophic week, but appetite there remains very fragile.

Overall, Friday’s post-CPI relief was welcome, but the fundamental concerns keeping investors awake at night remain unchanged. Appetite for Big Tech continues to wane: massive – and increasingly leveraged – AI spending casts a shadow over otherwise solid Q4 results. These companies carry significant weight in major US indices – the Magnificent 7 account for roughly a third of the S&P500’s total market-cap weighting. So if they tumble, other sectors will need to work harder to offset the drag.

Second, concerns about leveraged AI spending are now toped by growing anxiety that AI could replace businesses and jobs – which would negatively affect sectors previously expected to benefit from AI productivity gains and lower costs.

The interesting thing is that these two fears do not fully align. If AI is about to wipe out entire sectors and businesses, then piling into AI could make sense, as the “Big Replacement” would enhance returns on AI investment. But if the concern is that AI returns will take time to materialise and the transition will be gradual, then betting on businesses disappearing overnight seems inconsistent.

My take is that AI-related Big Tech stocks are trading at high multiples, and a downside correction was overdue. A further 10–20% pullback is plausible.

But AI-related anxiety and sharp selloffs appear exaggerated. Many companies will benefit from productivity gains and lower costs, which could lead to consolidation – but businesses are unlikely to disappear overnight. Some gems may already be trading at significant discounts. Adobe, for example, is trading at a P/E ratio of around 15.

So valuations between tech and the rest of the market will likely continue to converge, and sector rotation could help temper downside pressure at the index level – the lower the tech exposure, the softer the selloff. Voilà. That’s my big take.

This week will be relatively light. US markets are closed today and China is off to the Lunar New Year holiday. Still, there are several data releases and earnings to watch.

In the US, the Fed minutes on Wednesday and the growth and PCE updates on Friday will be the major releases. In the UK, jobs and inflation data will be in focus. The Reserve Bank of New Zealand (RBNZ) is expected to keep rates unchanged on Wednesday, and flash PMI figures will provide insight into activity levels toward the end of the week.

On the earnings front, Walmart will be interesting to watch, as it could serve as a dual indicator of US consumer health and AI integration, with potential implications for AI business models and what they mean for employment.