Eurozone economies under pressure, but ECB determined to fight inflation

European stocks renewed record on Wednesday, the US dollar consolidated gains and the S&P500 stocks got a late-session boost. Yesterday’s price action pointed at a possible end-of-quarter portfolio rebalancing as the session saw the laggards of the quarter like Apple and Tesla gain, and the stars like Microsoft and Nvidia retreat. Nvidia fell 2.5% yesterday. Goldman Sachs warned that the pension funds are likely to sell $32bn worth of equities as part of rebalancing. That could have a slowing impact on the equity rally, although the rebalancing act will hardly change the overall market trend given that there is a sizeable amount of cash waiting to flow into equities and bonds. The only thing that investors need is the Federal Reserve (Fed) rate cut dream to stay alive for the June meeting. And for now, that’s the case. Activity on Fed funds futures gives around 64% chance for a June rate cut.

But note that, this probability was around 75% last week and it’s coming lower as many investors think that the Fed won’t be able to cut the rates with robust growth and bumpy inflation. And indeed, the US latest GDP update is due today and is expected to confirm an above 3% growth for the US economy in the last quarter of last year, down from almost 5% printed a quarter earlier. These levels don’t call for an imminent Fed cut. This is perhaps why the US dollar is not willing to give back gains despite a relatively dovish Fed stance. The US dollar index is up by around 1% since the Fed plotted 75bp cut for this year and said that it will also start slowing the pace of QT.

Something must give.

• Either the US dollar should weaken because the Fed is expected to cut three times this year with the first cut due in June - in which case we could continue to see the stock market laggards catch up with the leaders of the past quarters and capital to flow into the other-than-tech sectors as well. And in case of policy easing – as predicted - appetite should also broaden to small and mid cap stocks, to EM funds and to commodities.

• Or the US dollar should continue its recovery on the back of robust data and a pullback in Fed cut expectations, in which case we should see the stocks give back strength.

But both a strong dollar and a stock rally is not sustainable in Q2.

Eurozone economies under pressure, but ECB determined to fight inflation

Higher interest rates and the energy crisis are taking a toll on Eurozone economies. Germany is expected to rise 0.1% this year – it’s more a stagnation than a rise. Slowing Eurozone economies and gloomy growth outlook for the next quarters back a June rate cut from the European Central Bank (ECB), yes, but the ECB says that it won’t commit to other rate cuts beyond June, before making sure that inflation is on a solid path toward the 2% policy target. And indeed, inflation numbers from Spain confirmed a rebound in consumer prices in March as the government continued to remove support that helped tempering the otherwise-unbearable rise in energy prices. So yes, the last mile in reaching the 2% inflation goal is not a given for the European countries either. And that’s certainly why the EURUSD holds ground near the 1.08 level – it’s because the ECB looks determined to continue fighting inflation. But a robust GDP and a hot inflation report could break the back of the EURUSD bulls.

Sumo fight

The sumo fight between the Japanese officials and the yen bears remains intense as the yen bears are testing the Japanese nerves near the 152 level. The threat of FX intervention slows the yen selloff at the current levels, but we saw in the past that the post-intervention effects remain limited when the market is turbocharged with opposite direction trades. Therefore, any pullback in the USDJPY – due to the threat of intervention or intervention – could remain short-lived. A hint of further policy tightening is certainly more effective than costly and barely effective FX threats.