The European Central Bank delivers a cautious cut
As expected, the European Central Bank (ECB) lowered interest rates by 25 basis points last week. The main refinancing rate is now 4.25%, and the deposit rate is 3.75%. Even though the decision was expected, European equities fell slightly, government bond prices rose (yields fell), and the euro appreciated right after the announcement. While we’re still own European equities to a slightly lesser extent than our long-term asset allocation, we recently increased our exposure, given prospects of economic recovery and compelling valuations.
ECB President Christine Lagarde said that keeping interest rates high for nine months has helped push inflation down. Meanwhile, the economy has started to grow. We see this gradual recovery continuing, with interest rate cuts providing a tailwind.
That said, the ECB’s guidance was that any future decisions on interest rates depend on how growth and inflation will develop. Assuming inflation slowly inches back towards the target, we retain our forecast for two more 25 basis-point cuts this year. This would bring the main refinancing rate down to 3.75%.
EU Parliament elections in line, but…
Nonmainstream / anti-establishment parties on the far-right of the political spectrum did slightly better than expected in last week’s elections, raising their share of seats in the European Parliament. This raised two main questions.
First, can the European centre parties work together to form a coalition? We think’s it’s likely. Incumbent Commission president Ursula von der Leyen has a good chance to serve a second term, given the gains for Germany’s centre-right CDU/CSU.
Second, what will be the new political landscape in France? French President Macron dissolved the French Parliament calling for parliamentary elections on 30 June and 7 July as Marine Le Pen’s Rassemblement National (RN) scored the victory. One possible result of snap election is that France may be heading for a period of co-habitation between a pro-European president and a prime minister with different views. This could complicate decision-making in the EU at a time when Europe faces several geopolitical challenges. However, the RN has distanced itself from former calls to leave the EU and abandon the common currency.
Early market’s reaction show that the euro could see a setback as well some French stocks. This reaction could be short-lived, but this does add a level of uncertainty over the coming weeks.
Mixed US data welcome by markets
US equities hit new highs again last week as markets dismissed the risk of stagflation (high inflation and slowing growth). US services activity rebounded sharply in May, but manufacturing activity contracted, while services and manufacturing price pressures eased. The labour market also showed conflicting signals: jobs openings fell and claims for unemployment rose, but job creation was once again strong, which took the market by surprise. Overall, the data paint a moderation in the US economy, opening the possibility for one or two Fed rate cuts towards year-end, although the timing is uncertain.
This week, the market expects May inflation to slow slightly compared to April (Thursday). With the ECB cutting last week, all eyes will be on the Fed meeting (Wednesday) to see if it follows suit. We don’t think it will; September seems more likely, though not a done deal yet and, at the margin, the strength of the US labour market has reduced the odds somewhat.
Oil prices volatility
Crude oil prices dropped last week, falling below the USD80/bbl after OPEC announced it would gradually phase out its 2-million-barrel-per-day voluntary production cut from October. This means that the market will come slowly come back into balance, after being undersupplied since the voluntary cuts were introduced in the third quarter of last year.
We continue to see oil prices trading between USD75/bbl and USD95/bbl as supply and demand find equilibrium. Stable oil prices should also help alleviate inflation worries. Commodities are part of our strategic asset allocation, as a long-term diversifier against geopolitical risks and as metals useful for future technologies are supported by megatrends such as artificial intelligence.
India’s election in focus
The Bharatiya Janata Party’s (BJP) leader, Narendra Modi, has been elected as India’s Prime Minister for a third successive term through a coalition. The need for a coalition surprised markets as Indian equities initially fell around 9%, accompanied by a softer rupee and a jump in Indian government bond yields. However, all regained ground by the end of the week, and the Indian Nifty equity index rose 1.3%.
We expect the new coalition to follow through with policies that had been set in motion during the previous term, including expanding the manufacturing sector. Authorities might also explore introducing some consumption-driven stimulus and direct support for the agricultural sector. India’s in a sweet spot, given its rapid growth, and it’s now starting to capitalise on the partial shift away from China as companies diversify their global supply chains. We’re exposed to India via our emerging market position in the strategic asset allocation.
The direction of the currency matters for India and foreign investors. For around two years, the Reserve Bank of India has managed to keep the rupee on a tight leash after years of depreciation. This means it’s unlikely to adjust rates lower before the Fed does.
Data as of 08/05/2024.
