Stock indices are a sea of green on Wednesday and risk sentiment has improved markedly, as the market weighs up a plethora of bad economic news from the US and what this means for the Fed. Right now, this means a 62% chance of a first rate cut in the US in September, 1 week ago there was only a 42% chance that the first rate cut could come in September.
A US economic slowdown is gathering pace
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Open account Try demo Download mobile app Download mobile appWe have mentioned the deterioration in US economic data for a while, but the prospect of a slowdown in the US economy is gathering pace, and has caught some traders off guard. To quantify the slowdown: the Citi US economic surprise index is at -11, which indicates that economic data is surprising to the downside rather than the upside. This means either the US economy is materially weakening, or that analysts have been too optimistic about the growth prospects for the US economy. Added to this, the Atlanta Fed’s GDPNow tool is predicting that US GDP will grow at a 1.8% annual rate in Q2, down from 2.7% a week ago. Q1 growth was 1.3% annualized, so the risk is that the GDPNow tool is overestimating growth in the second quarter.
The latest data point that suggests that the US economy is weakening was the ADP private sector payrolls figure for May. This reported payrolls growth of 152k last month, down from 188k in April. US services PMI was steady at 54.8, and the composite PMI was 54.5, up a notch since April.
The US economy: A perfect slowdown
The big question is, what does this mean for the future of asset prices? The deteriorating economic picture in the US is boosting the chance of a Fed rate cut in September, which is helping sentiment. US 10-year Treasury yields have fallen by 32 basis points in the past week, and this has boosted big tech. Nvidia’s share price hit a record high on Wednesday, and unsurprisingly, tech and communications services are leading the US blue chip index higher. The S&P 500 is a mere 11 points away from another record high. Thus, the slowdown in the economy is no bad thing at this stage: it is boosting the prospect of rate cuts but it is not signaling a recession, rather it is signaling a soft landing is coming into view.
Fundamentals justify the move higher in stocks
But is the move higher in stocks justified? The fundamentals would say yes. Analysts are predicting strong growth in earnings for US blue chips in the next year. EPS growth is expected to be more than 10%, and analysts are also expecting strong cash flows. The prospect of Fed rate cuts are also boosting the outlook for smaller US firms. Analysts are expecting EPS growth of more than 17% for firms in the Russel 2000. Europe and UK have some catching up to do, analysts are expecting negative EPS growth in 12 months’ time for the FTSE 100 and the Eurostoxx 600, however, after a strong Q1 earnings season, we expect a raft of analyst upgrades for Europe, which means that European shares could join in with this rally. The risk is that the US economy weakens more than expected and this weighs on the corporate outlook, but for now that is a risk that the market is willing to discount.
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