Risk Sentiment Improves as Economic Data Fuels Rate Cut Expectations

Risk-on sentiment has returned to global markets this week, fueled by easing inflation data that continues to support the case for more accommodative rate cuts by the Federal Reserve at its next FOMC meeting. Overall, market expectations suggest that policymakers can “thread the needle” of cutting interest rates to support a soft landing in the economy and ultimately avoid a recession.

This optimistic view has been bolstered by incoming economic data. A revised second look at GDP figures revealed that the US economy grew faster than expected in the second quarter. This positive trend was further supported by a solid expansion in retail sales during July. Simultaneously, while initial jobless claims have remained relatively flat, job openings are slowly starting to dwindle. This labor market dynamic likely supports the Fed’s case for cutting rates to put a floor under potentially slowing growth.

In Asia, stocks largely closed the week out in mixed fashion, led lower by China due to concerns about the country’s waning growth prospects. This outlook comes on the heels of news that policymakers are considering plans to allow homeowners to refinance $5.4 trillion worth of debt, as sagging property prices have weighed on spending and household wealth. Despite these challenges, stocks in mainland China rallied into Friday’s close but still ended down for the week, with the Shanghai Composite off 0.40% and the CSI 300 largely flat.

Other Asian markets managed to look past China’s concerns, with stocks in Hong Kong gaining 2% on the week, spurred by positive economic data from the US. Japanese stocks also moved higher despite concerns surrounding a potential rate hike by the Bank of Japan, with the Nikkei closing up around 1.2% for the week. Indian and Australian markets followed suit, with the Sensex up 1.6% and the ASX adding nearly half a percent.

In Europe, the mood is solidly risk-positive as investors digest data showing waning inflation and moderating economic growth across the region. Most major European markets are higher this week, with Italian stocks leading the way with a gain of roughly 2.2%. German stocks are trading flat on Friday but still up nearly two percent for the week, while the UK’s FTSE has posted a solid gain of around 1%.

On Wall Street, stocks are set to close out the week in mixed fashion. The big story this week was NVIDIA’s earnings and whether demand for the company’s AI-related products would be enough to support the broader rally in tech stocks this year. As a result, we’re seeing mixed performance, with the Nasdaq down around one percent for the week, large-cap stocks as measured by the S&P 500 mostly flat, while the Dow and small-cap stocks carried US equity market performance.

In the fixed income market, rates have stabilized, with 10-year Treasury yields falling to 3.9% from about 4.25% a month ago. The expectation that the Fed will cut rates in September is being priced into the market. Internationally, yields on 10-year German bunds and British gilts are trading largely flat for the week, while Japanese JGBs have caught a bid recently, with yields falling and prices supported by BOJ intervention.

In currency markets, the US dollar is trading modestly higher this week, with the DXY US dollar index at 101 on Friday morning, off around 0.75% over the past week. As a result, the euro is down around one percent, trading at 1.10 to the dollar, while the British pound has pared about 0.25% but remains at its highest level in over two years at 1.31 to the dollar. The Japanese yen is up modestly as BOJ policymakers signal readiness to continue raising interest rates, and the Chinese yuan closed at its strongest level since June 2023.

Looking ahead to next week, we’ll be entering a new month in which the Fed is expected to cut rates for the first time since the start of the pandemic. Key economic releases include business sentiment data on Tuesday, followed by trade and JOLTS data on Wednesday. However, the main focus will be on jobs data, with the ADP report on Thursday and the crucial Non-Farm Payrolls data on Jobs Friday.

As we enter the back-to-school season, portfolio managers will be reassessing their holdings and evaluating whether their current positions still make sense after this year’s strong run in prices. Investors should be prepared for potentially volatile conditions in risk assets in the month ahead as the market digests new economic data and central bank decisions.