Are G7 Central Bank Rate Cuts Positive For The Market?

The Bank of Canada (BoC) and the European Central Bank (ECB) kicked off a rate cutting cycle by the Group of Seven (G7) central banks this week. Although the Fed is likely to hold rates next week at a more than two-decade high, a slowing US job market and renewed disinflation supports our view that the Fed will start cutting rates in H2, likely as early as Q3. The aim of these central banks is to pre-emptively ease multi-decade high policy interest rates to support growth and avoid a recession, if disinflation continues. Standard Chartered bank in its market editorial said it believes proactively easing central banks, which is helping pull bond yields lower, are positive for risk assets, especially US equities, in the coming months.

In Emerging Markets (EM), the bank likes EM USD bonds, which are likely to benefit from renewed flows into Emerging Market debt as G7 central banks cut rates. Meanwhile, India’s ruling National Democratic Alliance, spurred by a surprisingly weak election mandate, is likely to increase spending in the rural economy and infrastructure. This should support corporate earnings growth, boosting Indian large-cap equities.

More G7 rate cuts coming: The BoC and ECB rate cuts were widely anticipated. Inflation in Canada has fallen within the BoC’s 1-3% target, while Euro area inflation is gradually declining towards the ECB’s 2% target (although inflation in May ticked up slightly). US inflation has been stickier, though, which means the Fed is likely to hold off from cutting rates next week. Nevertheless, the house said it expects the Fed to start cutting rates in Q3 if recent data signalling renewed disinflation and weakness in the job market continues for a few more months.

Watching incoming data: The chances of a Fed rate cut in July will rise if today’s monthly payrolls data for May falls significantly below the 175,000 level and next week’s core consumer inflation for May (consensus: 0.3% m/m) shows continued disinflation. The US job vacancy rate, a leading indicator for the job market and wage growth, has declined to 4.8%, approaching the 4.5% mark, when the unemployment rate is likely to start rising sharply. The Institute of Supply Management’s business confidence indicator suggested renewed contraction in US manufacturing activity in May. As a result, the Atlanta Fed’s GDPNow estimate for Q2 US GDP growth has fallen sharply from 4+% a few weeks ago to 1.8%.

Investment implications: G7 rate cuts are positive for risk assets overall. Early rate cuts by the Fed will be key. The Fed has achieved the so-called economic soft landing before – in the second half of the 1990s – helping extend the business cycle. As a result, US stocks rallied through to 2000.

Prefer US technology and communication services: Here SC remains constructive on risk assets amid G7 rate cuts, where it believes US equities are likely to see the strongest upside amid upbeat outlook for technology and communications services on AI-driven earnings upgrades. This week’s sharp pullback in bond yields also benefit these two sectors the most and keeps the economic soft-landing/Goldilocks thesis alive. The two sectors are driving corporate earnings estimates for 2024 and 2025. Also, US presidential election years have historically been positive for US equity market returns. 

Opportunities in India: SC continues to see opportunities in Indian large-cap equities amid political and policy continuity after the elections. There is scope for near-term volatility as coalition partners negotiate key cabinet positions. However, India’s economic and corporate earnings growth outlook is likely to get a further boost from increased government spending. The reduced mandate for the ruling NDA alliance is likely to lead to sharper focus on rural, infrastructure and green energy spending to significantly boost job creation. This should be positive for consumption (two wheelers, tractors, etc.) and infrastructure-related and green energy sectors (solar power, electric vehicles)

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