ECB cuts rates ; Solid US Jobs Numbers spook Bonds   

Market Review: It was a bit of a topsy turvy week for financial markets, but in the end most equity markets finished nicely higher, with the exception of the FTSE 100. The fixed income markets had looked to be on course for strong gains until the release of US Jobs data caused investors to rethink their recent projections of increasing economic slowdown and yields backed up sharply on Friday. Centre stage this week, must surely go to the ECB, who as widely predicted, became the first major central bank to cut interest rates on Thursday from 4 to 3.75%. Actually, that’s not quite true as Canada who is also a member of the G 7 , cut rates from 5 to 4.75% on Wednesday.

ECB Cuts Rates

I know it was widely predicted, but lets not underplay the significance of the move, as we have been waiting a long time for a rate cut from the ECB, BOE or FED and it was Europe that had the confidence to move first. Since its inception in 1999, the ECB had never lowered rates without the Federal Reserve doing so first. Historically, when diverging from the Fed, the ECB adopted a more aggressive stance, such as the ill-fated rate hikes just before the Lehman Brothers’ collapse in the summer of 2008 and ahead of the peak of the eurozone sovereign debt crisis, which led to Italian Prime Minister Silvio Berlusconi’s resignation in November 2011.

Now, by charting its own course again, lets hope the ECB is finally going to get a move right, but the announcement was peculiar to say the least, as it simultaneously raised its inflation forecasts for 2025/6, albeit only by a tiny amount. There was also no big fanfare claiming victory, just a typically European matter of fact delivery with many caveats attached, that suggested this is not the start of a steady procession of rate cuts, more one to test the water and then wait and watch to see the results play out in macro data going forward. There were no heroics from either equity or bond markets as there was no surprise and the ECB get 10/10 for ensuring markets were prepared for the news.

There was a different tone from the Bank of Canada, who seemed to suggest that this is indeed likely to be the first of a series of cuts, although that series is not going to be a straight line down by any means. The Bank’s summation of the move was a bit more dovish than expected, but they still emphasise the fact that each and every cut this year will require evidence that inflation is calming.

US Jobs Numbers : I cant imagine that J Powell will feel under any pressure whatsoever to follow the moves in Europe and from its northern neighbours, it is still all about the data for the FED as they have been at pains to emphasise over the last year. As we went through to Friday, there seemed to be a growing belief that the US economy was beginning to slow, in fact there was actually a growing chorus of voices starting to suggest that the chances of a hard landing were growing with bond yields dropping in the run up to the release. So, news that the US had actually added a whopping 277,000 jobs, exceeding all 77 forecasts by economists surveyed , caused an immediate reversal in treasury yields as fixed income investors instantly revised their views on the direction of economic travel and rate expectations.

However, as well as the Non-Farm Payroll (NFP) release from the Bureau of Labour Statistics, the government also released the Household Survey, a poll of a smaller sample of households about their inhabitants’ work status, which showed that the unemployment rate rose to 4%, and employment actually fell by 456,000. Who to believe? There was a similar divergence late last year which soon unwound at the start of 2024 in favour of the NFP, so I am inclined to run with the former as the best guide for the health of the American jobs market and ergo the US economy.

To my mind the thing that is going to decide the direction of travel for US equities this year and the one that investors are struggling the most with, is the question do we actually need rate cuts for stock markets to continue rising? You can see in the reaction to the strong jobs data on Friday that investors are clearly still undecided too. We got the big sell off on the numbers as they decrease the likelihood of cuts, but then we got the rebound as people realised that a strong US economy is no bad

thing for consumer spending and corporate profits.

My hunch is that corporate profits will become more important than rate cuts over the course of the year, and that this bull market can keep powering higher with three caveats. The first is that we don’t get a resurgence in inflation that causes an actual change in course, as un upward move in rates really wouldn’t be good for markets. And the second is that the ‘Fed Put’ remains in place, by which I mean they are willing to cut – even if they don’t actually do so – if economic growth slows. And then finally, that earnings and profit growth continue to surprise to the upside. Not too much to ask is it, surely?!

With the Q1 earnings season now behind us, with the earnings growth rate of 6.7% smashing the estimate of 1.7% and most company managements’ forward guidance positive, the omens are good on the earnings front. Looking at analysts’ consensus earnings-per-share estimates for 2024, 2025, and 2026 all three rose as the earnings reporting season progressed, with the latter two rising to new record highs. The actual earnings-per-share estimates as of the May 30 week are: 2024 ($244.68), 2025 ($279.67), and 2026 ($314.81) and with analysts notorious in undershooting you can expect those numbers to be beaten. The research house Yardeni, currently estimate $270 (2026), $300 (2025) and $325(2026), or an increase of 11.1% next year and 8.3% in 2026. If you slapped a Price to Earnings Ratio of 20 times on those numbers, which I would suggest is reasonable if inflation stays moderated then we would expect the S&P 500 to be at 6000 in 2025 and 6500 in 2026. I would take that.

That is a very arbitrary, hypothetical stab at the future and who knows what will actually play out. It is possible that AI will enhance productivity and the digital revolution will accelerate earnings like never before – the Cathie Woods ARK view. Set against that are legions of bears worried about inflation, recession , trade wars, tech bubbles , geo-political tensions and even conventional political worries such as Trump in the Whitehouse again. Stil,l I don’t know of any bull market that hasn’t had to climb a wall of worry.

Political Change in Emerging Markets

Speaking of political change before we get to the UK and the US, there is already a lot happening in the World at the moment, with Mexico, India and South African election results in. South Africa is leaving single-party control for the first time in 30 years, and investors seem initially wary of that will mean as the African National Congress Party may need to share power with more extreme Parties. Mexico has given the thumbs down to the free hand voters have given to Sheinbaum with her massive majority. And in India, initial polls proved wildly inaccurate as what seemed to be a huge win for Modi’s BJP party ended up seeing his majority cut and him needing a deal with the NDA to ensure his third term in office. The Indian stock market swung wildly during the week after euphoria for a big win, turned to panic as the actual results trickled in. But as has been the case for some time now, investors in India soon rediscovered their bullish disposition with the market finishing the week close to all-time highs.

Let’s see what next week brings …