Making sense of the forces driving global markets |
By Jamie McGeever, Markets Columnist |
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- Wall Street ends in the red, having earlier hit highs last seen in February-March. The S&P 500 falls 0.3%, the Nasdaq loses 0.5%. Consumer cyclicals sector falls 1%, and energy is the best-performing sector up 1.5%.
- U.S. stock market volatility, as measured by the VIX index, falls to its lowest in almost 4 months earlier in the day.
- Treasuries rally, also boosted by soft inflation and a strong 10-year auction. Yields end down as much as 7 bps, curve bull steepens slightly.
- Oil hits a two-month high, rising more than 4% after sources say the US is preparing to evacuate its Iraqi embassy due to heightened security concerns in the region. Brent crude reaches $69.77/bbl, WTI rises above $68/bbl.
- Precious metals rise, led by a surge in platinum to a 4-year high above $1,280/oz. Platinum rose as much as 5% and is up over 20% in June, which would be its best month since 2008.
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Good vibrations turn sour |
It's a "done" deal, according to U.S. President Donald Trump, although he and Chinese leader Xi Jinping still have to finalize the wording of the trade agreement between the two superpowers and sign off on it. The main points of the deal appear to be: China will remove export restrictions on rare earth minerals and other key industrial components; U.S. tariffs on Chinese goods will total 55%; Chinese tariffs on U.S. goods will total 10%. Trump could not have been more enthusiastic in his praise for the agreement on Wednesday, and Commerce Secretary Howard Lutnick said 'deal after deal' with other countries will follow in the weeks ahead. Yet, judging by the relatively muted market reaction, investors are less enthused. And given the chaotic and unpredictable nature of the Trump administration's tariff announcements thus far, the irony of Treasury Secretary Scott Bessent calling on China to be a "reliable partner" in trade negotiations will not be lost on some observers. Especially, one suspects, in Beijing. |
Based on these proposed China levies, and with the US expected to conclude more trade deals in the coming weeks, the overall U.S. effective tariff rate will be lower than feared a couple of months ago. That's a relief. But the effective tariff rate of around 15% that many economists expect will still be significantly higher than the 2.5% rate at the end of last year, and would be the highest since the 1930s. Also, as the May inflation figures showed, tariffs have yet to be felt on prices. Investors - and Fed policymakers, who meet next week - are in a state of limbo. How will corporate profits and consumer spending be affected? What proportion of the tariffs will companies "swallow", and how much will they pass on to their customers? Zooming out, inflation appears to be cooling around the world, although this trend is expected to reverse once tariffs start to fuel higher goods price inflation. Figures on Wednesday showed that U.S. consumer inflation and Japanese wholesale inflation were lower than expected in May. These reports follow similar numbers from Europe recently, and China remains stuck in its battle against deflation. Next up is India, which releases consumer inflation figures on Thursday, which are expected to show annual inflation slowed to 3.0% in May, the lowest in more than six years. Another focus for investors on Thursday will be the auction of 30-year U.S. Treasury bonds. |
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US stocks-bonds warnings flash amber again |
Calm has descended on U.S. markets following the 'Liberation Day' tariff turmoil of early April. But Wall Street's rally has revived questions about U.S. equity valuations, as stocks once again look super pricey compared to bonds. Since the chaotic days of early April, U.S. equities have rebounded fiercely, with the S&P 500 up 25%, putting the Shiller cyclically adjusted price-earnings (CAPE) ratio for the index in the 94th percentile going back to the 1950s, according to bond giant PIMCO. Stocks are looking expensive in absolute terms, and in relation to bonds. The equity risk premium (ERP), the difference between equity yields and bond yields, is near historically low levels. |
According to analysts at PIMCO, the ERP is now zero. The previous two times it fell to zero or below were in 1987 and 1996–2001. In both instances, the ultra-low ERP precipitated a steep equity drawdown and sharp fall in long-dated bond yields. "The U.S. equity risk premium ... is exceptionally low by historical standards," they wrote in their five-year outlook on Tuesday. "A mean reversion to a higher equity risk premium typically involves a bond rally, an equity sell-off, or both." But reversion to the mean doesn't just happen by magic. A catalyst is needed. Equities have recovered largely because they were oversold in April, trade tensions have been dialed down, and investors remain confident that Big Tech will drive solid AI-led earnings growth. |
So even though huge economic, trade, and policy risks continue to hang over markets, there is no sign of an imminent catalyst that would cause an equity market selloff. |
What could move markets tomorrow? |
- India CPI inflation (May)
- UK trade (April)
- UK industrial production (April)
- ECB's Jose Luis Escriva and Frank Elderson speak at separate events
- Brazil retail sales (May)
- $22 billion U.S. 30-year Treasury bond auction
- U.S. weekly jobless claims
- U.S. PPI inflation (May)
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. |
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