Q2 Market Outlook: Softening central bank policies to bolster reflation trade
Major indices in the US, Europe, and Japan surged to historic highs in Q1. In the US, the rally was fueled by AI-related stocks like Nvidia and Microsoft, while Tesla and Apple faced challenges. Despite a reduction in Fed rate cut expectations from six to three due to strong earnings and economic data, the equity rally remained intact. European markets benefited from a reflationary trend, Japanese stocks saw gains amid a weaker yen, while Chinese stocks experienced limited recovery despite stimulus measures. As the second quarter begins, strong risk appetite persists, with expectations of dovish central bank policies likely to bolster value stocks, energy, and commodities.
Q1 in a nutshell
The first quarter witnessed a surprise rate hike by the Bank of Japan (BoJ), an unexpected rate cut by the Swiss National Bank (SNB), alongside major US, European, and Japanese indices reaching new record highs, with varied performances among the Magnificent 7 stocks. Nvidia and Microsoft led the major US indices higher, while Tesla and Apple fell from grace. The market rally broadened beyond the US and the technology sector.
Robust earnings — especially from AI-related companies — supported the equity rally; Nvidia sales grew more than 200% compared to a year earlier, and together the US Big Tech stocks posted a 55% earnings growth.
In the meantime, the Federal Reserve (Fed) rate cut expectations got a significant pullback as economic data pointed at robust US growth, healthy jobs market and an uptick in inflation. The expectation of Fed cuts fell from six rate cuts to three, and matched the Fed’s dot plot. The Fed officials, on the other hand, kept their expectation of three rate cuts unchanged from the December projection.
FX trading to spice up with diverging central bank expectations
Investors are heading into the Q2 with the expectation of three rate cuts from the Fed, the first due in the FOMC’s June meeting.
But this expectation is subject to a sharp revision. Many investors think that if the Fed doesn’t proceed with the first rate cut in June/July, they will not cut the rates until after the November presidential election.
The European Central Bank (ECB) and the Bank of England (BoE), on the other hand, are expected to start cutting their rates regardless.
With the major central banks set to start cutting interest rates as soon as Q2, global risk sentiment remains robust. The equity rally should further broaden beyond the US, the technology stocks, to small and mid-cap stocks and commodities. The European indices showed an early sign of a reflation trade in the Q1; high quality and defensive stocks performed well.
Still, the European companies trade with a massive discount to the US, says NFG Partner’s Glenn Coxon, pointing at potential for a further rally in the European Stoxx 600 index.
Macroeconomic fundamentals look gloomy for the European countries, though the projections have slightly improved since last year and point that Europe could avoid recession and get away with stagnation if the European Central Bank (ECB) starts easing policy as expected. Based on the ECB officials’ comments, a June rate cut is the most plausible scenario, however the ECB doesn’t want to commit to further rate cuts beyond June.
Economic data, especially inflation numbers, should determine the future of the ECB policy. The ECB is expected to cut three times this year.
Across the Channel, Britain saw inflation ease significantly and is expected to cut rates late summer. If this is the case, the euro will likely remain under a slight selling pressure against the greenback, though sterling’s direction is unclear amid improved growth outlook that supports the currency.
In Japan, the Bank of Japan (BoJ) is expected to maintain an accommodative stance after having surprised the market with an earlier-than-expected rate hike in April and scrapped the yield curve control policy. The long yen trade — which was supposed to be the best trade of the year — has been a massive disappointment so far, but the yen appreciation remains on the menu.
A mosaic of central bank decisions will continue to spice up the FX markets in Q2 as the major central banks are expected to move at various times and speed creating interesting opportunities for FX traders.
Central bank easing to benefit energy & commodities
Commodities like gold, oil and copper are expected to benefit from a period of global policy loosening and falling interest rates.
Crude oil extended gains sustainably above the $80pb as the geopolitical tensions and OPEC’s commitment to extend supply cuts into the Q2 remained supportive of the bulls. Industrial metals are also on investors’ ‘to buy’ list. Appetite for uranium increases as it becomes clear that alternative energy sources could hardly replace fossil fuel in satisfying the world’s increased hunger for energy.
Gold advanced to record levels in the Q1 despite a pullback in Fed cut expectations. Increased demand from EM and diversification from the US dollar helped pushing the yellow metal to fresh highs, property crisis in China deepened despite stimulus measures deployed by the government to reverse the selloff.
Trend is gold traders’ good friend. Unless we see sizeable pullback, the trend should remain in favour of the gold bulls.
Elsewhere, Bitcoin could see further support from scheduled halving, while cocoa futures should normalize following historical rally.
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If you’re eager for more, make sure to watch our engaging and enlightening discussion with NFG Partner’s Glenn Coxon!
