Portfolio Update – June 2024

As 2024 races past its halfway point, the world has seen no shortage of political events that have kept it far from boring. The United States grapples with social issues, the presidential run has started with a terrible debate, a genocide continues to silently unfold in Palestine, and Europe is embroiled in political drama, giving everyone plenty to talk about. Despite the prevailing narrative seemingly pushing for conflict, the general population’s resistance offers a glimmer of hope that we might avoid yet another war.

Financially, the year has been relatively uneventful. Most central banks have embarked on a rate-cutting cycle, with interest rates lowered in the EU, Canada, China, Denmark, Hungary, Mexico, Sweden, and Switzerland. Contrary to my expectations at the start of the year, the US, UK, New Zealand, and Australia have kept rates steady. In hindsight, the data justifies this decision, and I should have anticipated it back in December. Of course, as usual and in line with expectations, Japan has played the contrarian role, being the only country to hike rates, though it may be followed by Australia later this year. Despite mixed success with timing, the rationale I outlined in December behind my expectations has proven sound.

However, the same cannot be said for the trade I suggested. The Japanese yen continues to weaken, and I can clearly see why the trade didn’t play out as expected. Firstly, I assumed the BoJ would start hiking rates in April while other major central banks would begin cutting around the same time. Instead, what happened is that the BoJ hiked only once in March, and we had to wait much longer for the first cuts to be implemented elsewhere. Secondly, I anticipated a hiking cycle from the BoJ: while this could still happen, it can currently feel like the March hike was a one-time event. It is difficult to expect significant movement in rate differentials when future rate hikes are uncertain, especially when other central banks either refrain from cutting or signal that rates will remain higher for longer.

In retrospect, that was a bad call.

Looking ahead, in order to form reasonable expectations on what to what might happen policy wise in the developed economies (excluding Japan), we have just to ask ourselves whether the disinflation trend will continue, and if so, whether it will continue because of a reduction in demand (ie. decline in growth) or a increase in supply (ie. higher productivity): the former is bearish risk, the latter isn’t.

Before we dive into the details for each country, I wanted to remind you that my Portfolio Updates are sent out monthly to all newsletter subscribers. If you haven’t already, make sure you don’t miss out – join over 500 professionals today by subscribing here!

United States

In June, talking about a recession is fashioned once again. However, while Nvidia being down nearly 20% from its all-time high might seem like a compelling reason to expect a recession, the economic data doesn’t exactly support this conclusion. So let’s start with the basics.

What’s a recession? While the technical definition is two consecutive quarters of negative GDP growth, this definition is a bit restrictive. Indeed, a real recession encompasses broader economic decline, including significant drops in consumer spending, industrial production, employment, and income levels across various sectors. Indeed, if you recall, in 2022 the US had a period of two consecutive negative GDP prints, but it never entered a recession: that’s because you can’t have a recession, and at the same time a strong labor market.

Looking at the data, the GDP growth is slowing down, and I’ve said it a few months ago already, beginning in my March 2024 Portfolio Update: “Looking ahead, we should expect growth to fall in the second quarter, although it will remain positive: I have my current forecast at 1.3%, while my friend @SheepTrades expects it at 1.0%.” The expectations for second-quarter growth have varied widely, and the market is only now realizing that the 2-3% GDP growth isn’t feasible for this quarter, hence the decline in equities and the shift in narrative. However, even though I expect low growth for the remainder of the year (potentially around 1.3%, 1.5%, and 0.6% for Q2, Q3, and Q4 respectively), it’s important to note that low growth is still positive economic expansion, albeit at a slower pace. Discussions about a recession are premature when growth rates remain in positive territory.

Another data point that has been prominently cited to support recession discussions is retail sales, which fell short of expectations in June. However, when viewed in context, real retail sales are currently on par with pre-2020 trend, showing minimal MoM fluctuations. Therefore, relying on this data to argue for an economic downturn reflects a lack of thorough research. Instead, what retail sales confirm, if anything, is that the expectations for Q2 GDP were significantly off the mark.

However, not all concerns are fully unfounded. While the overall labor market appears stable and resilient, its nuances tell a different story. As highlighted in my previous updates, there’s been a boom in blue-collar jobs, contrasting sharply with a gloomy outlook in sectors like finance and technology. I’ve seen the other day statistics indicating that the tech sector has wiped out all job gains made since 2020, which is crazy to even just think about.

There is also another significant concern: the weakening job market for young workers. This is primarily due to challenges in the entry-level job market, in turn driven by poor hiring practices, cumbersome application processes, and very limited leverage for candidates. On top of that, increased uncertainty about the future is prompting delayed retirements and reduced turnover, further exacerbating difficulties for entry-level job seekers. Unfortunately, few are discussing this issue, but I believe it will grow into a major concern in the coming months. High unemployment among prime-age workers has significant economic, political, and social implications. Put simply, without meaningful employment opportunities during this critical phase of life, we risk breeding nihilism, increased suicide rates, anarchism, and higher levels of drug use—essentially, societal disarray. In essence, since one’s twenties are dedicated to finding purpose in life, it is essential to provide this age group with purposeful opportunities to prevent potential chaos.

Nevertheless, for trading purposes, the aggregate figure is all that matters, and it’s so far it has been strong: don’t mistake my granularity for bearishness.

Federal Reserve

As widely expected, the Fed maintained the target range for the FFR at 5.25-5.50%, marking the 8th consecutive meeting at which rates have remained unchanged. However, there a few surprises.

The updated dot plot now signals only one rate cut this year, compared to three projected in March, while money markets had priced in two cuts at the time of the release. This median expectation, however, is finely balanced, with 8 out of 19 policymakers continuing to foresee two cuts by year-end. Looking ahead, the median projection for 2025 increased from 3.9% to 4.1%, and the 2026 dot remained unchanged at 3.1%. Interestingly, longer-term rate expectations increased from 2.6% to 2.8%, suggesting once again that R* has increased: some argue that this rate is still too low, but I believe that discussion holds little practical value.

Interestingly, money markets appeared relatively unfazed by this hawkish revision to the dot plot, maintaining high odds for two cuts this year. As of the time of writing, a 25bps cut for November is fully priced in, and there is nearly full pricing for a cut in September as well.

When it comes to the statement, it largely mirrored the previous one with very few changes. The only notable adjustment was the acknowledgement of “modest further progress” towards the 2% inflation objective, a shift from the May statement which noted a “lack of progress”. Once again, the Committee emphasized its stance on requiring “greater confidence” in inflation sustainably returning “towards” 2% before considering cutting rates. As mentioned previously, achieving the target is not a prerequisite for rate cuts, but inflation must show a sustainable trend towards reaching it first.

Moving to the quarterly Summary of Economic Projections (SEP), both headline and Core PCE forecasts were raised for 2024 and 2025, while remaining unchanged for 2026. Unemployment was held steady at 4.0% for 2024 but was revised upward by 0.1% for both 2025 and 2026, to 4.2% and 4.1% respectively. Real GDP forecasts remained unchanged across the entire projection period.

During the press conference, Powell hardly said something that hadn’t been said before. He emphasized that the Fed requires further evidence of inflation returning to target sustainably and that, if the economy remains robust and inflation persists, the Fed is prepared to maintain the current level of interest rates for as long as necessary. However, he also pointed out, consistent with the dot plot, that no one on the board anticipates rate hikes as their base scenario. He also added that if there were an unexpected weakening in the labor market, the Fed would be ready to take action.

Back in early April, I argued that expecting rate hikes was misguided given both economic data and the central bank’s reaction function, a position reaffirmed once again. Even assuming conditions diverge from the Fed’s expectations, it’s more probable that rates will remain unchanged for a longer period rather than see further hikes.

Remarkably, perhaps because of the violent dovish reaction to the CPI figures released earlier in the day, the markets barely reacted. Regardless, from a policy perspective, little has changed, and a rate cut remains the most likely next move. Therefore, while we can debate the timing of the initial cut (with a close look at the 6-month yield being crucial for accuracy), ultimately, we know that in upcoming meetings, the outcome will either be rates staying the same or decreasing—there is no third option.

Europe

Despite my interest in discussing the slightly weaker European economy, this month’s focus will be entirely on the European elections and the implications of the results.

As you all surely know already, the media has highlighted a rise in far-right parties in Europe following the election results. However, as I mentioned on Twitter recently, what is labeled as “far-right” today is nothing more than what was considered “normal” a decade ago. Therefore, this shift should not be overemphasized. Yes, the right won, but we are not teetering on the edge of a fourth Reich. The political center still holds sway, with the European People’s Party (EPP) capturing nearly 26% of the seats.

The crucial question now is whether the parties can collaborate effectively over the next five years. Another key aspect to watch is the selection of the next President of the European Commission: while there is speculation that Ursula von der Leyen might secure a second term, if she is reappointed, her priorities might shift, especially given the substantial losses suffered by the Greens and Liberals. Additionally, due to the election results at both the European and national levels, we can anticipate fewer significant cross-border European initiatives coming to fruition. The rise of anti-European parties is likely to influence policies related to security and immigration, but its effect on traditional economic policies may be minimal.

Speaking of national results, both France and Germany experienced significant setbacks. In Germany, Olaf Scholz’s party garnered only 14% of the votes, while in France, Emmanuel Macron’s party secured 15%. It’s tough to be on the losing side.

In Germany, the ruling coalition garnered less than 30% of the vote. Although snap elections seem improbable, growing tensions within the coalition, particularly evident in current budget negotiations, will likely lead to policy uncertainty and political frustration. This autumn, three regional elections are scheduled in East Germany, with the AfD expected to perform well, potentially adding to the political strain. Even in the absence of snap elections, the next national elections are slated for autumn 2025, making the introduction of new growth-oriented policies unlikely until then.

In France, the election results led President Macron to call for snap elections at the month’s end. This move has temporarily shifted the narrative from Le Pen’s victory to Macron’s political future, but the long-term benefits of this strategy remain uncertain.

While it’s impossible to predict the precise policies of France’s next government, the markets will closely monitor fiscal policies and whether changes in leadership might lead to reckless spending and resistance to European fiscal rules. However, I personally believe the chances of such outcomes are quite low. Europe tends to favor stability—“nothing ever happens”—hence, any new French government is likely to adjust its rhetoric post-election rather than risk economic instability. A similar pattern was observed with Meloni in Italy, where strong anti-European Italy-first rhetoric before the election gave way to conformity with the status quo once in office.

Consequently, as European markets, particularly French equities, declined, I took the opportunity to go shopping for my long-term portfolio, getting overweight France. With an investment horizon of a few years, a 20%+ decline due to unsubstantiated fears presents an excellent buying opportunity.

In summary, the national repercussions of these election results will likely influence EU cooperation, emphasizing domestic agendas. For the moment, the risk of new sovereign debt tensions is limited to France until the elections. However, the rightward shift in many countries could lead to more lenient fiscal policies at the national level, whether through growth-stimulating measures or increased social spending. This shift could, in turn, introduce new tensions with the European Commission and bring some uncertainty to financial markets.

European Central Bank

As widely anticipated, the ECB chose to cut rates by 25bps to 3.75%, although the Governing Council didn’t commit to a particular rate path. But to be fair, the ECB couldn’t do it any different, as credibility for a central bank is everything. Indeed, for a central bank, there are two kinds of consistency that drive credibility higher: time consistency, and policy consistency.

Time consistency refers to acting in line with the guidance previously provided: it’s obvious then that, even though there has been an uptick in the inflation data, after several weeks of Governing Council members strongly hinting at a June cut, not acting was out of the question.

Policy consistency refers instead to acting in line with the mandate and the reaction function, which is the reason why in the press conference we saw a strong emphasis that the decision was only “removing a degree of restriction”, that policy remained restrictive and that further decisions would be data dependent. This is also the reason why the ECB further reiterated its pledge to “keep policy rates sufficiently restrictive for as long as necessary”.

Regarding the ECB’s economic assessment, the statement noted that “despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year”. The accompanying macro projections also indicated that the 2024 and 2025 headline and core inflation forecasts were raised more than expected, while 2026 growth forecast was lowered as anticipated. All in all, the statement read hawkish cut.

At the press conference President Lagarde stated that she would not describe the ECB as being in a “dialing back phase”, though it is highly likely that this is indeed the case. On the unanimity of the decision, Lagarde mentioned that all but one governor supported the decision to lower rates. However, we weren’t left wondering about his identity for long as shortly after “sources” came out revealing the dissenting governor was Austria’s Holzmann, who also advocated for an increase in inflation projections. Additionally, Lagarde emphasized that the ECB is far from reaching the neutral rate and declined to commit to making rate decisions only during projection round meetings, although she acknowledged that more data is available during these meetings.

When it comes to market pricing, that has shifted slightly more hawkishly, as there was no explicit endorsement for another near-term rate cut. Recalling my April 2024 Portfolio Update, “the ECB may opt for a different approach, where rate cuts could be followed by periods of pause”. According to the latest ECB sources via Bloomberg and Reuters, another cut in July is highly unlikely. Regarding September, Bloomberg said there’s uncertainty while Reuters mentioned a rate cut would be warranted if the ECB’s inflation forecast for the last quarter of 2025 remains at 1.9-2.0%.

It’s interesting that the ECB and the Fed are now officially in monetary desynchronization, reflecting the difference in the disinflation cycle between the two economic areas. In other words, we can finally see rate differentials widen and some movement in the exchange rates.

However, I wouldn’t expect too much weakness in the EUR just because of this factor. Indeed, the relationship between the EURUSD rate and policy delta is very loose, and the expected widening in the rate differentials is quite limited anyway. One might argue that moving from 1.09 to 1.07 in the span of three weeks is evidence that I’m wrong, but at the same time, I believe this move has been mostly due to heightened political risk rather than policy-related factors, and the sustained decline in European equities confirms that.

United Kingdom

As expected, the MPC maintained rates at 5.25%. However, once again, the decision wasn’t unanimous: as in the previous meeting, both Dhingra and Ramsden were the lone dovish dissenters, favoring an immediate 25bps cut. The rest of the Committee voted to keep rates unchanged, resulting in another 7-2 vote split. Interestingly, the MPC noted that the decision not to cut rates was “finely balanced” for some policymakers, increasing the likelihood of a cut cut next time.

With no new economic forecasts released, all the focus was on the policy statement, which was quite unsurprising and very similar to the previous one. It reiterated that policy “will need to remain restrictive for sufficiently long” and “restrictive for an extended period of time” to return inflation to target. It also emphasized monitoring signs of inflation persistence and keeping “under review” how long rates should remain at the current levels.

Later reports indicated that Governor Bailey did not reiterate his optimism about the direction for a rate cut. However, this is likely because members of the MPC are refraining from commenting ahead of the UK general election. Therefore, it doesn’t necessarily mean that he no longer holds that view, but rather that he isn’t able to express it at this stage.

Overall, given the choice of words in the statement and the lack of surprises, the markets interpreted the meeting as dovish. Consequently, pricing has moved in a slightly more dovish direction, though not enough to see the first fully priced rate cut moved forward to September from November. Nevertheless, the next policy move remains set to be a cut, possibly in August based on current implied rates and the wording of the statement, potentially followed by just another cut in November before the end of the year.

Japan

The BoJ kept its short-term policy rate steady at 0.0-0.1%, as anticipated, through a unanimous vote. However, it surprised the markets by not announcing an immediate tapering of its bond purchases. Instead, it decided to maintain bond purchases in line with its March decision, deferring updates by stating it will trim purchases but will finalize a specific bond-buying reduction plan for the next 1-2 years at the next meeting. The decision on JGB purchases passed with an 8-1 vote, with Nakamura being the only dissenter, arguing that the bank should decide to reduce purchases only after reassessing economic activity and price developments in the July 2024 outlook report.

Additionally, the BoJ announced it will meet with bond market participants to discuss the meeting’s policy decision. It projected that underlying inflation will gradually accelerate and stressed the importance of monitoring financial and currency market developments. The press conference took on a hawkish tone, with the BoJ Governor suggesting a possible rate hike in July depending on forthcoming data and indicating that the bond-buying reduction will be significant.

However, analyzing Japanese monetary policy differs from that of other countries, for two key reasons: firstly, the BoJ is built differently; secondly, unlike other G10 nations, Japan has been grappling with deflation for a long period and is actually welcoming inflation. Therefore, if the BoJ becomes too aggressive, there’s a risk of overshooting and bringing inflation back below target, which poses a significant challenge for the country. For instance, at the moment core inflation is still just below target.

This situation presents a dilemma for the central bank: while aggressive measures could potentially support the MoF’s efforts to strengthen the JPY, there remains uncertainty about achieving sustainable inflation at the target level.

Speaking of the yen, it’s remarkable to see it return to levels last seen around the time of the Plaza Accord. And it’s a concern for Japan, of course. However, typically a depreciating currency tends to contribute to inflation, yet, despite the yen’s prolonged decline, this hasn’t noticeably boosted Japanese inflation, particularly if you look beyond food and energy. Overall this complicates the economic picture, and might explain why the BoJ has shown less concern about the weaker currency.

Certainly, the yen could continue to depreciate from its current levels until some form of technical stabilization occurs, though it’s unclear when this decline might bottom out. The MoF could potentially intervene again as well, but considering its past ineffectiveness, it seems unlikely they will waste more funds in this manner. As of the time of writing, my intervention probability indicator indicates a level just below 60%: while this is sufficient to warrant vigilance, it’s not high enough to justify taking the trade yet.

Australia

As expected, the RBA once again kept rates steady at 4.35%, refraining from any major surprises in its statement reiterating the Board’s firm commitment to returning inflation to the target.

The tone on inflation remained hawkish, emphasizing that inflation continues to exceed the target and is proving persistent. The statement also noted that while inflation is easing, it’s happening at a slower pace than previously anticipated. Furthermore, it acknowledged the uncertainty surrounding the optimal path of interest rates needed to achieve inflation targets within a reasonable timeframe, with the Board keeping all options open. Overall, the announcement and statement were devoid of significant surprises, and had minimal impact on the markets.

During the press conference, Governor Bullock struck a somewhat balanced tone. She mentioned the challenges in steering inflation back to the target range, and revealed that the Board had discussed the possibility of a rate hike at the meeting. However, she clarified that this discussion didn’t necessarily imply a stronger case for a rate hike. She also emphasized the Board’s vigilance regarding potential upside risks to inflation, but clarified that this vigilance didn’t imply an imminent rate increase.

However, later in the month, Australia recorded notably higher CPI figures, with headline inflation reaching 4.0% YoY in May, and core inflation hitting 4.1%. In response, the market started to price in a 50% chance of a rate hike by the RBA in September, Australian yields rose across the entire curve, and the AUD appreciated. Personally, I am skeptical that the RBA will opt for a hike, but the probability of such a move is indeed increasing. Additionally, stronger inflationary pressures are likely to delay any potential easing cycle until at least February 2025.