The rotation continues

Having had quite an extended period of low volatility and despite what appears overall to be an earnings season that is meeting analyst expectations and the ever-growing expectation the Fed will cut rate in September, risk assets around the globe have been on a downward path this week. The Vix fear index has risen almost 50% in the month. The Nasdaq index has lost almost 5% in the past few days as investors apparently are deciding to pause for breath. In reality, the correction is pretty modest; stocks like Nvidia have been down around 10% in the past month, only giving back a fraction of the gains from the year so far. There has been a general unwinding of profitable trades this year: tech down, small caps up, and commodities down as concerns about Chinese growth continue.

Speculation that the Fed will cut in September led to the yield on the two-year US Treasury note trading just 12 basis points above the 10-year at one point on Thursday. This is the closest the market has come to ending an inversion in place since the middle of 2022, quite a change from the spread of more than 50 basis points a month ago.

Yesterday’s US GDP report exceeded expectations, with annualised growth of 2.8%. The most significant positive contributions to real GDP growth in Q2 came from personal consumption, inventories, business investment in equipment, and government purchases.  The largest drag was net exports. Next week, the Fed meet for the last time before the September meeting, and everyone will be looking for confirmation that it is thinking along the same lines as the market.

Next week, the new Chancellor will announce the date for her first autumn statement and prepare us for how much she is likely to raid our taxes. According to a Telegraph article, some “experts” have warned that the Chancellor is preparing a £25 billion increase in the tax burden. At the same time, Ms Reeves is expected to sign off a series of above-inflation pay deals. They will be laying the blame squarely on the previous government. That may wash for a while, but that card can only be played for a brief period. The Bank of England will also meet next week. Will they cut rates in the face of these inflation-busting pay awards, making the decision a bit harder? One would imagine they will wait and see what the Fed does in September.  This morning, equity markets in Europe and the US indicate a slightly stronger opening.