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June 17, 2024 - Politicians fight to get elected, but markets eventually rule ...

Politics are back in the forefront in Europe, but we should not forget that the US is having its own presidential elections in early November. And those can get real messy as well. Back to us, the decision of President Macron to call snap elections in two weeks from now has created havoc in French financial assets (bonds and equities) as investors are getting prepared for the worse, regardless of what will finally happen. The rise of Le Pen comes at a time when the French fiscal deficit is already very high (higher than 5%), the debt/GDP at record high and the S&P just downgraded the country's rating to AA-. Le Pen has called for lower retirement age, subsidies to farmers and more support to the lower income citizens among other things, which all should result to an increase of the debt and the deficits. Markets have responded immediately.

But countries which run large deficits rely on the sweet trillions of international investors to finance them. And these investors can turn their back very quickly if they sense that their money is at risk. To make matters worse and given the huge advance in financial derivatives in the last 20 years, you don't have to be an investor holding the financial assets of a country (or a company) in order to have the upper hand. Speculators can start aggressively betting on a country's debt with the ease of a "click" and then others will follow. As many countries have learned in the recent past (Greece in 2012 for example), if they want to be part of the international financial system and be able to receive capital, their governments will have to play by their rules of the capital markets (of course to some extent). Unless you are Venezuela or Argentina. And staying with the example of Greece, it was the very vocal far-left government that finally signed all the necessary memorandums which carried harsh reforms in order to receive the valuable aid.

It is no surprise that Le Pen's party has already started to tone-down their rhetoric on the retirement age for example, as the country's bonds were being sold-off. And as a reminder, it took just a few days of steep sell-off in UK bonds, for Liz Truss to step down from the Prime Minister's seat in the UK. But the situation is expected to remain very fluid in the coming weeks, as all political outcomes carry a statistically significant probability.

Across the Atlantic, the FED did not surprise the markets and maintained interest rates unchanged. The only surprise was their new projections of how many rate cuts they are expecting for this year: namely just one. This number was two just a month ago and three previously. And as a reminder, the market had priced-in seven (!!) rate cuts for 2024, at the end of last year. We had said back then, that there is no reasonable scenario where the economy grows strongly or little above 2% , inflation falls to 2% and the FED cuts rates so aggressively. We thought that if the economy continues to grow at 2-3%, inflation will not be easy to be brought down to 2% and the FED will not cut rates. Today we received confirmation that our thinking was correct. The bond market has already priced out the rate cuts of this year. The equity market still discounts that growth will be 2-3% and inflation will fall to below 2% rather soon. It remains to be seen if this paradox will be priced-out from equities too.

During the press conference, Mr. Powell toggled between dovishness and hawkishness. He acknowledged the progress that has been made on inflation since the peak of 2023, but he also indicated that the good inflation data received in the morning of their meeting came "after several reports that were not encouraging." He also made note to the fact that rents (OER) have failed to slow. Just as a mathematical exercise, if OER is going to continue to expand 5.3% at an annual rate as it did in the least few months, the FED believes that inflation cannot get sustainably back to 2%, due to the big weight of the category in the calculations. The next question is whether enough will be seen in time for the September meeting to put two cuts back on the table in 2024. Between now and the September F meeting we are going to receive three more employment reports and three more CPI reports. At the moment, a decent majority of the FED (11 out of 19 participants) apparently expect to be on hold until December, or into 2025.

The Swiss National Bank and the Bank of England are meeting this week, on Thursday. It is quite unclear what the two central banks will chose to do, as the political turmoil in Europe might complicate decisions (including the UK, with their own snap elections called just a few days ago). The SNB was the first to cut rates, but saw inflation picking up slightly in the last two months, albeit to a relatively low 1.4%. But the bank attributed the uptick primarily to imported inflation due to the weakening of the CHF, which in the meantime has strengthened again. Most probably they will chose to hold rates unchanged. The BoE on the other hand is in a more tricky situation as it would normally cut rates due to significant improvement in inflation and the latest worsening unemployment data (although wage growth remained strong). But cutting rates just before the elections could be seen as interfering, and for that reason they might chose to wait for September.

US May inflation numbers surprised positively. The headline number was announced at 3.3%, down from 3.4% in April as the monthly change was almost zero. Core CPI also dropped to 3.4% from 3.5% in the previous month. Looking into the details, the main problem with inflation is consumer services (and primarily rents) and not consumer goods anymore. Core goods prices declined (-4bp) for the 11th time in 12 months and Core non-rent services (the so-called Super Core inflation) also fell 4bp. But on the flip side, "food away from home" (i.e. restaurants) continued to rise at a solid monthly rate of 35bp. proving to be one of the more persistent components of the inflation calculation. Increases in owners' equivalent rent (OER) also remained stubbornly high (rising 43bp in May) and the downtrend in rents has stalled since August of last year. As the strength in rents account for most of the reason that core inflation remains elevated, a resumption of the downtrend would be a positive development for lower inflation.

The weekly US labor market data were very soft. Contrary to the recent non-farm payrolls but consistent with other labor market metrics which show some weakness lately, the weekly initial jobless claims jumped to 242k, vs expectations for 225k. One has to go back to July of last year to find such as high number, but in absolute terms they remain low. We should note that as long as jobless claims remain under 400k there is no fear for a recession, rather than an economic slowdown. Soft labor market data will eventually bring inflation down and make the FED more comfortable for cutting rates.

And as if we did not have much to worry about in Europe, the EU decided to impose additional tariffs on Chinese-imported EVs. The tariffs will be added to the existing 10% import tax, and will range between 17% and 38% per automobile maker. The choice of which tariff to use will likely depend on whether the Chinese maker produces already in Europe or has plans to invest in Europe, offering thus some incentives to avoid the upper band. Our favorite Chinese EV maker, BYD Company, will fortunately be at the low end of the tariffs and its shares staged a relief rally of more than 5%.

European equities slumped but Nasdaq and S&P500 rose to a record high. What a difference a week makes ! The result of the Euro-elections led the French CAC40 to lose almost 7% last week and is now negative (slightly) since the beginning of the year. It was one of the best performing markets up until 2-3 weeks ago. The Euro Stoxx50 lost 4%, and is now up by about 7% on year-to-date basis. Switzerland managed to outperform (-1.7%), playing its important diversifier role in portfolios and offering the protection of the Swiss franc too.

High quality bonds rallied and also proved that they have a significant role in investment portfolios. The catalyst for the rally was primarily the turmoil in Europe, but the soft macro data in the US spilled oil into the burning fire. Those who had amassed record short positions in Bunds and Treasuries got burned again, offering the holders of the bonds nice returns for the week. The German 10-year yield is back at 2.35% and the US equivalent at 4.25%, both down more than 30bp from their recent highs.

Chart of the Week : Swiss stocks have started out-performing.

Swiss stocks have started attracting investors' attention again as they offer protection in times of turmoil. But it is unfair to think of them only as a hedge, as there are many companies which are international in nature and offer exposure to secular themes with above average growth prospects, like ABB, Sandoz, Novartis, Richemont to name but a few. And above all, it is important to note that Swiss stocks offer the greatest exposure to the US economy among major markets. The above chart shows the regional exposure by revenues and on the first column is how much they derive from the US. We can see that Swiss stocks (at the index level) receive one third of their revenues from the US, insulating them somewhat from European problems.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Pictet , photo: Euromoney.


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