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U.S. Stocks May Lag Europe Even as the USD Gains on the EUR

By:Ilya Spivak

Stocks in the U.S. may lag European peers even as the dollar gains on the euro as growth and inflation trends diverge, sending the Fed and the ECB in opposite directions

  • U.S. GDP data offers muddy signals on economic growth, inflation trends.

  • Incoming U.S. PCE inflation data unlikely to change much on Fed rate cuts.

  • Stocks and currencies in Europe and the U.S. may be setting up to diverge.

The markets struggled with what to make of first-quarter U.S. gross domestic product (GDP) data.

At the headline, output growth registered at the paltry annualized rate of 1.6%, far lower than analysts’ baseline forecast of 2.5% and even the most pessimistic model from the Federal Reserve, which called for 1.7% ahead of the release. Meanwhile, the core inflation component surged to a blistering 3.7% from 2.0% in the prior quarter.

U.S. GDP data: mixed signals?

A look under the surface appears to reconcile these disparate outcomes. Consumption–the main driver of economic growth–cooled off a bit but still looked generally strong. The main downdraft came from the external side of the equation. Trade shaved off 0.86 percentage points from headline growth as imports surged.

Source: BEA, MacroMicro

Stocks dropped and Treasury yields rose when the data crossed the wires as bubbly price growth nudged Federal Reserve interest rate cut expectations in a hawkish direction. Fed funds futures now price in just 29 basis points (bps) in easing for 2024, implying one standard-sized 25 bps reduction and a meager 16% chance of a second one.

Wall Street was quick to recover, however. The bellwether S&P 500 stock index began to recover within two hours of the data release. Within five hours, its GDP-inspired losses were erased. The intraday see-saw now has equities on pace to finish the session little-changed.

U.S. PCE data: inflation back in focus

From here, the March edition of the Fed’s favored personal consumption expenditure (PCE) measure of inflation rounds out the week in economic data releases. Headline price growth is seen rising to 2.6% year-on-year from 2.5% in February. The core rate excluding volatile food and energy is also penciled in at 2.6%, down from 2.8% previously.

Source: BEA

The PCE measure can be calculated with relative accuracy having seen consumer and producer price index (CPI and PPI) numbers for the same period, so a significant deviation from median projections seems unlikely. Absent an eye-catching deviation and with a Fed rate decision due May 1, the markets may opt to look through this release.

Europe and U.S. diverge on growth, prices

On balance, the main takeaway from this week’s news-flow seems to be the widening disparity between the U.S. and Europe. Purchasing managers index (PMI) data published early in the week revealed cooling momentum in the former–an assessment broadly underpinned by the GDP results–and a firming recovery in the latter.

Meanwhile, the inflation picture is diverging in the opposite direction. Eurozone consumer price index (CPI) data due next week is expected to put price growth at 2.4% year-on-year in April, matching the four-month low set in March. That is a stark contrast from the perky price readings on display across the Atlantic.

Taken together, this has made for a yawning spread in monetary policy expectations. The European Central Bank is priced to deliver three rate cuts against the Fed’s one. This seems to set up a favorable backdrop for the U.S. dollar, but Wall Street may find itself lagging share prices on the Continent (ETF: EZU).

Source: CME, ICE

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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