The stock market still recoils at the prospect of higher rates

Equity markets could do with a splashy new development in artificial intelligence to reignite the rally. That catalyst may come from a set of earnings, including Nvidia, due tomorrow evening after the Wall Street close. For now, however, the bond market’s doom-mongers are centre stage, weighing on equity indices at the start of the week.

The Nasdaq 100 fell on both Friday (-1.5%) and Monday (-0.45%). That may not look like much, but it is only the second time since late March that the index has declined for two sessions in a row. Investors have not lost their appetite for risk, but they have been unsettled by a negative signal that now outweighs, or rather brings together, all the warning signs that came before it.. I apologise in advance to bond-market purists for the shortcuts that follow, but I have neither the expertise nor the space to go into the subject in greater depth, so I will cut, simplify and strip things back.

The negative signal I have been banging on about is the fall in bond prices. Why are they falling? Because investors fear central banks may be forced to raise rates to tackle runaway inflation, a mechanism we explained in this article. And why would central banks suddenly stir into action? Because the war in Iran has driven up energy prices, a major source of broad-based price increases across goods and services. "Broad-based" means that central banks everywhere are facing the same problem at the same time, regardless of where they are in their monetary-policy cycle.

In the United States, since that is where everyone is looking, the real interest rate has moved into negative territory. The real rate is the official policy rate, 3.63% in the US, minus current inflation, 3.8% in the US. In other words, sitting on cash destroys value, so spending it becomes the better option. That is a powerful incentive to invest, supporting economic momentum while also tending to inflate low-quality assets, because the money has to go somewhere. When the economy is doing reasonably well, as it is in the US, there is little justification for keeping real rates negative. Such a stance can fuel inflation and encourage capital allocation that is questionable from an economic-efficiency standpoint. That is why the debate over Fed policy is gathering pace: as inflation picks up, the central bank has fewer arguments for leaving rates unchanged and more for raising them. Investors know the situation is not especially healthy, but they love free money, so they keep spending and hope the status quo lasts as long as possible.

Markets are nervous, but they keep buying anyway. That is the paradox of the moment, though in truth it has been with us for a long time. Optimists argue that even if rates were a little higher, monetary conditions would not be particularly restrictive. It is worth noting in passing that negative real rates are by no means unique to the US. Japan has been running negative real rates for years, while the eurozone has recently joined the club after the rebound in inflation. In April, inflation reached 3%, while the ECB deposit rate stood at 2%.

What should be taken from all this? Equity markets do not much like rate rises because they restrict access to liquidity. Central banks, meanwhile, are drifting into a world in which their room for manoeuvre is shrinking. Hence the slight return of doubt on stock markets, even though Europe coped rather well yesterday, starting the week in positive territory almost across the board. The backdrop also gives investors a reason to take some profits on names that have clearly overheated. Memory-chip darling Micron, for instance, has lost 15% in four sessions. That still leaves it up 600% over the past year.

The main swing factor for the path of interest rates remains the situation in Iran. Oil slipped a little overnight after Donald Trump said he had called off a strike on Iran following what was seen as a serious resumption of contact with Tehran aimed at reaching a peace agreement. Statements bind only those who believe them. The saga therefore continues, and the longer it drags on, the worse it is for inflation.

Elsewhere, Vladimir Putin will be in Beijing today for talks with Xi Jinping. The Financial Times understands that China's president told Donald Trump that Vladimir Putin may yet come to regret his invasion of Ukraine. The macroeconomic calendar is light. On the corporate front, The Home Depot will draw the spotlight in the United States today as a barometer of US consumption and prices.

In Asia-Pacific, Australia, India and Hong Kong are trading higher. Conditions are tougher in South Korea (-2.8%) and Taiwan (-1%), where the sell-off in chip stocks is painful. Tokyo is down 0.5% for the same reason. European leading indicators are a light green, while US futures are still pointing lower.

Today's economic highlights:

Today's agenda includes: in Australia, the Westpac Consumer Confidence Index, the Westpac Consumer Confidence Change, the RBA Hunter Speech, and the RBA Meeting Minutes; in the United Kingdom, Average Earnings including Bonus, Employment Change, Unemployment Rate, and the BoE Breeden Speech; in Spain, the Balance of Trade; in the Euro Area, the Balance of Trade; in China, the FDI Year-to-Date YoY; in Canada, the Monthly Inflation Rate, Core Inflation Rate YoY, Annual Inflation Rate, and the New Housing Price Index MoM; in the United States, the Fed Waller Speech, Pending Home Sales MoM and YoY, and the API Crude Oil Stock Change. See the full calendar here.

• GBP / USD: US$1.34
• Gold: US$4,542.23
• Crude Oil (BRENT): US$110.17
• United States 10 years: 4.61%
• BITCOIN: US$76,931

In corporate news:

• The EU has chosen EQT to manage its Scaleup Europe fund, worth nearly €5 billion.
• Standard Chartered announces a reduction of more than 15% in its support staff by 2030.
• Novo Nordisk says it is disappointed by the US Supreme Court’s ruling on Medicare drug pricing.
• Bayer agrees to pay $133 million for PCB clean-up in two US states.
• Evolution AB launches a €2 billion share buyback programme and secures a revolving credit facility.
• The Bundeswehr places a €1 billion order for Rheinmetall trucks.
• Uber increases its stake in Delivery Hero.
• Enel signs a $140 million agreement to acquire a portfolio of solar power plants in the US.
• Grizzly Research announces a short position in Ottobock.
• The CEO of Uniper welcomes the official launch of the reprivatisation process.
• The CEO of Indra Sistemas is stepping down following governance tensions.
• Roche and the MPP sign a licensing agreement for the flu treatment Xofluza.
• Accelleron launches a CHF 100 million share buyback programme.
• The proportion of Solvay’s capital sold short has exceeded 5%.
• Dormakaba acquires Airsphere and strengthens its presence in airports.

• Google and Blackstone are teaming up to compete with CoreWeave.
• Meta is rolling out new features on its AI glasses.
• Ford is in talks to supply military trucks in Europe and North America.
• The CEO of Nvidia, Jensen Huang, expects the Chinese authorities to eventually authorise the import of artificial intelligence chips from the United States.
• Dell Technologies is rolling out production-ready agent-based AI, from the workstation to the data centre.
• Apple has announced a special event at Apple Park on 8 June.
• AI chip startup Tenstorrent has attracted interest from Intel and Qualcomm with a view to a takeover, according to Bloomberg.
• Analog Devices is reportedly set to acquire Empower for $1.5 billion, according to Bloomberg.
• Today’s key earnings reports: The Home Depot, Keysight, Amer Sports, Diploma, James Hardie…

See more news from UK listed companies here

Analyst Recommendations:

• Watches Of Switzerland Group Plc: RBC Capital maintains its sector perform recommendation and raises the target price from GBX 560 to GBX 650.
• Vistry Group Plc: Barclays maintains its underweight recommendation and reduces the target price from GBP 3.60 to GBP 1.85.
• Persimmon Plc: Barclays maintains its equalweight recommendation and reduces the target price from GBP 15.14 to GBP 11.22.
• Barratt Redrow Plc: Barclays downgrades to equalweight from overweight and reduces the target price from GBP 4.82 to GBP 2.60.
• Bellway P.l.c.: Barclays downgrades to equalweight from overweight and reduces the target price from GBP 33.90 to GBP 20.20.
• Berkeley Group Holdings Plc: Barclays maintains its overweight recommendation and reduces the target price from GBP 42.80 to GBP 39.96.
• J Sainsbury Plc: Morgan Stanley resumes coverage with a recommendation of market weight and a target price of GBX 345.
• Travis Perkins Plc: JP Morgan maintains its overweight recommendation and reduces the target price from GBP 6.80 to GBP 6.30.
• Vistry Group Plc: JP Morgan maintains its neutral recommendation and reduces the target price from GBP 5.30 to GBP 4.30.
• Pagegroup Plc: UBS maintains its neutral recommendation and reduces the target price from GBX 250 to GBX 125.
• British American Tobacco P.l.c.: Hedgeye Risk Management upgrades to long from watch list.