Morning Update: Disinflation, Market Shifts, and a Weakened Dollar

Market Movements and Economic Indicators

A noticeable shift from Big Tech to small-cap stocks occurred following a surprisingly positive U.S. inflation report for June. Concurrently, U.S. borrowing rates and the dollar saw significant declines while Japan's yen garnered attention in the currency market. The anticipated volatility on the U.S. Consumer Price Index (CPI) release day was indeed intense. As the second-quarter earnings season begins with major U.S. banks preparing their reports, the confirmation of ongoing disinflation has made a significant impact.

Seeded by sharp declines in AI and EV leaders Nvidia and Tesla, the Nasdaq fell nearly 2%, retreating from record highs, whereas small-cap stocks in the Russell 2000 surged over 3%, reaching three-month highs and marking their best performance of the year. The S&P 500 saw a less dramatic decline, losing nearly 1%, with futures remaining stable overnight.

Tesla's 8.4% drop, its largest since January, was partly attributed to a Bloomberg report suggesting a delay in the launch of its robotaxi by approximately two months. The volatile rotation seemed to be a knee-jerk reaction to the positive inflation data, showing headline prices fell for the first time in four years, and annual inflation dipped below 3% for the first time in twelve months. Core inflation also came in below forecasts at 3.3%, the lowest in three years, and services and shelter components moderated. The background featured a notable drop in weekly jobless claims, adding to the mixed stock market signals. Friday's producer price updates are expected to further clarify the inflation picture.

Reactions from the Federal Reserve and IMF

Federal Reserve officials quickly praised the June report. St. Louis Fed President Alberto Musalem called it "encouraging," San Francisco Fed President Mary Daly mentioned "relief," and Chicago Fed's Austan Goolsbee termed it "excellent" news, aligning with the Fed's 2% inflation target. The International Monetary Fund maintains that the Fed could begin cutting interest rates later this year. Rate futures markets now fully price in a Fed cut by September, with expectations for up to 60 basis point reductions by year-end. Ten-year Treasury yields plummeted to a four-month low but bounced back above 4.2% early on Friday. The dollar weakened, particularly against the yen, which saw nearly a 2% surge amid speculation of Japanese intervention to bolster its value.

The tumult in global markets continued into early Friday, leading to diverse reactions. Japan's Nikkei fell 2.5%, and other tech-heavy Asian markets in South Korea and Taiwan also experienced sharp declines. Meanwhile, Hong Kong's shares surged, and Chinese mainland stocks showed mixed results due to conflicting signals from the June trade report—while exports exceeded expectations, falling imports raised concerns about domestic demand.

European Markets and Political Focus

In Europe, stock markets mostly reacted positively on Friday, with only the UK's midcap FTSE250 retreating slightly from its two-year peak following the CPI report. The dollar's retreat benefited both the euro and sterling, the latter experiencing a post-election high for the year.

In the political arena, U.S. President Joe Biden faces continued pressure to step aside from the upcoming presidential race after a series of verbal missteps at a NATO summit in Washington. Key developments that should provide further direction to U.S. markets later on Friday include the U.S. June producer price index and the July University of Michigan consumer survey. Additionally, corporate earnings reports from major financial institutions like JPMorgan, Citi, and Wells Fargo, among others, are anticipated.