There is a rapid rethinking of the assumptions that have driven global financial markets this year.

In bond and currency markets, investors raced to reallocate money as growing doubts about the U.S. economic outlook led to speculation that the Federal Reserve could end up cutting interest rates faster or more than planned. The catalyst for the change? Weak U.S. consumption, which showed up in a string of disappointing corporate earnings.

At the same time, shareholders are suddenly skeptical that tech companies’ huge investments in artificial intelligence will pay off soon, sending investors scrambling to sell off big winners like Nvidia Corp. and Broadcom Inc.

Copper and other industrial metals also reversed recent gains, with a slowdown in Asia and concerns about the U.S. and technology stocks contributing to their declines.

Even a report on Thursday showing stronger-than-expected U.S. economic growth in the second quarter did little to allay investor concerns about the path ahead.

“It appears that people have started to unwind positions in popular trades that have driven valuations to silly levels,” Louis-Vincent Gave, CEO of Gavekal Research, wrote in a note to clients.

“If the economy starts to slow, the pace of the slowdown becomes critical,” Torsten Slok, chief economist at Apollo Global Management, told clients Thursday. “A faster pace of slowdown would negatively impact earnings and increase the likelihood of a downturn in equity and credit markets.”

Here are some notable market moves and underlying assumptions that have changed:

Government Bonds

In bond markets, dimming global growth prospects are underpinning bets on rate cuts, with investors rushing to buy short-term bonds before rate cuts materialize amid concerns that monetary policy is now too tight.

At one point on Thursday, the two-year Treasury yield was just 12 basis points above the 10-year Treasury yield, the closest the market has come to ending the inversion since mid-2022 and a far cry from the spread of more than 50 basis points a month ago.

While the chances of the Fed cutting interest rates at next week's meeting look very slim, markets are already pricing in a bigger rate cut later this year.

Key part of U.S. yield curve close to ending inversion

Traders are pricing in about a 25 basis point rate cut by September, with about a 20% chance of a larger cut and more than 60 basis points of cuts by 2024.

The yen, one of the biggest victims of tighter U.S. monetary policy over the past two years, has rebounded about 5% from lows hit earlier this month, making it the biggest gainer among Group of 10 currencies so far.

Investors have long liked to borrow in the low-yielding yen to finance investments in higher-yielding currencies such as the Mexican peso or the Australian and New Zealand dollars, but now they believe that is changing as the gap between the yen and its peers narrows.

Stock Market

U.S. and European stocks have been driven this year by a consensus that inflation is under control, allowing the Federal Reserve to ease monetary policy later this year and avoid a recession.

As of mid-May, the Stoxx Europe 600 index hit a record high, giving investors a 12% return for the year. The S&P 500 hit a string of new highs, led by technology stocks.

Now, many investors believe the Fed is behind the curve — not only is inflation slowing but the economy is weak.

As a result, some market observers predict that the Fed risks making a policy mistake if it does not cut interest rates soon, and may have to take more measures later if it does not.

With nearly a third of S&P 500 companies reporting second-quarter results so far, sales figures are increasingly in focus, with a slowdown already starting to show. Just 43% of companies are beating revenue expectations, which would be the lowest in five years, according to data compiled by Bloomberg Intelligence.

The mania for artificial intelligence isn’t looking so rosy anymore after Google parent Alphabet Inc. surprised investors this week with its spending on the technology but had little to show for it in terms of revenue.

The Nasdaq 100 has fallen nearly 9% from its July 10 record, wiping $2.3 trillion off the market value of the index’s benchmark companies. The index is still up 12% this year, and an investor survey by Bank of America this month showed investing in the so-called “Big Seven” was the most crowded trade since October 2020 when it came to investing in growth stocks.

“It is increasingly difficult to justify the valuations of the mega-cap tech stocks under all but the most optimistic forecasts for future growth, earnings and monetary policy,” said James Athey, portfolio manager at Marlborough Group. “It is inevitable that this extreme scenario cannot continue.”

Metal

Growing pessimism about demand and the technology industry has also spread to metals markets.

Copper fell below the $9,000 a tonne threshold for the first time since early April, having fallen about 20% since hitting a record in mid-May. Aluminum hit a four-month low this week before recovering somewhat.

The change now is that investors who previously bought the metal on concerns about tight supply and rising use in data centers and other areas are now worried about rising inventories and a weak spot market.

“In the long battle between fear and greed, the former has the upper hand as many consensus positions have suffered losses this week,” said Cameron Crise, a Bloomberg macro strategist. “This all represents a collective ‘pain ride’, with pricing in almost the only fundamental that matters amid a reduction in investment risk across the board, and this is one of those cyclical events.”

The article is forwarded from: Jinshi Data