It took until the end of July for investors to find out how much the Fed would cut rates at the FOMC meeting on 31 July. The answer was 25bps and perhaps not much more after Fed Chair Jay Powell described the cut as a "mid-cycle adjustment." Markets hadn't waited for the actual cut announcement to price in the 180-degree dovish turn by central banks this year, the biggest factor driving risk assets higher.

But returns across risk assets in July suggest that the markets may have already moved on from central bank largesse to growth being the primary market driver. With the Fed not being as dovish as investors were expecting, the pivot towards growth-driven markets should be even more apparent.

A good example of that is the divergence in the July performance between US and ex-US equities - the former were up 1.5%, and the latter were down 1.3% (Fig. 1). US data has been getting better over the past month, based on retail sales, job growth, consumer confidence, and durable goods orders. Meanwhile, manufacturing and trade continue to slow in Europe, Japan, and parts of EM. This divergence also led to a strong US dollar, especially against the euro, where it appreciated 1.9% through July.

It's too soon to say that the US growth outlook has definitively improved, which the returns data also make clear. Cyclical stocks outperformed defensives in July by a few percentage points and the SOX semiconductor index is up 19% since 31 May. But small-caps continue to lag large-caps, and likewise CCC-rated high-yield bonds lag BBs (Fig. 2). If investors were really confident about the US expansion not ending any time soon, then these high beta assets should be outperforming as well.

The bottom line: With Fed rate cuts behind us and markets still pricing in ample central bank easing, absolute and relative performance in the coming months will likely depend more on growth than monetary policy. US growth should continue to be solid, while clear improvements elsewhere could take longer. But if, or when, growth does turn for the better, lagging cyclically sensitive assets could shine.

Fig. 1: US equities again led the pack in July

Total returns by asset class

Fig. 2: Small-cap stocks and CCC-rated bonds are underperforming

Relative performance of small-to-large cap US equities and CCC-to-High Yield US corporate bonds

Author:

Jason Draho, Head Asset Allocation Americas, UBS Financial Services Inc. (UBS FS); Michael Gourd, Investment Associate Americas, UBS Financial Services Inc. (UBS FS)

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Appendix

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