Diverging Rate Decisions

Here are some of the biggest stories from last week:

• Europe’s economy grew by more than expected.
• But inflation in the bloc saw a surprise uptick.
• The Bank of Japan delivered its second rate hike of the year.
• The Fed held its key rate steady but said a cut could come in September.
• The Bank of England lowered rates for the first time since 2020.
• Indian stocks' valuation premium relative to their Asian counterparts hit a record.
• The AI boom is derailing the US’s emissions targets.

Dig deeper into these stories in this week’s review.

Macro

New data this week showed the eurozone economy expanded by 0.3% last quarter from the one before, growing at the same pace as it did at the start of the year and surpassing forecasts of 0.2%. The better-than-expected performance, which should alleviate concerns that the region's nascent recovery might be losing momentum, was bolstered by strong growth in Spain, France, and Italy. That helped offset an unexpected 0.1% drop in Germany – the bloc’s biggest economy – due to a big dip in investment in equipment and buildings. So despite a positive report overall, the uneven growth across the region could pose a challenge to the European Central Bank as it deliberates the timing of its next interest rate cut.

However, the central bank received another important piece of data this week that could help inform its decision, with a separate report showing annual inflation in the eurozone increasing slightly to 2.6% in July from 2.5% the month before, defying economist expectations for a flat reading. The unexpected acceleration, combined with an economy that’s still chugging along and not in desperate need of the boost that comes from lower borrowing costs, could make the ECB wary about cutting interest rates aggressively. But for now, traders still see a quarter-point reduction at the bank’s next meeting in September as all but certain.

Central Banks

This week was a big one for central banks, with the Bank of Japan, Fed, and Bank of England all announcing their latest interest rate decisions.

The BoJ raised its benchmark interest rate to “around 0.25%” – the highest level since December 2008 – from a previous range of 0% to 0.1%. Policymakers stopped short of committing to any further increases, saying that any additional hikes this year would be data dependent. Finally, the central bank outlined plans to halve the amount of bonds it buys every month to around ¥3 trillion ($19.6 billion) by the first quarter of 2026. In taking these steps, the BoJ is showcasing its will to proceed with policy normalization after years of ultra-easy measures that included the world’s last negative interest rate until March this year.

The Fed, meanwhile, left its benchmark federal funds rate unchanged at a 23-year high for the eighth meeting in a row, maintaining it in a range of 5.25% to 5.5%. But the central bank gave its clearest signal yet that it’s readying for a policy pivot, saying that it could start lowering interest rates as soon as its next meeting in September. That comes as it becomes increasingly confident that inflation is heading toward its 2% target. After all, the Fed’s preferred inflation gauge, based on the core personal consumption expenditures price index, is now at 2.6%, having peaked at more than 5% in 2022.

Finally, in a tightly contested decision, the BoE delivered its first rate cut since the pandemic this week. Members of the Monetary Policy Committee voted five to four to reduce the bank’s key rate by a quarter of a percentage point to 5%, after having kept it at a 16-year high for a year in an effort to bring down inflation. The central bank stopped short of giving any specific guidance on where rates may settle in the future or the speed of cuts needed to get there, warning instead that it needs to be careful not to lower rates too quickly or by too much. However, it did upgrade its economic growth forecast for the UK economy for this year to 1.25% from 0.5%, but left its projections for 2025 and 2026 unchanged at 1% and 1.25%, respectively.

Stocks

Excitement over India’s rapidly expanding, consumption-driven economy has sent the nation’s shares almost 40% higher over the past year. But that’s left the stocks looking expensive. The MSCI India’s forward price-to-earnings (P/E) ratio is currently 24.3x – roughly 27% higher than its ten-year average. It also marks a 104% premium on top of the MSCI Emerging Markets index, which has a forward P/E ratio of 11.9x. Indian shares have always traded at a premium to emerging market stocks, sure, but the current gap is way above the ten-year average of 61%.

And just this week, the MSCI India’s priciness hit yet another milestone, extending its valuation premium over Asian peers to a new record. More specifically, the gap between the MSCI India’s forward P/E ratio and its Asia Pacific counterpart widened to more than ten points – the highest level recorded in two decades of data.

Emissions

As part of its commitment to the 2015 Paris Accord, the US – historically the world’s biggest polluter – has set a goal of halving greenhouse gas emissions by 2030, compared to 2005 levels. And the Inflation Reduction Act, passed in 2022, was meant to help put the country on track to meet that objective by offering generous subsidies and tax breaks to the energy and transportation sectors.

However, something unexpected happened in late 2022 that began disrupting the US’s noble plan: the mega-successful launch of ChatGPT kicked off a spending spree on AI data centers. See, these massive warehouses packed with computing gear consume an enormous amount of energy. Goldman Sachs, for example, forecasts that US electricity demand from data centers will expand at a 15% compound annual growth rate from now until 2030. That’ll leave them responsible for 8% of total US power demand by the end of the decade, up from about 3% currently.

Problem is, new investments in clean energy generation are struggling to keep up with this booming demand for electricity, which is being further supercharged by the rising use of EVs. That means dirtier sources of energy – like coal and natural gas – need to stick around for longer. So much so that the US will likely only achieve emissions cuts of between 32% and 43% below 2005 levels by 2030, according to new analysis by research firm Rhodium Group.

Still, Rhodium notes that its projections are based on current federal and state policies – and a lot could change depending on the election results in November. The report said that if former President Donald Trump were to win, it might result in policy reversals and the US potentially withdrawing once more from the Paris Accord. That, in turn, would put the country further behind its 2030 target – assuming that isn’t scrapped as well…

Next week

• Monday: Eurozone economic sentiment (August). Earnings: Palantir Technologies.
• Tuesday: Japan household spending (June), eurozone retail sales (June), US trade balance (June). Earnings: Uber, Caterpillar, Amgen, Airbnb, Rivian, Super Micro Computer.
• Wednesday: China trade balance (July). Earnings: Disney, Novo Nordisk, Shopify.
• Thursday: China loan growth (July). Earnings: Eli Lilly, Gilead Sciences.
• Friday: China inflation (July).