Global Market Euphoria: A Closer Look

Following a benign US inflation report on Tuesday, global markets witnessed a rush of capital into riskier assets. This shift has quelled concerns about stagflation and cleared the path for potential interest rate cuts by the Federal Reserve.

Equity markets have soared to record highs, with small-cap stocks, emerging markets, and semiconductor sectors continuing their upward trajectory. Despite the potential for Trump's trade policies to disrupt global commerce, implied volatility measures have significantly declined. Cryptocurrency gains have also extended, with Ethereum accumulating a 55% gain over the past month. Meme stocks have also seen a resurgence.

Decoding the Bullish Market Mood

These movements highlight a robust positive sentiment prevailing over the past few months. Concerns about an impending trade war, which triggered sell-offs in April, have given way to confidence in the economy's ability to continue growing strongly. This renewed optimism follows fresh hopes for interest rate cuts from the Federal Reserve.

“Sentiment is unexpectedly bullish, almost as if to say, ‘Tariffs? Who cares?’” said Neil Birrell, chief investment officer at Premier Miton Investors. “There’s a disconnect from the current economic reality, and a feeling of complacency or euphoria in the air.”

Market Expectations and Expert Views

Swap markets are currently pricing in roughly a 90% chance of a 25-basis-point rate cut by the Federal Reserve in September, with some traders even betting on a larger cut. Treasury Secretary Beisnt expressed on Tuesday that the Fed should consider a larger 50-basis-point cut next month.

Amidst this backdrop, the S&P 500 has regained its record high, highlighting strong corporate earnings that suggest a limited impact from tariffs. The benchmark index has surged nearly 30% since its April lows, and almost 12% since Trump's election in November of last year.

Falling volatility gauges are another sign of strong market confidence. The VIX index has fallen to its lowest level since last December, the MOVE index for bond market volatility sits at its most benign level since 2022, and implied volatility measures in the foreign exchange market have also dropped to a one-year low.

“Do I see lots of potential risks that could undermine current market sentiment and expectations? Yes. But I don’t think the market is irrational at the moment. The rally could go on for a very long time before the market becomes irrational. The cost of shorting is very expensive right now,” said Bernard Ahkong, chief investment officer at UBS O’Connor Global Multi-Strategy Alpha fund.

A Shift in Market Sentiment

In equity markets, the market mood has shifted from fears of a trade-induced recession in April to outright optimism about economic resilience, benign inflation, and potential rate cuts.

The AI craze has once again let tech giants to lead the way. The so-called “Magnificent Seven” tech stocks have risen almost 50% since early April, after a pullback in the first quarter.

This is largely due to strong earnings that have eased concerns about overspending on AI. An analysis by Deutsche Bank strategists shows that large tech stocks almost single-handedly drove second-quarter earnings growth, contributing 90% of the overall increase in S&P 500 profits.

Bloomberg strategist Mark Cudmore believes that “Fighting this equity rally is foolish, even if the fundamental framework supporting the market seems extremely flimsy. If long-end US Treasury yields rise, equities will eventually be hit — unless equities fall first, or Trump throws another policy curveball. But there’s no need to trade that logic too early.”

Optimism is even extending to the riskiest areas of the US stock market. The Russell 2000 small-cap index (which is typically more sensitive to interest rates than large-cap stocks) is logging its fourth consecutive month of gains.

Wall Street Caught Off Guard

This year's wild swings in the stock market have left Wall Street strategists in disarray—typically struggling to keep up with April’s steep declines and subsequent rebounds. A few forecasters who remained calm during the April sell-offs have been proven correct, such as Morgan Stanley’s Michael Wilson and former Wells Fargo strategist Chris Harvey. Although Wilson has warned of potential further near-term declines in the S&P 500, he has remained steadfast in his bullish 12-month target price, and has been advising clients to buy on dips since May.

Peers at investment banks such as Goldman Sachs and Citigroup haven’t fared as well. They hastily lowered targets after trade policies were announced, only to revert to bullish stances after Trump paused large tariff impositions and corporate earnings showed resilience.

Today, Wall Street forecasters have become more optimistic. Citigroup strategist Scott Chronert raised his year-end target for the S&P 500 again this month, partly because he expects tax cuts to offset the impact of tariffs. Although investors share this positive sentiment, positioning data shows that their equity allocations aren’t excessive.

However, in other markets, the recovery that started from April lows hasn’t been so certain. The US 10-year Treasury yield is less than 5 basis points different from where it was at the end of March. The Bloomberg dollar index is still more than 9% below its pre-inauguration high.

“Interest rate markets will continue to digest the expectation of further interest rate cuts by the Federal Reserve, as the discussions get hotter around a potential 25- or 50-basis-point cut in September,” said Laura Cooper, head of macro credit at Nuveen and global investment strategist. “Yesterday’s inflation data cleared the path for that discussion to get hotter.”