Markets Wrap

Euro Cyclicals Surge 9%, Outshine Defensives

European cyclical stocks surge amid economic optimism, challenging central banks' balancing act between growth and inflation control.

By Athena Xu

4/3, 17:00 EDT
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Key Takeaway

  • European cyclical stocks surge 9% YTD, outperforming defensives amid growing economic optimism and positive investor sentiment.
  • Speculation on fewer rate cuts in 2024 challenges equity markets, with rising 10-year yields pressuring stock valuations.
  • Debate intensifies over the impact of high rates on economic resilience, suggesting current policy may be less restrictive than assumed.

European Cyclical Stocks Lead the Charge


European cyclical stocks, including autos and banks, are outperforming in the current equity rally, reflecting growing optimism about the economic and earnings landscape. The Stoxx 600 cyclical index has seen a nearly 9% increase year-to-date, outpacing its defensive counterpart by more than double. This surge is supported by a positive shift in investor sentiment, with a net 21% of respondents in a recent European Bank of America fund manager survey expressing optimism about the region's economic prospects over the next 12 months. Additionally, 45% of respondents anticipate further upside for European cyclicals, buoyed by easing credit conditions and improving PMIs. The momentum in cyclical stocks is further evidenced by the broadening of equity rally gains, with sectors like retail and energy benefiting from the prospect of attractive shareholder returns.

Interest Rate Speculations and Market Reactions

The financial markets are currently grappling with the implications of potential interest rate cuts by central banks, amidst signs of economic resilience. Recent solid economic readings and a commodities rally have led to speculation that major central banks, including the Federal Reserve, may maintain higher interest rates for longer. This has resulted in a shift in trader projections, with fewer rate cuts expected in 2024 than previously anticipated by the Fed. The rise in 10-year yields to their highest levels since November has exerted pressure on equity markets, challenging the rationale for stock purchases at elevated levels. This dynamic underscores the delicate balance central banks must strike between supporting economic growth and managing inflationary pressures.

Real Rates and Monetary Policy Outlook


The outlook for real rates in the US remains a topic of intense debate, with stubborn inflation posing a challenge to the Federal Reserve's ability to cut interest rates as swiftly or significantly as markets expect. The yield on 10-year inflation-protected Treasuries suggests that real rates will stay buoyant through the second quarter. This is compounded by recent data, including a rise in the Institute for Supply Management's index of prices paid, which has stoked fears of creeping inflation. Despite the Fed's dovish dot plot unveiled last month, the central bank's cautious stance on rate cuts reflects concerns about reigniting inflationary pressures. This cautious approach is further justified by the Fed's revised estimate of the nominal neutral rate, suggesting that the current policy rate may not be as restrictive as previously thought.

Rethinking the Impact of High Rates on the Economy

The debate over the restrictiveness of current monetary policy settings is gaining traction, with some suggesting that high interest rates may have made the economy more resilient rather than constraining growth. This perspective challenges the conventional wisdom that policy is restrictive based on nominal and real yield levels relative to the past fifteen years. Instead, it posits that the economy and markets may have adapted to higher rates, potentially rendering current policy settings less restrictive than assumed. This hypothesis is supported by the behavior of economic growth, inflation, and financial markets, which collectively suggest that overall conditions may currently be accommodative.