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Markets took a pause after last week’s rally which brought the main stock indices to post their best monthly advance in years, and sovereign bond yields their largest monthly cuts in two years. Investors have now turned cautious ahead of this week’s US employment data while still pricing in the likelihood of interest rate cuts as soon as March 2024.

Stronger-than-expected March retail sales in the US casted further doubts on the Federal Reserve’s motives to cut interest rates as soon as this summer. Markets now price a mere 20% probability of a cut in June, and 50% for July.

In yesterday’s session, investors focused their attention to the release of the last FOMC meeting minutes, which reinforced previous communication that Fed members still expect inflation to return to 2% over the medium term, while acknowledging that it will take longer than previously anticipated.

Investors continued to adjust their expectations for future interest rate cuts following strong PMIs, higher-than-expected wage growth in the euro area, and some hawkish remarks from central bank officials. Markets are now pricing in just two cuts from the ECB this year and one cut from the Fed, down from three and two, respectively, last week.

Investors' risk appetite increased on Wednesday as the ADP jobs report for June surprised to the downside and the ISM services report came in below expectations at 48.8. Separately, the release of the latest FOMC minutes showed that Fed officials acknowledged a slight slowdown in the economy as well as easing price pressures.

The continued repricing of the Federal Reserve's interest rate decision later this week was the main driver of financial markets during yesterday's session. The probability of a 50bp rate cut in the upcoming meeting rose to 70% from 50% last week, and the total amount of cuts in 2024 is now expected to be 120 bp, up from 100 bp.

Investors’ risk appetite soured yesterday. Sovereign bond yields rose across the board on both sides of the Atlantic. In the Eurozone, peripheral spreads widened a tad as French finance minister acknowledged the country's budget deficit could come in above 6% this year, leaving the 10-year French reference on par with the Spanish counterpart.

The Federal Reserve lowered interest rates by 25bp to 4.25-4.50% and signaled it will slow down the pace of cuts given its upward revision to the inflation forecast for the next two years. The Fed considered that the good health of the labor market and the little progress made on inflation in the recent months gives it room to act more cautiously from now on.

With no major macro data to trade on, financial markets continued to digest President Trump's first executive orders. Overall, investors were relieved that tariffs were not imposed on the first day, and while Mexico and Canada appear to become the first targets, a more gradual approach towards China and Europe is now expected.

Investor risk appetite remained relatively high on Tuesday. In the eurozone, government bond yields were broadly unchanged. The ZEW index showed a rise in German investor sentiment in February, and ECB's Cipollone had some dovish comments on future interest rates, both of which offset news of future higher public spending on defence in the EU.

US President Trump announced a 90-day pause on the so-called “reciprocal" tariffs for all targeted countries, but still maintained the 10% general tariff rate and raised the tariff rate for China to 125% after both countries’ authorities escalated the tension. US stocks rallied and the S&P had its largest intraday gain in over 17 years (+9.5%).

Investors' risk appetite rebounded slightly last week, a trend that largely continued into Friday's session. In the eurozone, government bond yields rose slightly, even though ECB's Holzmann, who had been advocating for a pause in rate cuts, acknowledged the disinflationary impact of tariffs and said the ECB's next rate decisions were "completely open".

Financial markets remained mixed yesterday. US Treasury yields fell as data releases pointed to a higher risk of stagflation. The May's ADP survey showed job creation was much lower than expected; while May's ISM services survey showed the sector contracted slightly and prices paid by businesses rose. Attention will now turn to Friday's non-farm payrolls report.

A downward revision of US Q1 GDP, primarily due to weaker private consumption growth (0.1% qoq vs. 0.3% previously estimated), increased market expectations that the Fed could lower interest rates as much as 75bp this year compared to the 50bp expected before.