Why the Fed is wary of inflation

More power to the US dollar. # # --------------------------------------------------------------- The key takeaways today: - Why the Fed signaled one rate cut instead of three - France's snap election announcement unsettled the bond market - The US dollar is forecast to stay strong this year - Valuations are "the biggest challenge" for US equity investors - An "all-of-the-above" approach to powering the AI revolution - Investors are getting excited about utilities stocks - Briefings Brainteaser: Which currency fell the most after surprising election results on three continents? Was this newsletter forwarded to you? [Sign up now](. --------------------------------------------------------------- Why the Fed is still cautious about inflation Inflation may not be cooling as quickly as some investors may think, says Anshul Sehgal, head of US Interest Rate Products Trading in Goldman Sachs Global Banking & Markets, on this week's episode of [The Markets podcast](. Core CPI inflation in May came in well below expectations at 0.16% month-over-month, the slowest pace since August 2021. But according to Sehgal, there were elements of the report that weren't as promising as it appeared on the surface. Some sectors that aren't as sensitive to interest rates, like healthcare and medical services, “remain sticky” when it comes to inflation, he says. In an interview with Ashish Shah, global co-head and CIO of Public Investing with Goldman Sachs Asset Management, Sehgal notes that financial markets may have overreacted to the data. “One print does not make a trend,” Sehgal says. Also this week, the Federal Reserve indicated it would likely only cut its policy rate once this year. The US central bank had previously signaled that three rate cuts were likely. While the shift may have been surprising, especially coming on the back of tamer inflation data, Sehgal points out that the US job market “remains incredibly strong,” which could eventually drive up wages and reignite higher inflation. “It makes sense for the Fed to be cautious,” he says. If inflation stays low in the coming months, the central bank can always change its plan and move to two policy rate cuts, Sehgal adds --------------------------------------------------------------- What the French snap election means for the bond market French bond yields jumped after the country's far-right Rassemblement National outperformed Emmanuel Macron's centrist alliance in European parliamentary elections, spurring Macron to call a snap parliamentary election. While a status quo outcome — in which Macron's current ruling coalition stays in charge of domestic policy — is possible, the election also opens the door to a far-right government. The surprise snap election caused the spread, or extra yield, for French government bonds versus Germany's to widen “meaningfully,” according to Goldman Sachs Research analyst Simon Freycenet. But he expects the widening spread (compared with a week ago) to stay contained to less than 20 basis points, with an upper bound of 50 basis points. That's somewhat more subdued than in 2017, when the 10-year French-German bond spread increased by as much as 30 basis points, to 80 basis points, as Marine Le Pen challenged Macron for the presidency. Freycenet notes that the far right is no longer calling for an exit from the EU or the single currency. The main risks to bondholders are that a new government would fail to contain France's debt burden, that a far-right government would put domestic policy at odds with the rest of the EU, or that political uncertainty would cause more volatility for the bond market. --------------------------------------------------------------- The US dollar is likely to stay “stronger for longer” The US dollar has traded in a strong and tight range versus most of its major peers in 2024, and there's little reason to expect it to weaken appreciably anytime soon, [says Kamakshya Trivedi]( Goldman Sachs Research's head of global foreign exchange, interest rates, and emerging markets strategy research. He points to several factors that are likely to continue to support the dollar through the next 12 months: - The US economy: Despite high interest rates, economic data keeps coming up strong. - A patient Federal Reserve: The US central bank wants to make sure inflation has been tamed before cutting rates, and the dollar could move even higher if the Fed's global counterparts cut first. - The upcoming US election: Trivedi says that apart from which party wins, it's probably as important for the dollar whether there's a divided or unified government. A clean sweep in Washington may make big fiscal expansionary measures more likely, resulting in a stronger US currency. “Overall, we will continue to live in a strong US dollar world, with a number of risk factors that should support the dollar,” he says. “Any erosion in the dollar's strong valuation will likely be gradual.” When it comes to global finance, is there an alternative to the US dollar? Jared Cohen, co-head of the Goldman Sachs Global Institute, [writes in Foreign Policy]( that the true internationalization of a competitor currency is a long way off. --------------------------------------------------------------- Valuations are “the biggest challenge” for US equity investors After an impressive year-to-date rally, the high valuations of US stocks should now give investors pause, [according to David Kostin]( Chief US Equity Strategist for Goldman Sachs Research. “It's been a strong year economically,” Kostin said in a conversation with colleagues recorded on the sidelines of Goldman Sachs' RIA Professional Investor Forum. “Earnings are strong… but valuations are high. And I think that's the biggest challenge that investors are grappling with.” Participants at the conference, many of whom lead large independent investment advisory firms, were relatively cautious about the outlook for stocks over the next year. Among respondents to a pre-conference survey, 45% were bullish, while 33% reported feeling negative about markets. “I'm a little intrigued about the 33%,” said Padi Raphael, the global head of Third Party Wealth Management within Goldman Sachs Asset Management. “That same cohort also responded that they were interested in hedging solutions to mitigate some of the downside risk in markets that they were anticipating.” Raphael's observation chimes with what Adam Siegler, who leads the One Goldman Sachs RIA strategy for Global Banking & Markets, sees in terms of investment product demand. “We've seen tremendous growth in the structured notes market,” Siegler said. “A lot of these notes provide downside protection embedded in them, so that an investor can stay invested in the market but also have capital protection built into the structure.” He adds that the growth is unsurprising in the current environment, “because people want the equity exposure on the upside [and] some hedging on the downside.” --------------------------------------------------------------- Power surge: AI, renewable energy, and the future of electricity Carly Davenport (L) and Brian Singer (C) of Goldman Sachs Research talk to host Allison Nathan on Goldman Sachs Exchanges After an era of flat growth, electricity demand is set to surge to levels not seen in a generation. As the pace of energy efficiency gains for data centers slows and the AI revolution gathers steam, Goldman Sachs Research estimates that data center power demand will grow 160% by 2030. “To put that into context, if that 160% growth...were its own unique country, it would be a top 10 power producer in the world,” says Brian Singer, global head of GS SUSTAIN in Goldman Sachs Research, [on Goldman Sachs Exchanges](. That additional power will be sourced from an “all-of-the-above approach,” which includes natural gas, renewables, nuclear power, as well as companies that are building their own data centers, says Carly Davenport, Goldman Sachs Research's US utilities analyst. That translates into about 50 gigawatts of new power generation capacity in the US, says Davenport, who estimates about $50 billion of investment will be needed to build out the infrastructure to support that growth. Europe is at a similar inflection point, which could result in stronger power demand growth than the US, given the bloc's aim to produce roughly 70% of its electricity from renewables by the end of the decade. “The numbers are really, really big,” says Alberto Gandolfi, head of the European utilities team in Goldman Sachs Research. “If we put together data centers, AI-driven demand, and the electrification process, we see the potential for a 40%-50% increase in power demand in Europe over the coming 10 years,” he says. In case you missed it: Read [our previous article]( on how much power US and European data centers will need in an age of AI. --------------------------------------------------------------- Utilities stocks are now thrilling investors Often regarded as dividend-paying stalwarts, utilities stocks have become some of the most exciting names in the market. The utilities sector has returned 13% in the three months through June 7, far outpacing the equal-weight S&P 500's 1% gain, and making it the top performer among the 11 sectors. Interestingly, the sector has become a derivative AI play, [says Ryan Hammond of Goldman Sachs Research](. As highlighted on [the Goldman Sachs Exchanges podcast]( (see above), the rise of AI is expected to contribute to a substantial increase in power usage over the next decade, which could meaningfully drive electricity producers' businesses. [ Hammond explains that utilities retain their defensive qualities. “People still need electricity even in challenging economic environments,” which is why “historically the sector fares better than most when the economy slows.” Valuations have risen, with much of the sector's recent gains coming from multiple expansion. Yet Hammond points out that the sector's price / earnings to growth ratio remains below historical averages, suggesting that the rally is well-grounded in earnings expectations. “With the sector's mix of AI exposure and defensiveness,” Hammond says, “we think the utilities rally has room to run.” --------------------------------------------------------------- Briefings Brainteaser: Election shake-ups Emerging market currencies have gyrated amid unexpected election results on three continents. Which of these currencies fell the most since May 29 versus the US dollar, relative to a prediction based on market factors (as of June 7)? A) South African rand B) Indian rupee C) Mexican peso D) Chilean peso [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news By clicking on these links, you will be redirected to external websites that Goldman Sachs does not own or operate. 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