Equity risk premium has evapourated

An unseemly row between Trump and Musk, along with a series of mixed economic reports, sent US stocks lower on Thursday. Those two falling out in a public and fairly vitriolic way comes as little surprise; many predicted it was always likely to end this way. What one should pay more attention to is the economic data coming out this week. Where to start? The release of the latest Beige Book report, a summary of commentary on Current Economic Conditions by each Federal Reserve District, reported that in the 6 weeks that have passed from the previous survey, there was a modest weakening in growth in several districts. Combined with prices rising at a “moderate” rate, and expectations of faster cost increases due to higher tariff rates. Whoopsie Daisy, the survey also revealed hiring had slowed.

Another data point this week was Wednesday’s  ADP payroll report, which provides its own monthly preview of private sector employment ahead of the official numbers coming out later today, which indicated that net hiring almost evaporated. These say things come in threes, so here you go: the Institute of Supply Management’s survey of the services sector, which is now the bulk of the US economy, headline number that dropped below 50, indicating contraction in the service sector.

The two-year US Treasury, the most sensitive to shifts in interest rate sentiment, barely moved this week and remains just below 4%, indicating that the bond market is uncertain about the news and certainly does not suggest that the Fed is more likely to cut rates than it was at the beginning of the week. The Citi Economic Surprise Index, which had been on a modest uptrend since early April, has now experienced a downturn, reflecting the weakness in recent data.

As a consequence of the rally in the US market, which has substantially rerated US equities back above historic levels, and with 10-year US Treasury yields around 4.5%, the equity risk premium — i.e. the additional expected return one should receive from the increased risk of owning equities — has returned to zero. Later today, we will receive more employment data, including the unemployment rate, average earnings, and non-farm payrolls; Traders will not be far from their desks at 13:30 today.

Following another cut in interest rates by the ECB yesterday, as widely expected, the rate now stands at just 2%, as they lowered their inflation expectations in response to a stronger euro and lower energy costs. In contrast to the recent US data, the euro area economic surprise index has ticked higher in recent weeks.