Stocks drop as investors face gut check on Q2 rally

BLOOMBERG

Stocks fell with US Treasuries as the second-quarter (Q2) rally met resistance from economic headwinds and signs that positioning is overbought.The chemical industry led declines in Europe after Lanxess AG slumped as much as 15% on a profit warning, dragging shares of peers including BASF SE lower. Drug maker Sanofi gained the most since March after a favourable arbitration ruling. US contracts declined after Wall Street was shut for a holiday. An index of Asia-Pacific shares fell.
Investors caught between fear of missing out and concerns markets have run too far, too fast are contending with overblown valuations and economic headwinds. Bullish positioning in US equity futures grew, taking it to the most extended levels for the S&P 500 and Nasdaq 100 in data going back to 2010, according to Citigroup strategists.
The path of US monetary policy is another wild card. Federal Reserve Chair Jerome Powell will give his semi-annual report to Congress on Wednesday.
Policymakers at the Fed kept interest rates unchanged at their latest meeting but warned of more tightening ahead. Investors also await the outcome of policy meetings in Turkey, the UK and Switzerland. “If you consider that interest rates take at least a year to have an impact on the economy, the vast majority of all the rate hikes in this cycle have not yet had any effect,” said Mike Riddell, global macro portfolio manager at Allianz Global Investors.
“It feels like people are worried, but they’re not actually positioned that way.” The Fed decision came with forecasts for higher borrowing costs of 5.6% in 2023, implying two additional quarter-point rate hikes or one half-point increase before the end of  the year.
That contrasts with market pricing for some 20 basis points of tightening in the remainder of the year.
“The focus this week remains on the central banks and whether we are as close to the end of the tightening cycle as everyone wants to believe,” said Craig Erlam, a senior market analyst at Oanda. “Markets have been overly optimistic. The data simply hasn’t justified changing course yet.
Rate cuts this year look more fantasy than reality now.” Elsewhere in markets, US Treasury yields rose after the break from trading. Oil fell as China’s plans to support its economy were seen as insufficient to reignite demand. Alibaba Group Holding Ltd whipsawed before trading about 1.5% lower following the surprise replacement of its chief executive and chairman.