Situational Unawareness

Via Rabobank,

Markets have a habit of explaining every move with the most obvious narrative available. This week, that narrative was earnings. Investors spent days dissecting cloud growth, AI capex, free cash flows, and also Fed messaging, while some of the most dramatic price action of this summer was being driven by something else entirely. 

That "something else" was Situational Awareness, the AI-focused hedge fund run by a 24-year-old whizz-kid, which reportedly had to offload most of its public equity book to Citadel following the recent tech rout. It turns out that loading up on leverage and high-beta names works both ways, also if you're exceptionally smart. In a market where everyone is a momentum investor until they become a forced seller, those unwinds are never pretty. You take the escalator up, but the elevator down. 

The timing was certainly interesting. Earlier in the week, Citadel raised eyebrows by calling for a July Fed rate hike, adding to an already nervous backdrop. Days later, it emerged as the buyer of a large block of stock from a distressed seller. Readers can draw their own conclusions. Either way, once the position clearing became public, the sell-off looked less like a systemic event and more like a straightforward deleveraging episode. That was enough to help put a floor under markets, at least for now. 

This morning, chip stocks are ripping higher alongside a broader rebound in Asian tech. South Korea is once again leading the charge, with the KOSPI up 18%, capping an extraordinary week in one of the world's most volatile equity markets. 

Japan also joined the action. USD/JPY was hammered lower from 163 to 159 on Thursday following FX intervention, with Warsh's hold and relatively dovish press conference arguably providing the window the Japanese Ministry of Finance had been waiting for. The dollar had already begun to soften on its own, making intervention easier to execute. 

Initial speculation was that the move would be followed by a Bank of Japan rate hike, but that failed to materialise this morning. Only one of the nine board members, Hajime Takata, voted for a consecutive hike, which would have been the first such move in decades. Even so, Governor Ueda struck a sufficiently hawkish tone to help make the intervention stick, with investors seemingly content to take the BoJ at its word, unlike after this week's FOMC press conference. The yen currently trades around 160.4. 

China was the weak spot. The official PMI data disappointed, with both manufacturing and non-manufacturing activity slipping back into contraction territory. Domestic demand remains soft, and the Politburo meeting offered little comfort for those hoping for a fresh round of stimulus. Instead, policymakers focused on speeding up the implementation of measures already in place. 

The broader challenge is that China still relies heavily on exports to support growth, as the cracks in the domestic economy are wide. Weak consumer demand, falling foreign direct investment, subdued business investment and persistent overcapacity in parts of the industrial sector continue to weigh on activity. Record trade surpluses may flatter headline growth, but they do not provide a sustainable foundation for the economy, let alone its relationship with other countries.

In this report, we argue that China is likely to be pushed, at least gradually, towards a more consumption-driven growth model. That transition will not be painless. The adjustment could prove costly and disruptive, particularly if trade tensions with the rest of the world continue to intensify in the meantime. Our base case is that China's growth trend will continue to drift lower over the coming years and settle below the authorities' preferred 4.5%-5.0% range. We still expect growth of around 4.5% this year, but see it slowing to roughly 4.2% in 2027. 

As Chinese firms currently look abroad to absorb their excess production, Europe finds itself at the sharp end of the adjustment. Partly in response, the EU has rolled out a broad set of policies aimed at strengthening domestic production, reducing vulnerabilities in key supply chains and limiting exposure to external economic pressure. This report provides a non-exhaustive overview of those initiatives. Whilst there is clearly a more coherent framework emerging from Brussels, its is also fair to say that progress in implementation remains slow and uneven. 

US GDP grew by 1.5% q/q annualized in Q2, which, if you forget about silly things as decimal points, is bang in line with President Trump’s growth target of 15%. Consumer spending once again did the heavy lifting, rising 3.2% and accounting for most of the headline growth. Investment and exports also contributed positively, although government spending and imports acted as a drag. Business investment rose a strong 8.4%, largely thanks to continued spending on AI-related infrastructure and capacity expansion. Finally, real final sales to private domestic purchasers, often seen as ‘core GDP’ because it strips out trade, inventories and government spending, grew by a robust 3.9% in Q2, suggesting the private sector remains in good shape. 

In the UK, the Bank of England left Bank Rate unchanged at 3.75%, exactly as both markets and economists had expected. At first glance, the 6-3 vote split looked hawkish, with Catherine Mann joining Huw Pill and Megan Greene in voting for a 25bp hike. But the dissents do not tell a single coherent story. More importantly, the other six members appear comfortable tolerating inflation around 3% for the time being, provided second-round effects remain contained and the economy continues to soften. Bailey effectively confirmed as much in the press conference, making it clear that the Bank is not edging towards a rate hike. Oil prices remain the obvious wildcard, but the hurdle for a September hike still looks high. We expect no rate hikes this year.

Day ahead

The data deluge continues today. The French HICP print for July came in at 2.4% y/y while a much more modest 2.0% was expected, with energy prices being the main culprit. The euro area HICP print follows at 11:00 CET. Headline inflation is expected to tick up to 2.9% from 2.8%, while core inflation is seen holding steady at 2.4%. The expected rise in headline inflation mainly reflects rising oil and crack spreads, feeding through to fuel prices even more quickly than usual, while governments have started to roll back measures that had shielded households from higher energy costs, most notably Germany. 

Even if inflation rises to 2.9%, that would still leave it well below the ECB’s June projection of 3.4% for Q3 2026. That said, higher oil prices and mounting second-round risks reinforce the ECB’s concerns about underlying inflation pressures and keep it on track to raise rates again in September. 

In the US, the Employment Cost Index is expected to have risen by 0.8% q/q in Q2. That would leave wage growth at a pace the Fed could comfortably live with, broadly in line with 2% underlying inflation, assuming it still reacts to the data in a predictable way. Markets will also get a second look at the University of Michigan survey for July. The message probably remains familiar: households remain most concerned about fuel prices and, more broadly, the rising cost of living.