Barclays strategists say the markets may be nearing a point of peak hawkishness as recent comments from the Federal Reserve under its new chair, Warsh, have pushed real interest rates above the year-to-date range and strengthened the U.S. dollar. That combination has tightened financial conditions and set off a broad risk-off rotation in equities.
Investors have moved away from this year-to-date momentum leaders - concentrated in technology, AI and commodities - and have rotated into defensive and quality names. The bank’s team notes that the market now places greater odds on a September rate hike, though Barclays’ economists do not treat that outcome as their base case. With the Fed’s reaction function under Warsh still uncertain, the strategists warn that volatility could remain elevated through the summer.
Concerns over semiconductor valuations have been a contributor to the unwind of momentum, yet Barclays points to strong results from Micron (NASDAQ:MU) as evidence that AI-related demand is holding up. Those results, the strategists say, have encouraged investors to retain a buy-the-dip stance on the semiconductor sector.
More important for the second half, according to Barclays, is whether the inflation trajectory stabilizes. West Texas Intermediate crude has declined to about $70 a barrel - close to pre-war levels and below its five-year average - and prices for industrial metals have retreated by double-digit percentages from recent peaks. That backdrop opens the door to a disinflationary regime if energy prices remain subdued.
"If oil prices remain well behaved near current levels, disinflation could be the regime to position for into H2," the team led by Emmanuel Cau wrote.
Markets today are pricing in a full Fed hike in October and an additional move from the European Central Bank, but Barclays cautions that neither is a foregone conclusion. Given that context, the strategists see scope for performance to broaden toward European equities and cyclical underperformers - especially consumer-facing areas - as well as rate-sensitive pockets of the market that have been beaten down.
Supporting that view, the bank points to a modest pickup in European economic surprises, with the latest purchasing managers' index and IFO readings showing some improvement. Barclays suggests that if commodity deflation persists and central-bank tightening peaks, investors may rotate back into cyclicals and regional equity markets that lagged during the recent risk-off move.
The strategists nonetheless underline the conditional nature of this outlook: it rests on energy and commodity prices remaining near current levels, and on central-bank actions that do not further tighten financial conditions. Until the Fed’s policy path under Warsh becomes clearer, markets could experience elevated volatility even as the potential for a H2 disinflation trade emerges.