Coffee Break

Last week in a nutshell

• In the US, the headline PCE inflation rose to 2.3% YoY in October, and the core went up to 2.8% - disinflation is on pause and the FOMC wants to proceed gradually.
• In the euro zone, estimates of November inflation rose by 2.3%, in line with expectations and confirming the likelihood of a ECB rate cut at its December meeting. German retail sales fell 1.5% in October, much more than the expected 0.3% drop, partially reversing third-quarter gains.
• French Prime Minister Michel Barnier's government and OAT/Bund spreads came under pressure as opposition to the 2025 budget law grows in Parliament.
• The yen surged after Tokyo’s consumer inflation rose to 2.6%, fuelling expectations of a rate hike in December.
• Officials from Mexico, Canada, and China warned that Donald Trump’s tariff threats could harm economies, spike inflation, and damage job markets.

Investment convictions

Core scenario

• The global economic landscape is increasingly marked by monetary policy divergence, with central banks taking distinct paths. In the US, the Fed's near-term forward spread has narrowed to early-2023 levels, highlighting reduced policy accommodation.
• In the euro zone, manufacturing and services activity as well as sentiment are deteriorating, putting the ECB in a tight spot. Trailing behind France and Italy, Germany sees its challenges being compounded by declining exports to China, higher energy costs, and the anticipated impact of tariffs.
• Facing low expectations, activity releases from China have also surprised to the upside and shifted into higher gear in recent weeks.

Risks

• The euro zone’s economic revival is increasingly paramount to the war in Ukraine ending and energy prices easing – both are unlikely in the short term.
• Severe US immigration restrictions and massive tariff increases by the US could intensify inflation, and a tight labour market might force the Fed to increase its funds rate as soon as next year. As a result, the growth/inflation mix would deteriorate markedly.
• Such policies, notably trade uncertainty, would have a ripple effect on global markets.
• Geopolitical risks continue to pose a threat to global growth and energy prices, particularly with the ongoing war in Ukraine.

Cross asset strategy

1. Our outlook is largely guided by the two main market drivers: growth and inflation.
2. We anticipate outperformance from the US economy, driven by robust growth, no apparent disequilibrium, and reflationary policies and have an overweight equity allocation, which includes the broad market, financials, industrials and small-cap stocks – segments that would benefit from stronger GDP growth due to domestically-targeted stimulus policies. We are also long US dollar. Markets have re-adjusted Fed rate cut expectations following the US election, which represents a tailwind for the greenback.
3. Regarding our regional strategy:
   • We have further downgraded EMU equities, and have a negative view. The region is already weak and appears most vulnerable to the announced policies of the future US administration. We also downgraded UK equities where we switched towards a neutral view.
   • We have a positive view on emerging markets although the US election poses a challenge through currency impacts and trade tensions but our position comes with an option on China. We await greater clarity from the Chinese authorities and potential new support measures as a response to new US tariff initiatives.
   • We remain neutral on Japanese equities.
4. Concerning the equity sector allocation:
   • We have an exposure to cyclical themes in the US, including Small and mid-caps, Financials and Industrials.
   • Conversely, we reduced our allocation to defensive sectors, such as Healthcare and Consumer Staples.
5. In the fixed income allocation:
   • Contrary to equities in the region, European assets could shine in the fixed income segment. In our view, core European government bonds are an attractive investment following the weak news flow and the recent uptick in yields as they offer carry and a hedge in a multi-asset portfolio as correlations have shifted during the year. We maintain a long-duration bias via Germany, focusing on quality issuers.
   • We have downgraded the outlook on US sovereign debt and are negative on US duration.
   • Also, we see little room for credit spreads to tighten further.
   • We are neutral on investment grade and high-yield bonds, regardless of the issuers’ region.
   • We have a small exposure to emerging markets' sovereign bonds amid very narrow spreads.
6. We keep an allocation to Alternative investments and to gold.

Our Positioning

Our current portfolio holdings reflect a preference for equities, in particular US equities, and especially cyclical themes, while retaining some flexibility in emerging markets. We remain attentive to changes in trade policy and inflation, which will guide our continuous adjustments.
In the US, we further upgraded our positive view over the past weeks. We are tactically positive on China and the broader Emerging markets region, provided effective stimulus measures though. We are most prudent on the euro zone, where the news flow is deteriorating. We are neutral UK and Japanese equity markets. In the fixed income allocation, we continue to prefer core European bonds such as Germany’s for carry. We are negative on US duration. We are neutral on investment grade and high-yield bonds, regardless of the issuers’ region.
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