Coffee Break

Last week in a nutshell

• NATO member states pledged to raise defence-related spending to 5% of GDP over the next decade, a major increase hailed as historic—though internal divisions over Ukraine and Russia cast doubt on alliance unity.
• While the German cabinet signed off a big Berlin budget bill for 2025, the local Ifo business sentiment index climbed to 88.4, its highest in a year.
• Several key US data releases for May, e.g., personal income, consumer spending, deflators, new home sales, were worse than expected.
• Giving his testimony before Congress, Fed Chair Powell warned tariffs could cause persistent inflation, repeating the Fed needs more clarity before considering rate cuts.
• The release of the preliminary inflation data for June in several euro zone countries validated the cooling inflation picture in the region.

Investment convictions

Core scenario

• The global economy remains fragile, with growth expected to slow further amid lingering trade tensions despite a temporary US-China tariff truce, and renewed uncertainty over oil prices driven by the Israel-Iran conflict, increased OPEC+ output, and weakening Chinese demand.
• United States: Growth is trending lower and inflation risks remain as tariffs loom large, making the US dollar, hard data releases, and corporate profit growth key to watch.
• Europe: With growth holding up and inflation under control – mission accomplished for the ECB – attention now turns to fiscal policies aimed at mitigating broader growth risks.
• China: Growth remains constrained with little sign of acceleration and deflation persists, amid ongoing pressure from its trade confrontation with the US.

Risks

• Armed conflicts in Ukraine and the Middle East: These are impacting oil prices, the broader energy sector, NATO cohesion, and relations with the United States.
• US trade policy: Although there are signs of de-escalation, uncertainty surrounding US tariffs persists. Visibility remains very limited. Market sentiment is fragile and volatility could resurface at any time, even before the end of the 90-day pause of US reciprocal tariffs on 8 July.
• US budget negotiations: This is also a key issue, impacting notably debt and currency markets. Current discussions point to a widening deficit (between 6.5%- 7% of GDP) and potential budget cuts that could disproportionately affect low-income households.
• Noise in the macro data: Economic growth is slowing, but the picture is murky. The unsustainable gap between soft and hard data has started to close: hard data is weakening, following soft data downwards.

Cross asset strategy

1. With stock markets trading near the top of their recent range and several geopolitical uncertainties looming, we remain comfortable with a cautiously balanced and well-diversified positioning.
2. Global equities:
   • Our positioning is currently Neutral overall, with no particular regional bias due to capped upside without earnings support.
3. Regional allocation:
   • US equities appear fully valued, with markets pricing in a benign outcome on trade and fiscal policy. This limits upside potential and may increase vulnerability to disappointment.
   • Europe and Emerging Markets, while more exposed to trade tensions, could be supported by more attractive valuations and stronger fiscal responses, partially offsetting tariff-related headwinds.
4. Factor and sector allocation:
   • In this environment, we put an emphasis on well-diversified factors over strong directional bets.
   • The strategy is overweight Global Technology due to AI-driven structural growth.
   • Our views are positive on German midcaps, European infrastructure and defence, supported by fiscal expansion.
5. Government bonds:
   • European sovereign bonds continue to benefit from growth concerns, subdued inflation expectations, and the ECB’s supportive stance. In a multi-asset portfolio, they add valuable decorrelation and serve as a defensive anchor in the event of renewed market volatility.
   • We are Neutral on US Treasuries, with risks balanced between inflation and growth concerns.
6. Credit:
   • In credit markets, we maintain a preference for Investment Grade bonds over High Yield ones, and favour European credit over those in the US. Investment Grade remains a resilient asset class with strong fundamentals, particularly in European credit, where US versus European spreads have returned to negative levels.
   • High Yield spreads have tightened significantly, offering little risk premium, so we keep a cautious stance with a slight underweight on both US and European high-yield bonds.
   • We have an allocation to emerging markets debt, after a slight upgrade to neutral. The asset class benefits from positive real regional yields, potential support from a weaker US dollar, and the potential easing of tariffs.
7. Alternatives play a crucial role in portfolio diversification:
   • Gold remains overweight as a strategic hedge against geopolitical risks and real rate volatility. Demand is supported by central bank buying and retail inflows.
   • We maintain an allocation to alternatives to provide stability and diversification amid ongoing volatility.
8. In currencies, exchange rates will remain a focal point in trade discussions and broader market dynamics.
   • We are overweight defensive currencies (e.g., Japanese yen) and expect USD weakness as growth softens.

Our Positioning

Our base case has not changed as growth is softening across all major regions, but confidence intervals have widened. We continue to invest with caution as the global economy remains in a delicate balancing act. Beyond the uncertainties linked to the armed conflicts in the Middle East and Ukraine, we have identified three major catalysts that will impact financial markets in the short term: US trade policy, US budget negotiations, and noise in the macro data.
In equities, we avoid regional biases, emphasizing sector and factor diversification—particularly in areas with strong earnings momentum like Technology and sectors supported by fiscal policy, such as European infrastructure and defence.
In fixed income, we favour Investment Grade over High Yield, with a preference for the resilient European credit segment. We remain neutral on US Treasuries and cautious on High Yield, given tight spreads and limited risk premiums.
Our view on emerging market debt has improved modestly, supported by positive real yields, a softer US dollar, and easing tariffs. Alternatives continue to provide portfolio stability, with gold retained as a strategic hedge against ongoing asymmetric risks.