Last week in a nutshell
- The Reserve Bank of Australia and the Bank of Canada put an end to their tightening pause and hiked their reference rates by 25bp each.
- China’s economic releases pointed to a disappointing recovery as the economy struggles with softening demand and falling exports.
- In the U.S., the services sector barely grew in May while weekly jobless claims rose to their highest level since October 2021, suggesting mounting layoff announcements.
- Demand fears capped gains of oil prices after the last output cut announced by Saudi Arabia and OPEC+ members.
What’s next?
- The US Federal Reserve, the European Central Bank, and the Bank of Japan, will meet and decide on their monetary policy.
- Inflation data is due for key countries, notably the US, just ahead of the FOMC. The numbers are expected to show a gradual decline.
- Preliminary soft data published by the US Michigan University and ZEW on sentiment will show the impact of higher borrowing costs and the resolution of the US debt ceiling limit.
- In Asia, China and Japan will publish activity and trade-related data. While China’s recovery is stalling, Japan is enjoying a large influx of international tourists thanks to its weaker Yen.
Investment convictions
Core scenario
- Our main scenario incorporates slow growth, both in the US and the euro zone and remains the most likely. The magnitude of the market downside risk will depend on the upcoming economic slowdown. In our central scenario, it should be limited in a tight trading range.
- Looking forward, all our economic scenarios – though with different trajectories – point to lower growth, lower inflation, lower Fed Fund rates and lower 10Y bond yields by the end of next year.
- In the euro zone, the expected next stage of lower economic growth and increasing cyclical worries have likely already started. Deterioration in economic data has been widespread. After peaking in February, economic surprise indicators have fallen sharply into negative territory.
- In Emerging markets, Chinese pent-up demand was a positive point but a strong sustainable momentum behind the re-opening has not materialised yet. Clearly, this is not the post-pandemic recovery the world was betting on.
Risks
- The steepest monetary tightening of the past four decades has led to significant tightening in financial conditions. Financial stability risks have resurfaced recently in the US but appeared to have stabilised.
- After the dramatic drop in growth surprises in all major regions, the outlook is becoming less supportive.
- In Europe in particular, we believe the growth is at risk, especially on the downside. The ECB is hawkishly tilted and geopolitical tensions are not supportive.
- Overall, central banks have a narrow path and will have to compromise between price stability (keeping rates at a restrictive level for longer than currently priced) and financial stability (decisive action to avoid materialisation of systemic risk).
Cross asset strategy
- We have a neutral equities allocation, considering the limited upside potential. The positive economic scenario seems already priced in for equities, thereby capping further upside. We focus on harvesting the carry and are slightly long duration.
- Within an overall neutral equities positioning, we have convictions in specific assets:
- In terms of regions, we believe in Emerging markets, which should benefit from diverging economic and monetary cycles vs developed markets as European equities were recently downgraded.
- At this stage of the cycle, we prefer defensive over cyclical names, such as Health Care and Consumer Staples. The former is expected to provide some stability: No negative impact from the war in Ukraine, defensive qualities, low economic dependence, innovation, and attractive valuations. The latter, pricing power.
- Longer-term, we favour investment themes linked to the energy transition due to a growing interest in Climate and Circular Economy-linked sectors. We keep Technology in our long-term convictions as we expect Automation and Robotisation to continue their recovery from 2022.
- In the fixed income allocation, we have an overweight positioning:
- We are positive on US government bonds as the slowdown is advanced in the region. We do not expect a Fed easing as early as markets do. We are neutral EMU duration.
- We are overweight investment grade credit: A strong conviction since the start of 2023 as carry and duration offer a cushion and we focus on European issuers.
- We are more prudent on High Yield bonds as strong tightening credit standard should act as headwind.
- We are buyers of Emerging bonds, which continue to offer the most attractive carry. Dovish central banks should be supportive. Investor positioning is still light post-2022 outflows. The USD is not expected to strengthen.
- We have exposure to some commodities, including gold and commodity-related currencies, including the Canadian dollar.
- On a medium-term horizon, we expect Alternative investments to perform well.
Our Positioning
The overall equity strategy is neutral, with a preference for Emerging markets. We recently became slightly underweight euro zone equity following the outperformance of the region and the recent deterioration in cyclical indicators. Further to the equities’ allocation, we are neutral US, Japan and Europe ex-EMU. Our “late cycle” asset allocation strategy is axed around defensive sectors, credit, and long duration.
