Coffee Break

Last week in a nutshell

• Although Prime Minister Ishiba's ruling coalition lost its majority in the upper house, Japan nonetheless managed to finalize a major trade deal with the United States.
• Flash PMIs showed mixed global momentum: US and UK services held up, while euro zone and Japan signaled stagnation or contraction, reinforcing cautious investor sentiment.
• ECB and Fed struck a balanced tone—Lagarde hinted at flexibility amid slowing growth, while Powell remained cautious about inflation, nudging yields higher.
• Q3 US earnings season was off to a solid start: Alphabet and ServiceNow surprised positively on cloud, while Coca-Cola remained resilient despite FX headwinds.

Investment convictions

Core scenario

• United States: Growth momentum is fading as hard data deteriorates, with the economy likely to slow further in H2 2025. Inflation remains sticky and could reaccelerate towards 4% by year-end, delaying the return to the 2% target until 2027. While the Trump administration pushes its economic agenda supported by a weaker dollar and lower oil prices, higher tariffs and redistribution effects create mixed signals for markets and policy.
• Euro zone: Growth has shown timid improvement recently, but the region remains vulnerable to external shocks, particularly the looming impact of US trade tariffs. Inflation has moved into neutral territory, offering the ECB room to ease policy if needed. A recession should be avoided, but risks to the downside persist.
• China: Economic growth is underwhelming but relatively stable, with ongoing deflationary pressures weighing on sentiment. A trade deal with the US is expected by August, but the domestic outlook remains fragile amid weak demand and structural challenges. Monetary and fiscal tools remain available to prevent further deterioration.
• Global growth is trending lower, with diverging inflation dynamics across regions, deflation in China, neutral inflation in Europe, and stubborn inflation in the US. The path forward depends heavily on US policy choices and tariff outcomes. Amid an elevated uncertainty and a wide range of potential macro scenarios, forecasts are subject to frequent revision.

Risks

• US trade and fiscal policy: Although tariff escalation has been temporarily postponed, uncertainty remains high around the scope and implementation of US trade measures. The Trump administration’s evolving agenda, including a significant redistribution bill and rising tariff revenues, continues to fuel volatility in sectors like pharmaceuticals and base metals. Market sentiment is vulnerable to any reversal or surprise as the 90-day tariff pause is expiring.
• Growth fragility and data confusion: Economic signals remain mixed, with hard data in the US deteriorating and soft data already weak. The gap between sentiment and reality is narrowing, but not in a reassuring way. Across major economies, forward-looking indicators are losing steam without falling off a cliff, and the risk of underestimating the slowdown is growing.
• Geopolitical tensions and policy fragmentation: Armed conflicts in Ukraine and the Middle East continue to pose risks to energy markets and global security. Meanwhile, divergent central bank paths and rising protectionism are adding to policy fragmentation. In China, deflationary pressure reflects deeper structural issues, while in Europe, the full impact of US tariffs could disrupt what little growth momentum exists.

Cross asset strategy

• Financial markets are finding support in the ongoing earnings season and the recent trade agreement with Japan, which has improved visibility for key sectors. While discussions between the EU and the US continue, markets expect a pragmatic outcome.
• Global equities:
  • Positioning remains Neutral overall, with no significant regional bias despite the latest changes.
• Regional allocation:
  • We added Japanese equities via TOPIX, supported by improved visibility following the U.S.–Japan tariff agreement, which benefits key sectors like autos. The conclusion of this trade deal along with the possibility of fiscal stimulus due to the new political set up, creates a more constructive backdrop for Japanese equities.
  • We tweaked our exposure to US equities to capitalise on the renewed leadership of the tech mega caps.
  • Europe and Emerging Markets, while more exposed to trade tensions, could be supported by more attractive valuations and stronger fiscal responses, offsetting tariff-related headwinds.
• Factor and sector allocation:
  • We focus on resilient themes such as Technology & AI, European Industrials, and German Midcaps, while acknowledging trade-related headwinds in areas like Pharma and Semiconductors.
• Government bonds:
  • We are slightly constructive on duration in Europe, where ECB support and government stimulus continue to anchor yields.
  • The Fed has more time to hold rates steady and focus on how inflation is developing: We are Neutral on US Treasuries.
• Credit:
  • In credit, we prefer Investment Grade—particularly in Europe—due to solid fundamentals, while remaining cautious on High Yield given tight spreads.
  • Emerging market debt benefits from positive real yields and a weaker USD.
• 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 from traditional asset classes.
• In currencies, exchange rates will remain a focal point in trade discussions and broader market dynamics.
  • We remain constructive on defensive currencies, such as the Japanese yen, though we have recently taken partial profits on our JPY exposure. We continue to expect USD weakness as global growth slows.

Our Positioning

Financial markets are drawing support from a solid start to the earnings season and the recent US–Japan trade agreement. We initiated a position in Japanese equities via TOPIX, driven by improved macro clarity and the potential for fiscal support ahead of expected elections but maintain a neutral stance on equities. We favour resilient investment themes such as Technology & AI, European Industrials, and German Midcaps. In fixed income, we are constructive on European duration, Neutral on US Treasuries, and prefer Investment Grade credit, particularly in Europe, to High Yield. We also see selective opportunities in EM debt, supported by real yield differentials and a weaker dollar.