Coffee Break

Last week in a nutshell

• The US government shutdown entered its second week and as little progress has been made as both sides appear comfortable with their position.
• Few economic releases have been made in the US due to the government shutdown. University of Michigan Consumer sentiment remained subdued.
• In Germany, disappointing releases of factory orders and industrial production have underlined the urgency of reforming the economic incentives.
• Israel’s and Hamas approved a deal that will see the release of any remaining hostages held in Gaza in exchange for more than 2,000 prisoners.
• Tensions between the US and China have risen a notch as US President Donald Trump said he saw “no reason” to meet Chinese President Xi Jinping.

Investment convictions

Core scenario

• United States: GDP growth slowing but with no recession expected over the next 18 months; inflation facing upward pressure by tariffs, but the Fed appears willing to look-through and enters a new easing cycle, with markets pricing in several rate cuts by end-2026.
• Europe: Growth resilience to be tested by the rise in US tariffs and political uncertainty in France. Bund yields are stabilising around 2.75% while the ECB preserves optionality to cut, supported by persistently low inflation expectations.
• China: Trade visibility improving somewhat, but frictions remain. External outlook supported by some tariff relief, while domestic policy remains accommodative through selective credit easing and fiscal support.

Risks

• Fed independence at risk: The “Trumpification” of the Fed through 2026 threatens to rupture past practice, with a more politically driven reaction function. This could steepen the yield curve, raise inflation premia, weaken the US dollar, support nominal earnings in the short term, and ultimately trigger an unpredictable bond market sell-off… potentially requiring a renewal in quantitative easing.
• European political instability: Weak cohesion and fiscal fragmentation risk to weigh on the region. Renewed political tensions and nationwide strikes have resurfaced in France.
• Bond market credibility test: A loss of confidence in fiscal discipline could drive long-term yields higher, renew volatility, and destabilise equities and credit markets.
• Geopolitical and policy fragmentation: Ongoing conflicts in Ukraine and the Middle East pose risks to global security, while diverging central bank paths and rising protectionism add to global policy fragmentation.

Cross asset strategy

• The Fed’s rate cut cycle signals a broader regime shift, supporting global equities via lower short-term rates, a weak US dollar and reflationary momentum. We hold a constructive stance on equities.
• Global equities:
  • Overall positioning is Overweight, led by a positive view on all regions.
• Regional allocation:
  • United States: Slight Overweight: The Fed’s dovish pivot sets the stage for further easing. US tech remains a core conviction amid slowing but resilient growth. Despite elevated valuations, the reflationary context favours upside.
  • Japan: Slight Overweight: Trade visibility and tariff relief continue to support cyclical sectors, especially exporters. Structural reforms and upcoming elections point to fiscal stimulus and stronger corporate returns.
  • Europe: Slight Overweight: Tariff relief offers support, and Germany’s expansionary budget has now been approved. The ECB is on hold but retains flexibility, with low inflation, potentially allowing room for policy action.
  • Emerging Markets: Slight Overweight: Emerging equities benefit from a softer USD and improved trade visibility. EM debt remains slightly overweighed, supported by attractive yields and lower funding costs.
• Factor and sector allocation:
  • We continue to favour resilient themes such as Technology & AI, European Industrials, and German Midcaps.
  • We hold exposure to US small- and mid-caps, which likely benefit from lower financing costs under a dovish Fed.
  • Healthcare remains supported as most of the bad news now appear discounted in the prices.
• Government bonds:
  • We are constructive on core European duration, where stable ECB policy and low inflation expectations anchor yields.
  • US Treasuries remain Neutral, with tariff-driven inflation and a Fed reshape adding complexity.
• Credit:
  • We prefer European Investment Grade credit, where spreads are attractive versus US credit.
  • High Yield has a more limited risk/reward given tight spreads and low embedded risk premia.
  • Emerging Market debt is an Overweight on attractive yields, better trade visibility, and dovish Fed support.
• Alternatives:
  • Gold remains Overweight as a hedge against geopolitical risks, real rate volatility, and a weaker USD; supported by strong central bank buying and retail flows.
  • We acknowledge that the US dollar remains the key pivot for emerging markets and precious metals. Recent positioning on a weaker USD and stronger gold looks somewhat stretched.
  • We retain allocations to alternative strategies for portfolio stability and diversification.
• Currencies:
  • We remain underweight USD, as Fed easing and political pressure weigh on the currency.
  • We favour defensive currencies such as the Japanese yen and hold selective long positions in EM currencies with strong fundamentals.

Our Positioning

Economic signals remain uneven, data visibility is clouded by the US government shutdown, and inflation is edging higher again. Yet risk assets continue to climb, driven by easier liquidity and expectations of central-bank support. Our conviction remains risk-on as fundamentals and technicals confirm a constructive outlook for equities, and the upward trend is likely to continue in the medium term. As a result, we now hold a balanced overweight allocation across the US, euro zone, Japan, and Emerging Markets. In Europe, we emphasise Industrials and German mid-caps as a catch-up trade, while continuing to back resilient global themes such as Technology & AI and Healthcare. On the fixed income side, our strategy includes Emerging Market debt, supported by attractive yields, tariff relief, and improved investor flows. We also remain constructive on core-European duration while in credit we continue to prefer European Investment Grade over High Yield.