Coffee Break

Last week in a nutshell

• Fed Chair Jerome Powell confirmed that the time has come to cut its funds rate. He gave no hints on the timing nor the pace of subsequent rate cuts.
• The ECB revealed that the euro zone wage growth slowed to 3.6% YoY during Q2, down from 4.7% in Q1 2024, reinforcing the case for additional rate cuts.
• Flash PMIs for the month of August revealed persistent strength in the UK, a boost from the Olympics in France and some moderation in the US.
• On the political front, Kamala Harris was coronated presidential candidate at the US Democratic convention in Chicago.

Investment convictions

Core scenario

• Despite uncertainties over a weakening of the US economy, we keep our central scenario of a soft landing.
• US Private domestic demand continues to grow at a solid pace while consumption is only slowing gradually. Also, if composite business activity indicators are volatile, they stay at expansionary levels. Finally, among China weakness and doubts over US consumers, US retail sales, earnings and profits remain resilient.
• In the US, growth forecasts are increasingly influenced by political and monetary factors. EU growth is dependent on a pick-up in consumer activity, while China's growth remains subdued.
• The cooling of inflation – and core inflation – is a synchronised global development. Supportive (i.e. lower) inflation news also paves the way for European central banks (e.g., ECB, BoE, SNB, Riksbank) to further cut interest rates in Q3. With several emerging market central banks already cutting since 2023, and the Federal Reserve joining the chorus, the long-awaited global easing cycle is on its way.

Risks

• Looking ahead, we caution against policy decisions that lead to higher tariffs and a tighter labour market in the US, which could ultimately lead to rising inflation again or significantly higher taxes, which could weigh on growth.
• The upcoming change in the White House and the potential reprioritisation of US economic policy could affect the speed and extent of monetary easing.
• Although most of the unwinding of carry trades put in place over the past two years appear to have been completed, a renewed rise in the Japanese yen could lead to further stress in the markets.
• The recent snap elections have put France in an unprecedented situation: a coalition must be formed to provide political stability in a context of limited fiscal space to boost supply. Next year, we see a risk of downgrade or a negative outlook in all scenarios as the debt ratio rises.
• In China, economic activity remains fragile and price developments remain deflationary as consumer confidence remains low. Additional tariffs could jeopardise continued recovery.
• Geopolitical risks to the outlook for global growth remain tilted to the downside as developments in the Middle East and the war in Ukraine unfold.

Cross asset strategy

1. Despite uncertainties over a weakening of the US economy, we keep our central scenario of a soft landing and hold a long duration and a neutral equity stance.
2. We have actively managed the volatility spike early-August, adding derivatives to protect against upside risks which materialised via a V-shaped recovery.
3. We prefer developed markets vs emerging markets and especially US and UK equities which are more defensive. We have turned tactically neutral on Japan which should suffer from any further JPY strengthening and faces some political uncertainty.
   • In the US, the Q2 earnings season is supportive but data from the technology sector reports are not comparable to former quarters. We therefore locked in our profits and have a neutral positioning on the sector.
   • In the UK, valuations remain attractive with the potential for multiple expansion and the BoE poised to cut interest rates.
   • In Japan, exiting the multi-decade long deflation as well as corporate governance reforms bearing fruit should counterbalance a less dovish Bank of Japan. However the carry trade unwinding and JPY strength is a headwind.
   • In the euro zone, while tail risks in France have diminished, the surprise victory of the left-wing alliance and a hung parliament imply political uncertainty. A higher risk premium remains justified.
4. In the equity sector allocation:
   • We have increased our position on healthcare. Q2 earnings indicate that the normalisation of overearning from COVID, due to destocking excess inventories and demand for COVID-specific products, is mostly complete.
   • On the contrary we decreased our allocation to Small caps.
5. In the fixed income allocation, with monetary policy easing and heightened uncertainty, government bonds are an attractive investment as they offer a hedge in a multi-asset portfolio. Also we see little room for credit spreads to tighten further:
   • We favour carry over spreads, with a focus on quality issuers: we maintain our long duration bias via Germany and the UK.
   • We are neutral on US duration.
   • We have a relatively small exposure to emerging markets sovereign bonds amid very narrow spreads.
   • We are neutral on investment grade and high yield bonds, regardless of the issuers’ region.
6. We keep an allocation to Alternative investments and to gold.

Our Positioning

Taking into account current market volatility, we reduced our overall exposure to equities, with an overall equity weighting fairly close to neutral. We have actively managed the volatility spike early-August, adding derivatives to protect against upside risks which materialised via a V-shaped recovery.
Within equities, we have chosen to keep a preference to UK equities relative to the euro zone. In our sector allocation, we also had tactically reduced our exposure to US mega-cap companies and the technology sector while we have increased our exposure to healthcare, which also has defensive qualities. We decreased our exposure on small and mid-caps as they offer little protection in heightened volatility episodes.
With regard to our bond exposure, as outlined in our outlook for the second half of the year, we anticipated that the correlation between equities and bonds should revert to negative again as inflation normalises, enabling safe bonds to resume their protective role within a diversified portfolio. We therefore maintained a long duration exposure with a focus on German bonds. Simultaneously, we remained neutral on corporate investment grade and more cautious on global high yield.