Coffee Break

Last week in a nutshell

• French voters propelled far-right National Rally to strong lead in first-round legislative elections.
• US data for May and preliminary readings on June inflation from a handful of EU members confirmed the cooling.
• In June, the Bank of Japan debated the need for an interest rate hike in July amid rising inflation risks.
• The first US presidential debate showed a head start for the Republican frontrunner Donald Trump.

Investment convictions

Core scenario

• Facing a rise in political uncertainty, a higher risk premium appears justified in Europe. In the US, the hawkish repricing of the monetary policy from the Federal Reserve is now largely behind us.
• Beyond the election uncertainty in the euro zone, the activity pick-up from quasi-stagnation should represent a support for equity valuations. Forward-looking indicators point into that direction.
• Global disinflation trends have been confirmed by the most recent inflation data. At the current juncture interest rates have peaked and growth remains resilient.
• In China, economic activity has shown some fragile signs of stabilisation but the evolution of prices remains deflationary as consumer confidence remains at very low levels.

Risks

• Snap elections in France have brought political risks back into focus for financial markets, especially for French stocks and government debt. We expect a risk of downgrade or a negative outlook in all scenarios as the debt ratio is rising
• 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.
• Bond yields are to be monitored especially given the diverging paths taken by the US central bank and its European counterpart.
• Although unlikely, a stickier-than-expected US inflation path while economic growth slows down too much and unemployment rises, could force the Federal reserve to reconsider its course.

Cross asset strategy

1. As the recent rise in political uncertainty spilled over into financial markets and French assets, leading to somewhat higher volatility in the region, we are currently slightly overweight equities.
2. We have the following regional equity investment convictions:
   • Neutral euro zone equity as the bloc faces a rise in political uncertainty and a higher risk premium appears justified.
   • Slight overweight US, UK and Japan, neutral Emerging markets.
   • In Japan, exiting the multi-decade long deflation as well as corporate governance reforms bearing fruit should more than counterbalance a less dovish Bank of Japan.
3. In the equity sector allocation:
   • We have a positive view on the Tech sector: good Q1 earnings and guidance, peaking long-term yields, reasonable valuations, broad market leadership within IT and the industry’s relative insensitivity to the upcoming US presidential elections.
   • A Pan-European small cap bias gives us the benefit of lower inflation, lower central bank rates and higher growth than expected.
4. In the fixed income allocation:
   • We prefer carry to spreads, with a focus on quality issuers, hence we are neutral peripheral European bonds and prefer core countries. We continue to watch OAT-Bund spreads as key macro risk gauge.
   • We seized an attractive entry point on US government bonds as yields shot back up to 4.7% in April.
   • We have a relatively small exposure to emerging markets sovereign bonds amid very narrow spreads and a strong US dollar.
   • We are neutral on investment grade and high yield bonds, regardless of the issuers’ region.
5. In our forex strategy, we are positive on commodity currencies as the global manufacturing cycle picks up.
6. We expect Alternative investments to perform well as they present some decorrelation from traditional assets and keep an allocation to gold.

Our Positioning

Our outlook on equity remains positive but we take into account the latest developments in France. We are slightly overweight developed markets equities and neutral euro zone. We are overweight US Tech and pan-European small and mid-caps, a reflection of our conviction in lower inflation, lower central bank rates and higher-than-expected economic growth. We are neutral Emerging markets equity until consumer confidence gains traction. On the fixed income side, we are positive on Core European duration as a safe haven and UK duration. The objective is to benefit from the carry in a context of cooling inflation and pending rate cuts by the ECB and BoE this summer. In credit, we remain neutral - high yield and emerging debt - amid very narrow spreads and a strong USD.