LAST WEEK IN A NUTSHELL
- The ECB announced that its asset purchase programme will come to an end in December but its very dovish forward guidance pushed the EUR down by 2% against the USD
- As expected, the Fed increased its rate by 25bp and a hawkish surprise came from the steeper upcoming hiking path of two other hikes by the end of this year and further three in 2019.
- Emerging markets were dragged down by the monetary policy announcements resulting in a stronger USD.
- Fed Chair Jerome Powell said that the US economy was in great shape, an assessment confirmed by a strong batch of economic indicators.
- US President Trump announced that the US would apply from July 6th a 25% tariff on more than 1,100 Chinese goods worth USD50bn, reviving risk-off sentiment.
- Whether or not restoring the oil output that was cut last year will be discussed at the OPEC summit on Friday.
- The ECB Forum on Central Banking will star this Monday with renowned speakers like Draghi, Powell and Kuroda.
- Global flash PMIs for June are likely to be the data highlight of the week.
- Core scenario
- The global expansion is synchronised, self-sustained and not easy to derail.
- US growth accelerates towards 3% and the euro zone growth cycle may have peaked.
- Gradual rise in inflation in the US, but no inflation fear.
- US Fed monetary normalisation is progressive, other central banks are in no hurry to tighten.
- Market views
- Global equities are supported by solid earnings growth, in particular in the US.
- Valuations have become less stretched after the correction earlier this year and solid earnings growth.
- Credit is expensive, in particular in the US, leaving little room for improving fundamentals.
- US equities are supported by the tax reform, buybacks and still attractive valuation vs. bonds.
- Risks to our core scenario show that markets are switching between two “opposite” risks: inflation fear and recession fear.
- Outside the US, the macro momentum is peaking, concerns about protectionism are intensifying, European political risk makes a comeback and geopolitical risks have increased.
- On the other hand, strong demand and tensions in the Middle East could lead to a spike in the price of oil and tight US labour markets could lead to an overshoot in wages while the Fed’s monetary tightening is making progress.
- Drifting too cold (a shock on growth or fear of recession in one key region) or too hot (an unexpected acceleration in inflation) will trigger higher volatility.
RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY
We are overweight equities vs. bonds via US and EM equities. We keep a short duration, and expect the 1.15-1.25 range on the EURUSD to hold
CROSS ASSET VIEWS AND PORTFOLIO POSITIONING
- We have gained more conviction and we maintain our equity exposure to overweight as we expect the underlying favourable background to prevail
- US growth re-accelerates and global growth momentum outside the US is expected to continue.
- We are overweight on US equities. The improving earnings growth and the positive impact of Donald Trump’s tax reform and deregulation are a support for the asset class. In addition, valuations are no longer too expensive. “America first” policy is likely to impact other countries negatively.
- We are neutral on the euro zone. The region still displays a robust economic expansion but uncertainties have risen recently (new Italian government, potential trade conflict with the US, weaker activity indicators). By ending its QE at the end of the year, the ECB remains accommodative and is in no hurry to hike rates. We prefer small and mid-caps to large ones.
- We are underweight Europe ex-EMU equities. The region has a lower expected earnings growth and thus lower expected returns than the continent, justifying our negative stance. “Brexit” negotiations remain a risk, while negotiations on new trade relations are stalling.
- We are underweight Japanese equities. Japanese stocks show a weakening earnings momentum as corporates can no longer rely on the JPY weakness. In addition, the leadership vote of the LDP party by September represents a risk for PM Abe. On the positives, the accommodative policy mix remains good news for Japan.
- We are overweight emerging market equities. Emerging equities benefit from strong global growth and attractive relative valuation. Our preference goes to EM Asia, the cornerstone of the high weighting of the tech sector (28%). We do not foresee a global trade conflict.
- We are underweight bonds and keep a short duration
- We expect a gradual rise in inflation, but no inflation fear.
- Global monetary tightening is progressive. Outside of the US, other developed market central banks are in no hurry to tighten.
- With a tightening Fed and expected upcoming inflation pressures, we expect rates and bond yields to resume their uptrend. In addition to rising producer prices, rising wages, fiscal stimulus and trade tariffs could push inflation higher.
- The overall improvement in the European economy could also lead EMU yields higher over the medium term. The ECB remains dovish in its QE plans and is opposed to a strong euro. Political uncertainties in Italy could delay the ECB tightening, but not derail the end of QE.
- We have a neutral view on credit overall but prefer EU to US in both Investment Grade and High Yield. Spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
- The emerging market debt faces headwinds with a strengthening USD and rising Treasury yields but we believe spreads can tighten from current levels. The carry is among the highest in the fixed income universe. It is an attractive diversification vs other asset classes.