Multi-Asset Investments Views: We all live in America (but investors can travel)

Equity investors’ patience has been rewarded, as markets comfortably navigated August’s introduction of the new US tariff regime. Consequently, indicators of trade policy uncertainty have normalised. The second quarter (Q2) earnings season proved to be globally positive and once again exemplified the US economy’s resilience, although earnings that missed expectations were heavily sanctioned by investors. The macroeconomic backdrop further fueled convictions that the Federal Reserve (Fed) would be in a position to cut rates in September as well as in December. We continue to hold an overweight in risk exposure.

Despite July’s Fed policy meeting minutes striking a hawkish tone investors have since focused on a September rate cut, as signs of weakness were seen in both jobs data at the start of August and in heavily negative revisions to previous numbers. Fed board members are shifting their attention away from sticky inflation to potential labour market weakness.

Fed Chair Jerome Powell emphasised in the opening paragraphs of his speech at the Jackson Hole economic policy symposium that “the balance of risks appeared to be shifting”, potentially warranting a policy adjustment. He did however underline the Fed board’s independence and data dependency which are key for confidence in the US dollar and US Treasury market. We are wary of any further steepening in global yield curves led by weakness in long-dated bonds and are not in a hurry to add duration in this area. We maintain our target of 1.20 for the euro/dollar exchange rate and thus remain US dollar sellers.  

Meanwhile, European Central Bank (ECB) President Christine Lagarde’s tone has softened regarding weakening Eurozone activity expected through Q2 and Q3. Hawkish ECB policymakers have dismissed such concerns and maintain the ECB is likely done with rate cuts. The market now is pricing less than one cut before year end which may prove to be overly cautious. We are positive on two-year German bonds (Bunds) and have a preference for Bunds over US Treasuries, but only when we have seen a further shake-out in the long end of the US yield curve due to the overriding influence of the US market on most other interest rate markets.

In the run-up to the Jackson Hole symposium we adjusted our derivatives holdings in our equity overlay strategy. The short position on US small caps versus the Nasdaq index was closed due to extreme short investor positioning on the Russell 2000 index futures. Some exposure was also reallocated from US large caps to Eurozone equity indices to diversify risk and reduce the heavy concentration in the US assets inherent in global strategies. It’s worth noting that even in the perennially dominant US Treasury market, foreign participation is falling from 70% pre-COVID-19 to 64% currently¹  and price concessions demanded by local dealers at auctions to make up the shortfall is rising. 

Despite our intention to favour more diversification into European assets there remains a source of stress from the political environment in France which needs to be addressed. To this end we have initiated positions to reduce our exposure, with a long German MDAX (mid-cap) index versus short CAC 40 trade in equity indices and a long Bund 10-year versus French OAT 10-year position in bond futures. The end-of-summer rentrée is shaping up to be a period of political and social tension for France and this is likely to be reflected in equity underperformance, especially given the high concentration of financials in the CAC 40, and a widening of government bond spreads.