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In the wake of Canadian and Australian inflation publications, American rates rose this week.
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We remain cautious on French sovereign debt, which we are underweighting while waiting for a better entry point.
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On equities, we maintain our neutral bias while waiting for better buying points.
Australia and Canada surprised this week with stronger-than-expected inflation releases. Rate market expectations immediately adjusted: in Australia, a final rate hike is now on the cards, and in Canada, the rate cut cycle that began on June 4 is likely to be more cautious. In Canada, the rebound in inflation seems to be mainly due to a rebound in rents, while the other components seem to confirm a downward trajectory for inflation.
In the wake of Canadian and Australian publications, American rates rose this week, going from 4.21 before the PMI publication last Friday to 4.35 currently. Two thirds of this rebound is explained by the nominal part, ie excluding inflation expectations, while real rates only increased from 1.96 to 2.01. In the United States, the dynamics of disinflation seem to be confirmed: the US Core PCE over 1 and 12 months are very close to the Fed’s target and wages are converging towards the normative rate of 3% to 3.5%. The strengthening of the dollar also helps reduce inflation by strengthening the purchasing power of imported goods. According to the 2nd revision of growth figures for the first quarter, consumption, the main driver of American growth, showed itself to be less resilient than at first reading. Signs of consumer weakness are expected to continue in the second quarter, with the high interest rate environment making it increasingly complicated to resort to borrowing to pay for purchases. The declarations of Daly and Goolsbee point to particular attention to the “dual mandate” pointing out the risk of seeing the unemployment rate increase further.
In an environment where the economic slowdown is gradually taking the place of inflation in investors’ concerns, rates are gradually becoming more attractive in diversified portfolios. This is particularly true in Europe where the French experience in June showed that the bond market constitutes a preferred hedging instrument in the face of political risk. The ECB should continue its cycle of rate cuts: Olli Rehn, governor of the Finnish central bank, known to be more conservative than his counterparts, is also leaning towards the ECB’s two rate cuts. In this context, we are strengthening our bond exposures. On the other hand, we still remain away from French debt which still seems expensive to us relative to European countries according to our internal scoring model taking into account financial and extra-financial criteria (ESG). Indeed, the state of its public finances justifies an A rating against AA currently. A stable political system and low financing costs were until now considered assets by the agencies. Rating agencies are also expecting a reduction in the deficit of 20 billion euros by 2025 as promised by the current government. Even in the case of a relative centrist majority or no majority, no program being really compatible with this objective, the tightening of the 10-year OAT-Bund spread seems to us limited to a return towards 60bp, without forgetting the risk of Close elections within a year due to lack of a stable majority. Conversely, the establishment of an RN or NFP government would trigger a clearer spread towards 100bp. A clear lull could certainly occur subsequently but probably only after the budgetary negotiation with the EU in the fall, conducive to supporting volatility while the RN plans to cut 2 billion contributions to the European budget from the summer and that the NFP refuses to comply with budgetary rules. We therefore remain cautious on French sovereign debt, which we are underweighting while waiting for a better entry point.
On equities, we maintain our neutral bias in anticipation of better buying points: the period ahead of the earnings season is generally a source of volatility, conducive to profit warnings from companies while they have to pause their share buyback program.
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