Global Asset Allocation: The View From Europe

1. Market Perspective

• There is firming in global growth expectations, with recent data tilted more positively, while inflation continues to decelerate across most regions.
• US growth remains most resilient amongst developed economies, while weak European growth is potentially bottoming. The emerging markets growth outlook is improving, with hopes for stabilisation in China driven by policy support.
• While progress on inflation gives support for the US Fed to pivot towards cuts, resiliency in the economy could delay the start. The European Central Bank is moving closer to easing amid fragile growth and as inflation has moved past its peak. The Bank of Japan cautiously eyes exiting its negative rate policy in the first half of this year.
• Key risks to global markets include impacts of geopolitical tensions, central banks’ policy divergence, a retrenchment in growth, a resurgence in inflation and the trajectory of Chinese growth and policy.

2. Portfolio Positioning

As of 29 February 2024

• We shifted to a modest overweight position in equities, which was funded from cash and supported by a firming growth and disinflation backdrop, positive earnings trends and reasonable valuations outside of large‑cap growth.
• We continued to add to US large‑cap value as we think a firming cyclical environment, where both growth and inflation stabilise from here, could favour value stocks.
• Within fixed income, we remain modestly overweight cash relative to bonds. Cash continues to provide attractive yields and liquidity to take advantage of potential market dislocations.
• Within fixed income, we remain overweight high yield and emerging market bonds on still attractive absolute yield levels and reasonably supportive fundamentals.

3. Market Themes

Getting Back Together

Heading into 2024, the consensus view was that the US Fed was going to be the leader in cutting interest rates among developed market central banks, given its progress on inflation and higher current rates, while the European Central Bank (ECB) was seen as a laggard given stickier inflation and despite weaker growth. Fast‑forward to today, US growth has surprised to the upside and the pace of disinflation has slowed, and the labour market has remained resilient, pushing out rate cut expectations. Conversely, a quickening in disinflation, now below the US, and fragile growth in the eurozone, have pulled forward expectations of an ECB rate cut. However, the ECB appears to also be taking a patient approach, cautiously monitoring wage growth and upcoming labour negotiations to assure that inflation pressures are abating. Ironically, the diverging dynamics between the two appear to be bringing the Fed and ECB back together again, at least from a timing standpoint, with markets now pricing in rate cuts to start in June for both. And while more synchronised moves by the central banks could help mitigate volatility, there remains a lot of uncertainty between now and June that could push them back apart.

No Bull!

Within fixed income markets, the bull steepening of the yield curve has been a consensus trade among bond managers that has proven elusive thus far this year, with everyone betting that the Fed would soon be embarking on cutting rates, sending short‑term yields falling faster than longer‑term yields—a positive for short‑term bond prices—as the curve re‑steepened. The yield curve has now been inverted for a record number of months, typically a harbinger of an impending recession. The resilience of the US economy and its still gradual progress with disinflation are increasing the odds that the economy skirts a recession this time around. While welcomed news on the economic front, it has given the Fed breathing room to stick with the ‘higher for longer’ plan to ensure inflation is indeed under control, and it is an unwelcome development for those betting short rates were coming down soon. Those hopes also extended to equity investors, bullishly expecting falling short‑term yields would entice the over USD 6 trillion pile of cash parked in money market funds back into risk assets. While the bet on the bull steepening has proven elusive thus far, we do expect it—albeit later and more gradually playing out.

 

For a region-by-region overview, see the full report (PDF).