CIO Views: UK back in focus; China’s consumer challenge
- 25 July 2024 (5 min read)
Chris Iggo, CIO AXA IM Core
UK moves back into investors’ focus
The UK’s economic outlook is improving. Historically, when elections have delivered a change in government with a large majority, both equity and UK bond markets have performed well. The Labour Party’s 174-seat parliamentary majority should mark a period of policy transparency with the stated aim of boosting growth.
The new government has pledged fiscal stability and suggested any new spending will be fully funded, with only selected tax increases as part of the proposed fiscal plans. Partnering with the private sector is also promised, with a focus on energy and other infrastructure projects. As such, the growth-inflation balance should improve, which will support stronger investor confidence in UK assets.
The broad equity market has increasingly traded at a discount to the US and European markets while sterling’s relative cheapness should provide a further attraction to investors and overseas corporates looking to acquire UK assets. In the near term, the Bank of England is likely to start lowering interest rates from their current 5.25% level.
Headline inflation dropped to 2.0% in May and further declines in core inflation should be seen over the second half of 2024. The recent appreciation in the pound’s trade-weighted exchange rate should also help soften inflation going forward. As such, the gilt market and UK corporate bonds are attractive, with shorter maturity investment-grade corporate bonds yielding above 5.0% on average.
Alessandro Tentori, CIO Europe
Bunds in favour
European government bond markets look almost priced to perfection with expectations for a European Central Bank (ECB) deposit facility rate of around 2.70% by the end of 2025 - not far off AXA IM’s forecast. This trajectory is likely to be accompanied by a typical steepening of the German Bund curve, worth around 70 basis points over two years based on the forward curve.
According to ECB President Christine Lagarde, there is a fine line between data dependency and data-point dependency, which will allow the Governing Council to look through unexpected, albeit short-lived, inflation surprises. However, the process of policy normalisation will be subject to uncertainty about the natural rate of interest, i.e. the interest rate at which policy will no longer be deemed restrictive. So what could possibly go wrong for investors?
We’ve already had an amuse bouche of government bond volatility in the aftermath of the European Parliament elections. Luckily, this proved to be short-lived. However, it should serve as a reminder of the complex interaction between fiscal and monetary policies. At this stage, European government bond spreads appear to fully reflect differences in fiscal discipline between member states (see figure). However Germany stands out, not only in terms of compliance with the Stability Rules, but also for the valuable liquidity premium attached to Bunds.
Ecaterina Bigos, CIO Asia ex-Japan
More needs to be done for China’s consumer
Post pandemic, China has seen positive momentum in fixed asset investment and industrial production. It is also enjoying a revival of export growth in some high value-added sectors. However, China continues to face challenges, as it is looking to rebalance from an investment-led to a consumption-based economy, and it needs to find an alternative to the real estate sector as a lasting source of economic expansion. Its property sector, along with its related activities, once accounted for 25% to 30% of GDP.
Weakness in the sector not only acts as a drag on the overall economy but also on broad consumer confidence, due to its negative impact on wealth. According to a 2019 survey from the country’s central bank, 96% of urban households in China were homeowners, of which nearly 40% owned more than one property.
The government announced various policy packages to support its property market. While the overall direction is geared towards stabilisation and transformation, adjustment is expected to take time. Meanwhile, more needs to be done directly for the consumer, for its transition towards consumption-led growth. Given consumer confidence is very low, policies to expand social safety nets and to grow the middle-income class should be in focus.
Asset Class Summary Views
Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.
| Positive | Neutral | Negative |
|---|
Rates | Data flow in major economies pointing to rate cuts in second half of 2024 | |
|---|---|---|
US Treasuries | Election may impact the timing of a rate cut but Federal Reserve is close to easing | |
Euro – Core Govt. | Further ECB rate cuts expected but markets have priced this in | |
Euro – Peripherals | Bonds remain subject to political events and to the relative debt/GDP outlook | |
UK Gilts | New government pledges fiscal stability. Two interest rate cuts expected this year | |
JGBs | Low returns. Policy indecision by Bank of Japan and weak yen make JGBs unattractive | |
Inflation | Stable expectations as data shows gradually lower inflation in the second half of 2024 |
Credit | Income assets should be part of portfolios. Low spreads suggest limited excess returns | |
|---|---|---|
USD Investment Grade | All in yields are attractive but excess return limited | |
Euro Investment Grade | Stable growth and lower interest rates support income focus in credit | |
GBP Investment Grade | Returns supported, given current yields and expectations of a faster pace of rate cuts | |
USD High Yield | Fundamentals and funding strength remain strong | |
Euro High Yield | Strong fundamentals and ECB cuts support total returns | |
EM Hard Currency | Volatility has subsided but a later Fed interest rate cut will delay recovery |
Equities | Earnings cycle remains robust; AI likely to underpin continued concentrated US returns | ||
|---|---|---|---|
US | Growth set to continue to dominate but need to watch company earnings momentum | ||
Europe | Positive economic surprises and attractive valuations | ||
UK | Monetary policy and change of government should boost sentiment | ||
Japan | Benefits from growth in semiconductors. Reforms in focus for broader performance | ||
China | Growth remains unbalanced. Accelerating industrial output, masks a weak consumer | ||
Investment Themes* | Secular spending on technology, automation, to support relative outperformance | ||
*AXA Investment Managers has identified six themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Technology & Automation, Connected Consumer, Ageing & Lifestyle, Social Prosperity, Energy Transition, Biodiversity.
CIO team views draw on AXA IM Macro Research and AXA IM investment team views and are not intended as asset allocation advice.
Disclaimer
This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.