PERSPECTIVES

OUR CENTRAL SCENARIO

ÉRIC BERTRAND
Deputy Chief Executive Officer,
Chief Investment Officer
OFI INVEST ASSET MANAGEMENT

Tariffs were the story in April but in May it was the budget

In the aftermath of the tariff episode, Donald Trump has unveiled another flagship promise of his campaign: new or rolled-over tax cuts. In the midst of ongoing confusion and uncertainty surrounding the imposition of tariffs on its trade partners, the White House announced a proposed budget that focuses on tax cuts, partially funded by as-of-yet unsigned tariffs and by savings generated by DOGE⁽¹⁾, the government department that has just lost its charismatic leader, Elon Musk. This budget will, at best, keep the public deficit high (at about 6.5% of GDP as things stand) and the loss of the US’s last AAA rating among the three ratings agencies.

The issue of financing US debt and of the dollar’s strength are back in the spotlight at a time when investors are concerned about Japan’s long-dated bond trends and yield curve. Long-dated US bond yields, which are both a source of concern and a counterweight, will be a key issue in the coming months.

Against this backdrop of weak visibility, the US Federal Reserve is in a wait-and-see mode and is unlikely to change its monetary policy between now and yearend.

It must address contradictory forces: higher, but temporary inflation and resilient growth supported by future tax cuts on the one hand, and concerns on the ultimate impact of the current environment on the other.

After lowering its rates to 2%, the ECB is expected to stand pat before seeing whether a new cut is necessary, based on what tariff agreements will be signed.

On long-dated yields, we are taking advantage of rising US bond yields to reweight the asset class at 4.50%. We are neutral on European curves, a stance we believe properly prices in our scenario.

We still like corporate bonds, particularly high yield, with its carry opportunities. Any upward movement in yields is worth exploiting for expanding exposure.

Equity markets have rallied on both sides of the Atlantic, possibly encouraged by the opening of negotiations on tariffs and “moderately slowing” growth. After selling into the rally in US indices to lower our exposure, we are also taking our profits on European markets in moving to a neutral position. Our reasoning is as follows. Two forces are pulling against each other on the markets: 1/ concern over the trajectory of growth and margins, given the current uncertainty over tariffs and in response to resilient economic figures; and 2/ the coming tax cuts. Volatility is therefore likely to stay with us and open up some contrarian opportunities in the coming weeks.

OUR VIEWS AS OF 05/06/2025

Donald Trump’s about-faces on tariffs continue to stoke volatility on the bond markets. While the peak in volatility now seems to be behind us, the May rally calls for caution. On the fixed-income markets, we are neutral on euro rates and now prefer a positive bias on US rates. While the US Federal Reserve is keeping its key rates unchanged for the moment, the 4.5% Treasury Note yield, in our view, prices in a portion of the risks on US debt. We would not rule out higher yields in the coming weeks, but if that happens, it would create new buying opportunities. In Europe and Japan as well, yields have risen quite high. We are taking this opportunity to shift our exposures to maturities towards 30 years. On the credit markets, we believe that carry remains attractive but prefer to stay neutral in investment grade and to lower the cursor in high yield.

The equity markets’ rally from their lows has been impressive, given that no proper trade agreement has yet been signed. Earnings releases have been in line with forecasts, with no particular sticking points. Even so, few companies are currently able to say with certainty what impact tariffs will have on their business volumes. They will no doubt adjust their forecasts when releasing their half-year figures. With valuations now more generous, we have decided to neutralise our exposure to European equities.

The euro-dollar exchange rate got a boost from the sudden shifts in Germany’s fiscal paradigm and the US trade paradigm. We are sticking to a neutral stance on the euro-dollar for three reasons: 1/ monetary policy expectations are rather well priced in on both sides of the Atlantic; 2/ the good macroeconomic news from the euro zone, with its stimulus plans, are offset by uncertainty on the outcome of tariff negotiations; and 3/ President Donald Trump’s policies have engendered a risk premium on dollar-denominated assets, thus limiting the benefits to the dollar, despite the high level of uncertainty.

MACROECONOMIC VIEW

WHAT HAPPENED TO ALL THE DEALS?

OMBRETTA SIGNORI
Head of Macroeconomic Research
and Strategy
OFI INVEST ASSET MANAGEMENT

BETWEEN UNCERTAINTY ON TRADE POLICY...

Uncertainty is still high on where US trade policy will end up. On top of the 90-day pause on reciprocal tariffs between the United States and China, and Donald Trump’s threat to impose 50% tariffs on the euro zone, US courts have now also gotten into the act. Alongside negotiations still in progress, the US Court of International Trade at first suspended reciprocal tariffs (but not those on steel, aluminium and cars) on the grounds that the declaration of a state of emergency was illegal. This decision was then suspended by an appeals court, and reciprocal tariffs ultimately remained in place, pending a ruling by the Supreme Court. In any case, the Trump administration has alternative legal avenues to apply across-the-board reciprocal tariffs⁽²⁾. But the prevailing uncertainty could truly slow down business investment decisions by US (and international) companies in the coming months.

...AND LACK OF FISCAL CONSOLIDATION

Tariff policy is a key tool for Donald Trump, both in negotiations and to reduce the trade deficit and finance his tax cuts. The reconciliation proposal was approved by the House and is going to the Senate.

It is expected to be completed this summer and should make it possible to prolong and extend tax cuts implemented in 2017 (under the Tax Cuts and Jobs Act⁽³⁾) and to raise the debt ceiling prior to the deadline. Under our baseline broad protectionist scenario (10% reciprocal tariffs for everyone and 60% for China), customs revenues would amount to 2,000 / 2,500 billion dollars over 10 years – not enough to guarantee an improvement in the public deficit, which is expected to come in at between 6% and 6.5% of GDP in the coming years.

WAIT AND SEE BY THE FED

Total US inflation fell to 2.3% yearon- year in April, while core inflation remained stable at 2.8%. These figures suggest that services inflation was moderating and that, barring protectionism, the US was indeed well on the way to meeting the inflation target. Increased tariffs have already raised retail prices of certain goods. However, they have not yet shown up on an aggregate level, given that companies stocked up aggressively to get the jump on tariffs and that prices had recently fallen on goods with high Chinese import content. Probably not for another one to three months will the impact of tariffs begin to show up, and uncertainty over current negotiations could also delay that impact. Once again, the Fed can afford to wait before lowering its rates, given the inflationary risks and the resilience the real economy has shown.

EUROPE HANGING ON NEGOTIATIONS WITH WASHINGTON

In the euro zone, uncertainties on growth continue to point downward, due to protracted tariff negotiations. In May, PMI numbers fell below the 50 threshold for the first time this year, due to weakness in services, reflecting lacklustre domestic demand. Inflation should, on the whole, stay on the right track, and the European Central Bank’s wage tracker slowed to 2.4% in the first quarter of 2025. We believe the ECB still has some room to lower its key rates before indisputably entering into accommodative territory. We continue to believe that the extent of the downward cycle will depend mainly on ongoing trade talks with the US but also on how fast the new German government implements its stimulus plan in concrete form. If reciprocal tariffs exceed 10% by far, the risk of prolonged stagnation, or even an economic contraction becomes real for countries that export the most to US, such as Germany and Italy.

INTEREST RATES

LONG BOND YIELDS FALL VICTIM TO TARIFFS

GEOFFROY LENOIR
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT

The bond markets are still jittery. The Trump administration’s blows have introduced uncertainty into central bank actions. True, the ECB is sticking to its easing cycle, with a new rate cut priced in for June, but the US Federal Reserve remains especially cautious, torn between depressed survey data and rather resilient business data, and between downward risks to growth and upward risks to inflation. Public finances would benefit from a rate cut, but Jerome Powell is refusing one for the moment, while the proposed budget approved by the House of Representatives suggests that the deficit will worsen in the coming years. As a result, the term premium⁽⁴⁾ on US yields has risen and, the 30-year yield is now hovering around 5% after hitting 5.15% on 22 May.
Curves are steepening not just in the US. Long-term financing costs are under pressure everywhere, for example in the 30-year Japanese yield, which hit 3.19% before pulling back below 3%. Meanwhile the Bank of Japan (BoJ) is holding steady on key rates but while reducing its purchases of Japanese bonds. In light of the current economic uncertainty and the difficulty in quantifying the extent of the coming, tariff-induced inflationary shock, bond investors are wary. Some long-term debt investments are not attracting the same amount of demand as in the past, have triggered sudden shifts in rates.

Against this backdrop, we are taking advantage of this curve steepening to reallocate risk on long sections, European and Japanese ones in particular, while lowering it on 2-year paper. Meanwhile, although US yields are likely to remain volatile in June, we believe that the 4.50% range on 10-year maturities is attractive. As a result, we are shifting our exposure to US bonds tactically while keeping some leeway for a scenario that would point upward on interest rates.

CARRY, SPREADS AND RISK MANAGEMENT

Investment grade corporate bonds ended the month strong, and high yield performed even very well, with its best month since late 2023. True, volatility continued to be driven by Donald Trump’s announcements and counter-announcements on tariff policy.
But the market appears to have taken note that the consequences of this policy will do less harm than initially expected. With key rates down in the euro zone and investors on a cautious footing after the equity markets rally, carry, in our view, gives corporate bonds a solid edge over other asset classes.
With this in mind, credit spreads have narrowed, as the primary market got carried away with about 70 billion euros in issuance, one of the busiest months ever in terms of volumes. Order books were oversubscribed by far, with issue premiums often low or non-existent, thereby illustrating investor appetite. Subscriptions to investment grade and high yield credit funds have also begun to be a powerful technical factor in support. Although yields fell on the month, we remain constructive on high yield corporate bonds, as carry is still high. Even so, we acknowledge that, based solely on spreads, the market has once again become a little expensive. From the risk management point of view, we therefore prefer to reduce our exposure by lowering our stance on the asset class by one notch. Our bias is more neutral on eurodenominated investment grade corporate bonds, as they are more exposed to shifts in interest rates, on which our approach is more measured at this stage.

EQUITIES

FROM ‘AMERICA FIRST’ TO ‘TACO’⁽⁵⁾ IS NOT A LONG TRIP!

ÉRIC TURJEMAN
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT

Contrary to the old adage, selling in May and going away was not the best strategy, either in Europe or in the US. The indices rallied robustly against a backdrop of initial tariff negotiations between China and the US. The (temporary) reduction in tariffs between the two superpowers caused volatility to recede and the markets to return to their highs. The world is realising that the worst-case scenario is not the most likely one. The Trump administration seems to have become more pragmatic and is reassuring markets by taking more into account the economic impacts of its policies.
And yet, at this writing, no proper agreement has yet been signed. First-quarter releases were ultimately reassuring, but very few US companies (less than 10% of the S&P 500) have opted to include the tariff impact in their full-year guidance.

In some cases, they pointedly widened their projected ranges on full-year margins and earnings forecasts, while sticking to midpoint levels. They want to reassure but their comments laid bare their limited visibility, as seen in business confidence indicators, which are stuck at low levels. Corporate America’s questions on how to manage tariffs have overshadowed all other concerns. Our conviction is that most of the tariff impact will be passed on into sales prices, in order to preserve companies’ margins.

But woe be to those companies that are excessively forthcoming on the subject. Amazon* and Walmart*, for example, were severely reprimanded by Trump himself for having announced coming price hikes to offset increased tariffs.

KEEP AN EYE ON LONG BOND YIELDS

The Trump administration is realising that long bond yields could become an issue. In fact, everything that could throw oil onto the fire, such as a perceived imminent rise in retail prices, is becoming a cause for concern. But for the moment, the markets have shrugged all this off. This is illustrated perfectly by the lack of reaction to Moody’s downgrade of the US credit rating. But for how much longer? The proposed budget could add 3,300 billion dollars of debt over the coming decade. The public deficit only becomes a problem when investors have decided that it is a problem.
Jamie Dimon, the much-respected head of JP Morgan, is increasingly doing just that. All eyes will therefore be on long bond yields.

EUROPE HELD UP WELL

Europe still looks like a safe haven. In addition to an economy that fared better than expected in the first quarter, corporate earnings came out 6% above forecasts, an all-time high range. True, earnings forecasts were revised downward, but these are due to the euro’s strength, particularly vs. the dollar. And the outlook is rather favourable, with Germany planning to accelerate its investments between now and 2030, the impact of which is likely to benefit the entire euro zone. Meanwhile, companies in Europe and worldwide are still hanging on the announcement of tangible and definitive measures regarding tariffs that will apply to European products in the US. Until then it’s hard to be very enthusiastic, especially as other announcements are still possible, and that, at 14 times current year’s earnings, European equity markets are not, in our view, very cheap.

EMERGING MARKETS

SOUND FUNDAMENTALS!

JEAN-MARIE MERCADAL
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT

Asian markets are brushing up against their year’s highs, despite a highly challenging international environment. The pause in US tariffs has certainly helped but, on the whole, Asian economies have held up rather well and companies are reporting strong results…

Asian markets’ performances have been encouraging on the year to date. Chinese equities have gained almost 10% in dollars, and the ex-China equities index almost 5%. After the pause announced by Donald Trump, trade negotiations between China and the US are continuing discretely, with both sides having much to lose from an escalation. However, in the meantime, China is accelerating its decoupling from the US. Before travelling to the ASEAN⁽⁶⁾/GCC⁽⁷⁾/ China summit in Malaysia, Li Qiang, the Chinese prime minister, signed an agreement with Indonesia on cross-border settlements in renminbi (RMB). Meetings are scheduled with European leaders in early June as part of the 50th anniversary of Sino- EU relations. China is also expanding its imports from central Europe via the Belt and Road Initiative⁽⁸⁾.

Meanwhile, closer and closer ties are being formed with Gulf countries.

China needs energy from Gulf countries, which, in turn, need manufacturing equipment, infrastructures and renewable energy to ready themselves for the postpetroleum era. Exports to the US now account for just 3% of Chinese GDP. This decoupling is also occurring in finance. China is gradually switching its holdings from US bonds to gold, a trend accelerated by Moody’s downgrade of the US credit rating.
The search for new trade markets is crucial to keeping China’s formidable industrial apparatus humming, as the Chinese economy’s shift towards its domestic market faces a number of obstacles. For example, confidence, while improving, has not yet been reestablished, with youth unemployment still high and real estate only just beginning to stabilise. Meanwhile, China is now very heavily indebted (with total debt amounting to almost 300% of GDP) and does not have the fiscal capacity to create a system of social protection and pension financing that would free up consumer spending. The problem here is that China’s industrial overcapacity is exacerbating domestic competition and, in turn, maintaining deflationary forces. This is the case in particular of electric vehicles. BYD* has lowered its prices by between 10% and 30%. Other automakers will have to follow suit, although only three out of 50 are profitable. Another example is in meal delivery. JD.com* wants to get in on this market dominated by Meituan* and Ele.me*, triggering a price war and a loss of 100 billion dollars in the combined market cap of JD.com* and Meituan*.
Corporate quarterly reporting season showed an overall improvement. Earnings of Hong Kong-listed companies rose by 6.5% vs. the first quarter of 2024. The “beat/ miss” ratio⁽⁹⁾ improved to 44%/51%, vs. 39%/58% in the fourth quarter of 2024. For 2025, the consensus forecasts increases of earnings of 8.3% in 2025 and 11.8% in 2026, which works out to an estimated 2025 P/E of 11.8. As for Shanghaiand Shenzhen- listed companies, earnings rose by 8.9%. The “beat/ miss” ratio there also improved, to 44%/54%. Forecasts for 2025 are for 16% earnings growth and 12.4% in 2026, or a 2025 P/E of almost 12.5.
Elsewhere in Asia, results were also positive on the whole, particularly in India, where forecasts were beaten and where growth is very strong. Since Liberation Day⁽¹⁰⁾, several countries, such as India, China and Thailand have lowered their key rates. The long-term outlook remains rather encouraging.
Emerging bonds denominated in local currencies also strengthened, by 9.7% in dollar terms on the year to date, despite the notable increase in US rates. On the whole, the current uncertainty is causing global capital to diversity away from the US and the dollar. Emerging bonds in local currency look well placed in the current macroeconomic environment, in particular vis-à-vis Asian currencies, which recently strengthened appreciably. The index of emerging debt denominated in hard currencies, rose by almost 3.5% in USD.

FIGURE OF THE MONTH

$760bn

Over the past five years, China’s US bond holdings have shrunk from 1,100 to 760 billion dollars, moving into gold.

CHINA’S RESERVES (US bonds vs. gold)

Source: Bloomberg, May 2025

Document completed on 05/06/2025