PERSPECTIVES

OUR CENTRAL SCENARIO

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

The art of the deal⁽¹⁾

The start of Donald Trump’s second term lived up to expectations. His call for territorial expansion to Greenland and Panama, the imposition of customs tariffs on Chinese, Mexican and Canadian imports, Elon Musk’s youthful spin-doctors⁽²⁾ and the reauthorisation of plastic straws – his tweets have come one after another, followed by as many executive orders. That said, beyond the blunt tone of his announcements and “table flipping” that violate normal laws of political discourse, we are beginning to see the outline of a plan to gain the upper ground in negotiating “deals”. One example of this was the one-month postponement of tariffs, pending an assessment of military reinforcements by Canada and Mexico along their borders with the US. The content of Trump’s plans is not as cartoonish as their form and, the measures announced so far have not been as brutal as might have been feared from his campaign statements.

The markets guessed all of this, sending risky assets to a bullish start on the year.

US economic growth should continue to be driven this year by internal forces but also by the impact of likely tax and investment measures. With this in mind, the US Federal Reserve is expected to stay in pause mode for a few more months, pending greater visibility, before making about two rate cuts, as the economy lands softly against a backdrop of under-control inflation. In Europe, the European Central Bank (ECB) is expected to continue lowering its rates by at least 75 basis points in the coming months. While inflation is receding very gradually, the risks to European growth must not be overlooked.

As for market interest rates, after a nice rally to start the year, we are taking some profits while sticking to our positive bias, given current carry levels, as well as the expected monetary easing, which is likely to steer bond yields downward on the year. As they have for several quarters now, corporate bonds remain attractive, particularly with less volatility in credit spreads.

Equity markets almost reacted more to the DeepSeek* affair⁽³⁾ than to Trump’s announcements. This first bolt out of the blue on AI has brought a halt to the very strong momentum of “BATMMAAN”⁽⁴⁾ valuations, which is not such a bad thing. The “US tech” market will become increasingly mature but should continue to lead the pack. While AIs costs are likely to be driven lower by Chinese competition, companies won’t be reducing their investments but will have to integrate more AI into their processes. Against this backdrop, we reiterate our positive view on equities, while overweighting the US for the moment. Volatility will stay with us in the coming weeks, and the time will probably come to return more aggressively to the euro zone, once the situation is clearer.

OUR VIEWS AS OF 10/02/2025

With central bank policies diverging, we are leaving our cursors in place for all asset classes except euro zone government bonds, on which we are lowering our weighting slightly. Although we expect current yield trends to continue, a short-term rebound cannot be ruled out. The current political environment calls for some caution, especially in Europe. For the medium term, we still believe that the 10-year German bond could trade between 2.00% to 2.60%. Against this backdrop, momentum is still in place on corporate bonds. There do exist some risks of a widening of spreads, but carry offers some protection that in our view makes it worthwhile to remain invested. Meanwhile, money-market rates continue to fall, tracking ECB rates downward. We will no doubt be adjusting this cursor in the coming months. As an indication, with €ster at 2.66%, moneymarket rates are still higher than the interest rate on the French Livret A passbook savings account, which has just been lowered to 2.40% in February.

2024 was an excellent year on global equity markets, and 2025 is also off to a good start. For once, European markets have outperformed their US and Asian peers on the year to date, as their relative valuations has at last pulled momentum in the other direction. However, we don’t think this is yet the time to reverse our overweighting from the US to European equities, as Europe does not look best armed for the trade wars that Donald Trump has unleashed. But we do expect to dial back our underweighting of European equities at some point this year. In the meantime, we reiterate our positive bias in favour of markets across Asia.

While we do not expect a massive dollar rally in our baseline scenario from current levels, we believe that momentum continues to favour the dollar for two reasons: 1/ American exceptionalism in terms of growth is likely to remain in place in 2025; and 2/ potential implementation of customs tariffs confers a risk-aversion premium on the dollar, which we also expect to benefit from the US Federal Reserve’s cautious rate-cut stance and from weakness in partner economies.

MACROECONOMIC VIEW

TWO FLOORS, TWO ATMOSPHERES

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

DONALD TRUMP’S MOTTO: “AMERICA FIRST”

On the economic front, the United States began the year on a solid footing. Fourth-quarter 2024 growth was quite strong (2.3% annualised), driven by a strong contribution from consumption. Business investment dipped slightly, due mostly to strikes at Boeing*, but all leading indicators – whether durable goods orders, business surveys or bank financing conditions – suggest that it is likely to make a positive contribution to growth in 2025, with a potential additional boost from deregulation.

THE FED MAY DECIDE TO PROLONG ITS PAUSE

Inflation is likely to continue receding slowly in the coming months, thanks to favourable base effects, but there’s no rush to lower key rates, given how solid economic growth is. Any economic forecast is subject to additional uncertainties regarding the exact shape of government policies, as well as their economic repercussions, as we noted in our Focus of October 2024⁽⁵⁾ and our Perspectives of January 2025⁽⁶⁾. After keeping key rates unchanged in January, the US Federal Reserve could therefore decide to stand pat for longer than expected, especially if tariffs are indeed imposed in the coming weeks.

THE EURO ZONE FLATLINED IN LATE 2024

The first details available from national accounts suggest that it was probably foreign trade and not consumption that dragged down economic activity, which backs our view that private consumption should be the main driver of growth of close to 1% this year. As for business investment, the latest survey of commercial banks by the European Central Bank (ECB) suggests that credit conditions tightened further in Germany and France, due to concerns over economic and political uncertainties. That means that transmission of monetary policy via the banking sector is still essential and is another gear in the machine that is expected to lead the ECB to lower its rates further. On the price front, services inflation has held at about 4% since the end of 2023, which is too high. However, services inflation is maintained mainly by wages, and the ECB wage tracker, which is based on granular data from collective bargaining agreements, suggests a sharp slowdown in wage trends by yearend. It is against this backdrop that we continue to expect the ECB to lower its key rates to 2% by mid-year.

WHAT ARE THE SOURCES OF UNCERTAINTY IN EUROPE?

Visibility on European growth continues to trend downwards, particularly in the event of higher customs tariffs. Donald Trump may indeed threaten the European Union with either across-the-board increases or on specific goods, such as steel aluminium or voitures. Another event to keep an eye on is elections in Germany. After several years of economic stagnation (with GDP now no higher than it was in 2019), Germany’s institutions and companies are well aware that the country needs more investment, either through special funding or a constitutional reform of the cap that limits the structural federal deficit to 0.35% of GDP. Even the president of the Bundesbank spoke out in favour of reform, recently in Davos. The reform of the so-called debt brake can be adopted by Parliament with a two-thirds majority, but that would harder to accomplish if the AfD were to win 30% of the vote or if smaller parties, such as Die Linke, BSW, or FDP, enter Parliament, owing to their stances on this issue. In that case, the constitutional reform would take longer to be adopted and investments might not emerge until 2027. However, there is some wiggle room in the budget and the option of using other instruments in the meantime.

INTEREST RATES

DIVERGENCE OF MONETARY POLICIES

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

As the year begins, the divergence between central banks is now official. The European Central Bank (ECB) lowered its key rates for the fifth time, with the deposit rate now at 2.75%. The ECB is expected to stick to its rate-cut cycle this year, while the US Federal Reserve is now in pause mode. The markets are now pricing in no more than two rate cuts in 2025, with the first one not happening until summer. So the 4.50% key rate seems, for the moment, to suit a robust US economy driven by Donald Trump’s proactive policies. Moreover, core inflation remains stubbornly high, and the announcement of higher US customs duties is creating uncertainty on the coming inflation trajectory.
In other parts of the world, the Bank of England cut its rates further, while the Bank of Japan moved in the opposite direction, with a 25 basis point hike in its key rate, to 0.50% – true, this is still low but is also a level not reached since 2008.

DEMAND FOR BOND ISSUANCE HAS NOT WEAKENED

On the fixed-income markets, yields began January on an upward trend before pulling back in the wake of US inflation data that were slightly below expectations. The 10-year US yield moved from 4.57% to 4.54% on the month after rising as high as 4.80%.

The same goes for the 10-year German yield, which hit 2.65% but in early February pulled back to its yearend-2024 levels, at about 2.36%. Meanwhile, the France/ Germany spread narrowed by about 10 basis points on 10-year paper. France took advantage of an across-the-board decrease in interest rates in the second half of the month, when the government of François Bayrou was under threat of a no-confidence vote and the pace of Treasury issuance was very high, with almost 40 billion euros in debt issued in January, or a little more than 10% of its programme for 2025. More broadly, in the euro zone, issuance net of quantitative tightening, i.e., ECB purchases, is expected to hit a record of almost 800 billion euros in 2025 (sources: Société Générale and Bloomberg). This is a technical upward driver of interest rates.
The primary corporate market was also quite busy, with almost 95 billion in new issuance (sources: Ofi Invest Intermediation Services and Bloomberg). A record level close to that of 2024. With investor demand still strong for this asset class, credit spreads narrowed further and are currently trading at levels that we feel are attractive.

KEY POINTS

After a lukewarm January for sovereign debt indices, we remain bullish on duration. We are dialling back very slightly our overweight stance following the recent decrease in rates but remain bullish on the main regions – the euro zone, the US, the UK and Japan – in this context. In corporate bonds, we believe that spreads are already narrow but we are leaving our positions unchanged, as we expect investment grade and high yield this year to offer close-tocarry yields of, respectively, about 3.5% and 5.0%. Our preference is slightly in favour of A ratings over BBBs (as the spread is at an all-time low) and, in high yield, in favour of BBs, which are less exposed to the economic cycle. We reiterate our preference for financials, particularly subordinates, which look a little more attractive that non-financials.
Selectivity is still essential, with active management of credit risk in a context in which political visibility is worsening, particularly amidst Donald Trump’s announcements and possible increases in customs tariffs on Europe and elections in Germany.

EQUITIES

ROLL BABY, ROLL!⁽⁷⁾

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

Seldom has a year got off to such a roaring start. The first 15 days of Donald Trump’s term alone have already grabbed headline after headline. Whether it’s Canada, Mexico, Greenland, Panama, cryptocurrencies, the European Union, or China, zones of conflicts between the new administration and the rest of the world have emerged from all sides. Among other things, this has caused volatility to begin moving back on the equity markets. The Republicans’ roadmap is clear, even if restoring a little lustre to the American dream must come at the expense of its historical partners. The art of the “deal”⁽⁸⁾ is making a big comeback in politics, for better or for worse!

THE ARTIFICIAL INTELLIGENCE (AI) SURPRISE CAME FROM CHINA

This month the shock came from China. DeepSeek*, a Chinese startup, took the world by storm when it claimed it was able, for a few fistfuls of dollars, to achieve more or less the same thing that US hyperscalers had spent dozens of billions of dollars trying to do.

A famous Silicon Valley venturecapitalist even termed this AI’s “Sputnik moment”, referencing the Soviet’s breakthrough in space exploration 70 years ago. But it was especially DeepSeek’s announced development cost that shocked the market participants. How did a small company come out of nowhere and, with a few million dollars, manage to outmanoeuvre the planet’s largest companies? By nature, the markets don’t like it when answers aren’t immediately forthcoming. That’s why they brought down the hammer on AI sector stars. Nvidia* and Broadcom* dropped by more than 15% in one trading session, Vertiv* by 30%, and GE Vernova* by more than 20%. In a way, the entire AI ecosystem became suspect. Not until Wednesday 29 January and the releases of earnings by Microsoft* and Meta* did some reassuring news emerge. DeepSeek* is not the revolution described by some. It changes nothing in already planned investment spending, which remains far higher than in 2024. And, to top it all off, it is entirely plausible that, if such technologies were to lead to more rapid adoption of AI by all economic agents, it would then be necessary to invest even more in calculating power. On the other hand, it may make sense to take some profits after the ride AI has been on over the past two years.

A STRONG START TO THE YEAR FOR EUROPEAN EQUITIES

The other surprise came from Europe. While the consensus remained by far in favour of US equities, it was European equities that turned in the month’s best performance. The absence of AI actors from major indices certainly played a big role. But so did the strong releases by a few heavyweight listed European companies, such as ASML* and SAP*, which managed to beat forecasts, triggering a robust rerating of their shares. The biggest surprises of all came from luxury stocks. Few analysts had bet on a material improvement in topline momentum, but that is indeed what happened, driven mainly by the renewed strength of US consumption. That was all that was needed to drive a rally by a sector that had been snubbed by investors over the past two years.
When the CAC 40 beats the Euro- Stoxx 50, which itself outperformed the S&P 500 – well, that doesn’t happen often! Why not enjoy it? And yet, as in 2024, European markets have almost hit the level that we had envisioned for the full year. That’s why we are leaving our recommendation unchanged for Europe, even though the historic valuation gap with the US is likely at some point to cause us to reverse our geographical hierarchy. In addition, all of Asia remains attractive in our view.

EMERGING MARKETS

WILL THE TRADE WAR ACTUALLY HAPPEN?

JEAN-MARIE MERCADAL
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT

Since Donald Trump took office on 20 January, he has issued one executive order after another, particularly on customs tariffs, although no final decisions have been made. This has caused some turmoil on the markets, especially in emerging currencies. So far, China has done fine.

The Donald Trump/Elon Musk alliance marks a true turning point in US economic policy. The future will tell whether this unprecedented combination of domestic tax reductions (particularly on companies), public spending cuts and increases in customs tariffs will pay off. For the moment, the markets are not fully convinced. US equities are about where they were on 20 January, whereas Chinese equities are up by 5%!

TARIFF UNCERTAINTY HAVE MADE EMERGING CURRENCIES HIGHLY VOLATILE

The US plans to impose a 25% tariff on imports from Mexico and Canada but only an additional 10% on imports from China. Other tariff announcements may target Europe. But, for the moment, our feeling is that these headlinegrabbing announcements are actually a negotiating tactic, given that a sudden hike in tariffs would undermine the US consumer and economic growth.

All this has pushed down almost all emerging currencies by 2% to 3% against the dollar, including, of course, the Mexican peso. They have fallen less against the euro, as the euro has also weakened. So, the mix is still attractive and on the year to date, emerging bonds denominated in local currencies are up by 2%, while those in hard currencies, by 0.5%.

CHINESE ASSETS HAVE HELD UP REMARKABLY WELL

The additional 10% tariff on Chinese goods is relatively moderate compared to the 60% that Trump had threatened during his presidential campaign. Chinese equities are up by 5%, while the yuan has gained 0.5% vs. the dollar. China is now better prepared for a trade war with the US than it was in 2018, and the balance of power is more even. China has begun to retaliate with tariffs on US farming equipment and raw materials. These tariffs have been rather low for the moment, but China has several other, more drastic means of potential retaliation. S&P 500 companies, for example, generate almost 100 billion dollars in revenue in China; US technological firms depend on Chinese rare earths… Moreover, Chinese farm produce imports from the US can be easily replaced by suppliers from Latin America, Europe or Australia. Meanwhile, the People’s Bank of China could consider devaluing the yuan.

In short, there has been no escalation for the moment, and both countries have opportunities for economic collaboration, which opens the door to a win-win situation. For example, Chinese companies have the industrial capacity to set up jointventure factories in the US. Elon Musk could serve as a go-between, having played a key role in the electric car ecosystem in China, with Tesla having located there more than 10 years ago. What’s more, Trump also has a geopolitical agenda and may need China’s support against Russia during potential peace negotiations on Ukraine. This constructive scenario between the two countries does not seem to have been priced in yet at current levels.
Beyond that, the true challenge for China is to restore confidence in the country and to boost household consumption. The latest statistics show something of a slowdown after several rather encouraging months. A firm stimulus plan is expected in early March from the “Two Sessions” (the annual plenary sessions of the National People’s Congress and the Chinese People’s Political Consultative Conference). In this more volatile and uncertain environment, we believe that Chinese equities offer an attractive diversification. They are priced rather low, and the recent DeepSeek episode highlighted the strength of Chinese tech, once again drawing investor interest.

FIGURE OF THE MONTH

+5%

The increase in the MSCI China since an additional 10% US tariff was announced (vs. the 60% that had been mentioned). This illustrates the relative “cordiality” in the initial contacts between Donald Trump and China, despite discordant stances on many recurring issues.

TREND IN EXPORTS IN CHINESE GDP

The Chinese economy depends less and less on exports, particularly to the US, which now accounts for just 3% of GDP. The relative weight of exports is expected to decline further in the coming years, with the shift towards the domestic economy that the government wants.

Sources: OECD, HSBC (including re-exports to third countries) as of end-2024.

Document completed on 10/02/2025