Monetary discipline, fiscal largesse
Developed-market central banks have adopted a noticeably more restrictive tone since the end of August, against a backdrop of the protracted conflict between Iran and the United States and rising prices for oil and refined products. Admittedly, these inflationary pressures still stem mainly from supply shocks. However, after Covid-19, the war in Ukraine and now tensions in the Middle East, central bankers can no longer systematically disregard inflation levels that remain persistently above their targets. Preserving their credibility on price stability remains a major challenge, as long-term interest rates continue to rise. The rise in bond yields, which began in 2022, reflects both monetary tightening by central banks in response to inflation risks and more structural concerns relating to the trajectory of public debt and persistent budget deficits.
This trend is notably reflected in higher real yields and the term premium required by investors. Against this backdrop, the measures announced by the US Treasury to support the yen while avoiding a reduction in Japanese holdings of US bonds, together with increased buybacks of long-term debt, have had only a limited impact on bond markets. Only a credible fiscal adjustment capable of placing deficits on a sustainably lower path would be likely to change investors’ perceptions. For these reasons, we remain cautious on sovereign bonds in terms of both weighting and duration, and we favour credit.
The dollar remains under pressure
Notably, the Federal Reserve’s more hawkish rhetoric has not resulted in a lasting strengthening of the dollar. Despite interest-rate differentials that remain favourable to the United States, growing concerns about the sustainability of federal debt and the Treasury’s steadily increasing financing needs continue to weigh on the US currency. This gradual erosion of confidence in US sovereign assets is benefiting gold, which continues to rise, as well as bitcoin, which gained 25% in August. The precious metal is benefiting both from its safe-haven status in a tense geopolitical environment and from its role as a hedge against risks linked to deteriorating public finances and potentially more persistent inflation.
Beyond these public-debt issues, economic fundamentals remain broadly sound. In the United States, the latest employment figures support the reflation scenario, while activity in Europe is proving more resilient than expected. However, the rise in gas prices, as the continent needs to rebuild its stocks ahead of winter, remains a vulnerability. In this environment, corporate earnings continue to grow, the AI theme remains supportive and the private sector’s financial position is broadly healthy. Following the decline in July, equity markets rebounded and valuation levels eased slightly, particularly in emerging markets.
