Admitting that some other senior colleagues at Axa were expecting a cut of 25 bps, “my personal call [on the US Fed decision] in September was 50 bps,” said Chris Iggo, chair of the Axa IM Investment Institute and CIO of Axa IM core, at Axa Investment Managers, during an interview on 1 October 2024.
Fed on a steady interest rate declining path
“The economists have their views, and it’s based on their understanding of the economy... I take a market view.” In addition to evaluating what is priced in, he explained that he needs to review his teams’ positions and assess “where the shocks might be.” At the announcement of a cut of 50 bps, “there was no real drama.”
Looking ahead, Iggo expects two more cuts of 25 bps each by the end of the year “because the election does complicate things.” Beyond 2024, he noted that the market is pricing “a steady decline to 3%” for 2025, a neutral level in line with his view and the dot plot of the Fed. He stressed that the level should be the terminal rate. “Real neutral rate at 1% and then inflation at 2%, so that's their kind of nirvana, where the Fed wants to be.” Yet he added: “if the economy is still going at 3%, then it will be difficult to get [down] to 3% interest rates.”
US inflation: mixed pressure
Iggo sees the strike of dockworkers on the east coast of the US as a supply shock. Beyond the effects on supply of goods to consumers and businesses and “some inflation pressure,” Iggo does not expect any impact on the monetary policy unless the strike goes beyond one month. He would not be surprised to see “the current administration [to] put pressure to get this thing settled before the election.”
Until last week, “China was looking very weak and was kind of exporting deflation.” However, he stressed that it is too soon to assess whether the plan--which he qualified as a “circuit breaker stopping the downward spiral, hopefully”--will change the trajectory for China, let alone have global implications. “They have to get domestic demand going again in China… [yet] they’re rebuilding their savings so they’re not spending.”
Long term rates: the large gains are behind us
From a flat level not later than a month ago, the 2Y-10Y yield curve has steepened with the rates standing now at 3.66% and 3.80%, respectively. “It will keep on going in that direction… i.e., spread to go higher,” predicted Iggo. He thinks that is normal when the Fed cuts interest rates.
“[Rates] will probably go higher because of importing inflation on tariffs… plus more tax cuts which would stimulate the economy
“If [the Fed] goes to 3%, then the 2-year yield should be around 3.20% and the 10-year yield will probably stay close to where it is now.” According to an in-house valuation model, Axa expects the 10-year yield to hover around 3.75% to 4.00%. “You need a recession to see them going lower.”
Recession on the horizon
Outside external shocks that led to the Great Recession in 2007-2009, for instance, “the amplitude of the economic cycles got much shorter… and gentler… compared to the 70s and 80s… the extremes are less frequent… in normal business cycles,” observed Iggo. Apart from maybe the tech sector, he struggled to see “what's the trigger that would create a recession.” Therefore, he sees the likelihood of a shallow recession at 25% and a deeper one at 5%. If any, he would it expect it to be “modest,” not going below -0.5%.
Could a recession come from concerns on the ever-increasing government debt pile?
“There’s zero correlation between the debt level and deficits and a recession, unless the US government can’t finance itself,” affirmed Iggo. “That’s a real black swan event, because they can always print money.”
Iggo remarked that the Congressional Budget Office projected that the federal deficit would be about 6% of GDP for the next 10 years and the debt-to-GDP level would go above 120%, a level only seen by the weakest sovereign in Europe before covid.
Impact of potential election of Trump
“[Rates] will probably go higher because of importing inflation on tariffs… plus more tax cuts which would stimulate the economy… and [higher] risk premium on the yield curve.” Moreover, Iggo noted that 30-year yield are trading at a spread of 80 bps (up from -20bps a year ago) over the 30-year swap yield. “That’s typically a sign of a higher risk premium in government bonds… a long-term fiscal risk premium… whereas in Germany, it’s almost the other way around.” Another reason may be related to a greater liquidity on swaps versus the long-term treasuries.
Direction of travel for the ECB until the end of 2025 and long-term rates in the EU
“We are expecting one more cut--25 bps--in December and then down to 2.5% [from currently at 3.5%] by the end of next year,” predicted Iggo. “You’ve got the old problems, that Germany looks very weak. Spain is booming, but Spain’s tiny compared to Germany. France has its political issues. Is it going to have a budget? Italy looks to be on a better path at the moment. Having a view about the entirety of the euro area is quite difficult,” explained the British CIO.
Despite some wage pressures in Germany, he thinks that “inflation seems to be under control in Europe,” which should justify ECB rates to sail smoothly toward 2.50%.
Iggo noted that yields are higher for Spain and Italy, but he does not consider them as attractive. As an EU proxy, French bonds are not expected to move lower--a trading range of 10-15 bps--from the current levels (2-year at 2.25%, 10-year at 2.80%). In fact, yield spreads between France and Germany increased on the back of budget uncertainty in France. “Until [it is solved], I don’t think we’ll see much improvement… you see significant moves in French yields usually because foreign investors are either moving in or moving out.”
EU: boring growth
“The euro area is maybe not as weak as we thought, but it’s not super strong either.” Iggo expects annual GDP growth to reach 0.5%, “maybe 1.00%,” over the next one to two years thanks to a return of consumers helped by lower energy prices.
Three scenarios on the impact of Ukraine
“Things just stay the same, so it’s not really affecting anything.” The second is if “things get much worse,” such as Russia starts invading neighbouring countries in the West. “It would be bad for financial markets… bond yields down, equities down, the euro down but the dollar would benefit.” In a third scenario in which Putin is gone or a land agreement is reached, he would expect a mini-Marshall Plan that would stimulate activity.
Social cohesion in the West at risk
“Everywhere we seem to be seeing a breakdown of social cohesion,” commented Iggo. He sees the polarisation of politics in the US migrating also to the UK. “We have had a new government, for eight weeks, and already the [yellow] press says that [prime minister] Keir Starmer should resign.”
He thinks that there are real concerns by the population about cost of living, immigration and the “haves and the have nots… while governments don’t seem to be addressing those issues.” These developments are not currently affecting financial markets, “but political upheaval could affect [them] eventually.”
Iggo is concerned that right-wing parties taking power in some countries may change policies. “They don’t have the best economic policies, Mr. Trump being an example.”
Strong momentum in climate change
“I think the momentum is shifted away from the public sector to the private sector.” He commented that companies set out targets in their sustainability reports. Iggo thinks that some companies set net-zero targets for 2030 “and they have to stick to those targets really well, otherwise shareholders are going to question them.”
He expects that the rapid expansion of renewable energy supported by its largest buyers in the US, the technology firms, “will lower the cost of power for everybody.” Iggo reported the words of Axa’s climate expert just back from the US: “the Americans, there’s no politics. They’re just doing it. They’re just investing in clean technologies.”