Appreciation of US dollar loses pace

The economic gap between the US and Europe widened further in November. The purchasing managers' indices in the eurozone fell sharply, while they rose again in the US. Investors are now expecting much sharper interest rate cuts from the ECB than from the Fed. The widening of the interest rate differential has caused a strong appreciation of the US dollar. We benefited from this movement due to our overweight in the US dollar and our focus on euro government bonds. Meanwhile, the yield advantage of 10-year US Treasuries over German Bunds has risen to 220 basis points, which is well above the historical average of 100 basis points and has rarely been exceeded. Consequently, tactically, we expect a countermovement in December and are thus taking some of the profits.

Equities remain overweight

The regional gap has also widened further on the stock markets. US equities have returned around 9% more than European equities since the beginning of October. However, this is largely justified by corporate earnings momentum and we expect this trend to continue until the end of the year. Within US equities, we continue to favour better market breadth. Strong seasonality should ensure further stock market gains in the short term despite high valuations and euphoric sentiment. We therefore remain overweight in equities at the expense of bonds. We are now increasing our allocation to alternative investments by adding gold and catastrophe bonds.

What is our current view on the financial markets and how are we positioned?

Yen instead of dollars

• The US dollar has appreciated sharply (+6.5% since October against the CHF and EUR) due to the election of Donald Trump, the economic dominance and the rising interest rate differential.
• However, positioning is now heavily increased, the US dollar is expensive, technically there is resistance ahead and in the past seven years the US dollar has always lost value in December.
• We are therefore taking profits and reducing our overweight, while buying the Japanese yen in return.
• We expect further interest rate hikes by the Bank of Japan, which is why the interest rate differential will continue to narrow. At the current rate of 155 yen per USD, the upside seems significantly greater than the downside (around 5%).

Tactical countermovement in US yields

• Since mid-September, when Donald Trump was suddenly seen as the favourite, yields on 10-year US Treasuries have risen sharply (from 3.6% to 4.5%) due to the expansionary economic policy in the US.
• However, the Trump effect now seems to be priced in, and the appointment of the fiscally conservative Scott Bessent as the new treasury secretary has temporarily halted the rise in yields.
• We expect a tactical countermovement and are therefore reducing our overweight in European government bonds and buying some oversold long-dated US government bonds.

High and uncorrelated additional return on catastrophe bonds

• After the record year of 2023 (20% performance in USD), 2024 is also shaping up to be a very successful year for cat bond investors, with a performance of 16% so far.
• Fears of significantly higher losses due to climate change have not materialised so far, with modelled losses remaining around 2% per year.
• By contrast, the spread over US Treasuries is currently 8%, a historically high level that reflects the significant increase in insurance premiums.
• Cat bonds remain a very attractive addition to a mixed portfolio, and we are now increasing our allocation after the hurricane season.

Tactical Asset Allocation in December 2024