CIO Views: UK back in focus; China’s consumer challenge

Chris Iggo, CIO AXA IM Core

UK moves back into investors’ focus

The UK’s economic outlook is improving. Historically, when elections have delivered a change in government with a large majority, both equity and UK bond markets have performed well. The Labour Party’s 174-seat parliamentary majority should mark a period of policy transparency with the stated aim of boosting growth. 

The new government has pledged fiscal stability and suggested any new spending will be fully funded, with only selected tax increases as part of the proposed fiscal plans. Partnering with the private sector is also promised, with a focus on energy and other infrastructure projects. As such, the growth-inflation balance should improve, which will support stronger investor confidence in UK assets. 

The broad equity market has increasingly traded at a discount to the US and European markets while sterling’s relative cheapness should provide a further attraction to investors and overseas corporates looking to acquire UK assets. In the near term, the Bank of England is likely to start lowering interest rates from their current 5.25% level. 

Headline inflation dropped to 2.0% in May and further declines in core inflation should be seen over the second half of 2024. The recent appreciation in the pound’s trade-weighted exchange rate should also help soften inflation going forward. As such, the gilt market and UK corporate bonds are attractive, with shorter maturity investment-grade corporate bonds yielding above 5.0% on average.

Alessandro Tentori, CIO Europe

Bunds in favour

European government bond markets look almost priced to perfection with expectations for a European Central Bank (ECB) deposit facility rate of around 2.70% by the end of 2025 - not far off AXA IM’s forecast. This trajectory is likely to be accompanied by a typical steepening of the German Bund curve, worth around 70 basis points over two years based on the forward curve. 

According to ECB President Christine Lagarde, there is a fine line between data dependency and data-point dependency, which will allow the Governing Council to look through unexpected, albeit short-lived, inflation surprises. However, the process of policy normalisation will be subject to uncertainty about the natural rate of interest, i.e. the interest rate at which policy will no longer be deemed restrictive. So what could possibly go wrong for investors? 

We’ve already had an amuse bouche of government bond volatility in the aftermath of the European Parliament elections. Luckily, this proved to be short-lived. However, it should serve as a reminder of the complex interaction between fiscal and monetary policies. At this stage, European government bond spreads appear to fully reflect differences in fiscal discipline between member states (see figure). However Germany stands out, not only in terms of compliance with the Stability Rules, but also for the valuable liquidity premium attached to Bunds.

Ecaterina Bigos, CIO Asia ex-Japan    

More needs to be done for China’s consumer

Post pandemic, China has seen positive momentum in fixed asset investment and industrial production. It is also enjoying a revival of export growth in some high value-added sectors. However, China continues to face challenges, as it is looking to rebalance from an investment-led to a consumption-based economy, and it needs to find an alternative to the real estate sector as a lasting source of economic expansion. Its property sector, along with its related activities, once accounted for 25% to 30% of GDP. 

Weakness in the sector not only acts as a drag on the overall economy but also on broad consumer confidence, due to its negative impact on wealth. According to a 2019 survey from the country’s central bank, 96% of urban households in China were homeowners, of which nearly 40% owned more than one property.

The government announced various policy packages to support its property market. While the overall direction is geared towards stabilisation and transformation, adjustment is expected to take time. Meanwhile, more needs to be done directly for the consumer, for its transition towards consumption-led growth. Given consumer confidence is very low, policies to expand social safety nets and to grow the middle-income class should be in focus.

Asset Class Summary Views

Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.

*AXA Investment Managers has identified six themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Technology & Automation, Connected Consumer, Ageing & Lifestyle, Social Prosperity, Energy Transition, Biodiversity.

CIO team views draw on AXA IM Macro Research and AXA IM investment team views and are not intended as asset allocation advice.