AXA IM: Outlook US, UK and EU - bad timing for everyone

AXA IM: Outlook US, UK and EU - bad timing for everyone

January 14, 2025

Outlook
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By Gilles Moëc, Group Chief Economist and Head of Research, AXA Investment Managers

The surge in US long-term yields, driven by prospects of ill-timed fiscal stimulus, has triggered global bond market contagion. The UK is notably impacted, but a weakening outlook could push the BOE to offer more support than expected. In the Euro area, contagion is limited, but the ECB must address tighter financial conditions in its policies.

Resumption of the Fed’s descent to accommodative territory won't happen before 2026
More signs last week of the impressive resilience of the US labour market is the immediate cause of the additional surge in long-term US yields. But more fundamentally this heralds the fact that, unless the new administration radically changes course, adding more fiscal stimulus and another supply-side shock in the form of tariff hikes will come at a particularly bad time given the resistance of US inflation. We think there is still some space for one “last cut” in the first half of this year, with a low level of confidence, but we think a proper resumption of the Fed’s descent to accommodative territory will not happen before 2026, when the economy starts deteriorating in response to the implementation of “Trumpnomics”.

Market too timid on its expectations for rate cuts from the Bank of England
Higher yields, and a “stopped out” Fed are bad news for everyone. The UK has been a clear victim of bond market contagion. To the country’s usual source of vulnerability – particularly its chronic current account deficit – one needs to add the fiscal expansion announced in last October’s budget, and a “stagflationary” dataflow. This leaves the British government with only unpalatable solutions to deal with the effect of a rising debt servicing cost on its discretionary room for manoeuvre (cutting spending, hiking tax, or changing once again the fiscal rules). Still, we think the market is currently too timid on its expectations for rate cuts from the Bank of England. We think that the deterioration in the real economy will usher in a more convincing pace of disinflation, which will offer some capacity to offset the “bad winds” from the US bond market.

ECB needs to take the tightening in financial conditions on board
If contagion has been more measured in the Euro area, long-term rates have also been on the rise there and this goes beyond “self-inflicted damage” from member states and should be treated as a symmetric shock. This will add to the zone’s difficulties, and the latest surveys are concerning. We think the ECB needs to take the tightening in financial conditions on board to move quickly to neutral, and then into accommodative territory.

 

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