Outlook for the third quarter: thin air on the stock markets, government debt weighs on bond markets

Bond markets: subdued outlook for government bonds

While the international stock markets recorded two positive quarters in a row, the bond markets showed the opposite picture. After losses predominated in the first quarter, the second quarter also ended in the red. ICE BofA's index of government bonds from the eurozone recorded a loss of 1.3 per cent. In contrast, European corporate bonds with an investment grade rating were in the black. Since the beginning of the year, they have achieved a plus of 0.5 per cent. European high-yield bonds even performed positively in the second quarter, rising by 1.5 per cent; since the beginning of the year, they have recorded a plus of 3.1 per cent – according to the ICE BofA indices. Corporate bonds benefited from the higher yield level and a certain narrowing of spreads. 

In general, stubbornly high inflation and generally good economic data weighed on the government bond markets, as significantly fewer interest rate cuts by the major central banks were priced in as a reaction to this over the course of the first half of the year. We have also adjusted our forecast for the European Central Bank (ECB). We expect only two interest rate hikes by the end of the year and only one further hike next year. The ECB's key interest rate is likely to settle at around 3.0 per cent in the medium term. 

The global economy is only growing moderately, and inflation is trending downwards. In principle, this is not a bad environment for government bonds. But the yield curve is still inverted. This means that if yields do not fall, long-dated government bonds will underperform short-dated government bonds. This is likely to dampen demand for long-dated government bonds. 

Added to this are the risks due to the high national debt and high deficits in individual countries such as the USA, France, and Italy. A buyers' strike could occur at any time in one of these countries, leading to turbulence on the government bond market. 

In the USA, the US Federal Reserve would very likely intervene and thus accept a weakening of the US dollar. The EU Commission has opened excessive deficit procedures against France and Italy. This means that the ECB is not allowed to buy government bonds from either country. Only if the countries take measures to combat the deficit – for example through government austerity programs – could the ECB buy government bonds in Italy or France again. The second half of the year also promises to be turbulent against the backdrop of the US elections.

Stock markets: Major price losses unlikely

Prices on the international stock markets continued the positive upward trend of the previous quarter in the second quarter. The MSCI Europe rose by 1.2 per cent, the MSCI World by 3.2 per cent and the MSCI Emerging Markets Index by 6.3 per cent – all in local currency. The stock markets benefited from continued solid corporate earnings growth. The boom in artificial intelligence also appears to be spreading ever further. Data centers, electricity production and electricity distribution were identified as new growth sectors. The higher yields on government bonds also had no significant negative impact on equity market valuations. In the USA, an increase in valuation was even observed. The negative effect of higher government bond yields was more than offset by the positive effect of higher future earnings growth expectations. 

The air on the international stock markets is becoming increasingly thin. Expectations for corporate earnings growth have risen considerably and are now very high. It is likely to become increasingly difficult for companies to fulfil these high expectations. Especially as the global economy is only growing moderately and inflation rates are tending to fall, which means less room for companies to raise prices. Valuations on the stock markets, such as the price/earnings ratio, have also risen significantly recently and have reached very high levels, particularly in the USA. 

In times of economic crisis or recession, there are usually large price losses on the stock markets. There is currently no sign of a recession in either the USA or Europe, meaning that corporate profits could continue to rise moderately. The balance sheets of companies and private households on both sides of the Atlantic also appear to be in good shape for the most part. This argues against major price losses in the third quarter. However, geopolitical risks and other risks could of course materialize at any time, which could also have a greater impact on share prices given the high valuation.  

Eurozone economy: new elections in France damp-en sentiment, but upswing remains intact

There was a pleasing improvement in economic data in the eurozone in the second quarter. The purchasing managers' indices rose noticeably until May and consumer confidence improved steadily. The reasons for this were that real wages showed pleasing growth, energy prices normalized, and the labor market remained strong. There were also initial signs of an upturn in the credit cycle. Obviously, a certain familiarization effect with the higher key interest rates has set in. 

In June, however, the business climate indices suffered a significant setback due to the announcement of new elections in France – coupled with fears that Marie Le Pen's radical, anti-European party could form the new government in France. This raises the question of whether the political developments in France could derail the upturn in the eurozone. At present, we expect only a dampening of sentiment that will have little impact on the economy and therefore believe that the upturn is intact. 

However, there is a risk that the political developments in France could affect the French government bond market and contribute to a noticeable rise in yields there. As France is currently in an EU deficit procedure, the European Central Bank (ECB) would probably not be able to buy French government bonds under the TPI in order to calm the situation again. Only government austerity measures and a return to EU rules would allow the ECB to buy French government bonds.

At the same time, core inflation remained stubbornly high. In June, it still stood at 2.9 per cent and was therefore well above the ECB's inflation target. The reason for this was persistently high price momentum in the services sector, which is mainly due to the high wage momentum. Early indicators currently show that wage momentum in the eurozone is likely to weaken in the coming months, meaning that inflation in the services sector could also lose momentum. Against this backdrop, we still expect the ECB to cut key interest rates twice this year – in September and December. However, there is a risk that the ECB will not be able to cut the key interest rate in September due to unfavorable inflation dynamics. In addition, our analyses have shown that the neutral key interest rate in the eurozone may have risen to 3.0% since the pandemic. Against this backdrop, we only expect the ECB to cut the key interest once in 2025 at the March meeting .  

US economy: Despite weaker economic growth, the Fed is likely to focus on inflation.

The US economy showed the first signs of weakness towards the end of the quarter – as can be seen from the "Citigroup Surprise Index", which slipped significantly into negative territory from the beginning of May, signaling persistently disappointed expectations in the published economic data. 

One example of this is retail sales, which even fell below the level of December 2023 in May and have therefore fallen since the beginning of the year. There are increasing signs that many low-income consumers are having to significantly reduce their consumption. Firstly, they have used up the high savings they built up during the pandemic. Secondly, the labor market and wage growth have weakened somewhat recently. And thirdly, high interest rates are increasingly weighing on debt sustainability, as shown by the rising default rates for consumer and car loans. 

However, middle and high-income consumers are not affected by this. However, they mainly consume services, so the sluggish consumption of goods (retail sales) should not be overestimated as an economic risk. According to a survey by Nationwide Travel Insurance, 91 per cent of consumers surveyed are planning a domestic trip this year and as many as 50 per cent of consumers surveyed are planning an international trip – significantly higher figures than last year. 

In principle, however, we see that high interest rates are increasingly slowing economic activity and therefore expect the US economy to grow at a slower pace. Our growth forecasts are therefore unsurprisingly below the Bloomberg consensus at 2.0 per cent this year and 1.4 per cent in 2025. At the same time, however, it is becoming apparent that inflation could remain stubbornly above the Fed's inflation target. In our view, the Fed will focus more on inflation than on the slowdown in growth. Accordingly, we expect only two more rate cuts this year: in September and December.    

Asian economy: Continued loose monetary policy in Japan and no end to the property crisis in China

Despite an inflation rate of over 2.0 per cent, the Japanese central bank only appears to want to move away from its ultra-loose monetary policy in homeopathic doses. At its meeting in June, it announced its intention to buy fewer government bonds in future. However, there were no signals that key interest rate hikes would soon follow. One result is a continuous depreciation of the Japanese exchange rate on the currency markets. The Japanese central bank is thus taking a major risk, as its own population could lose confidence in the future stability of the currency if the downward trend continues unabated. In the event of a loss of confidence, savers would flee with their savings into real assets or take their money abroad to safety. This could lead to high inflation due to self-fulfilling expectations. Against this backdrop, it would be advisable to raise the key interest rate as soon as possible in order to stabilize the Japanese yen on the currency markets. Especially as the macroeconomic benefits of the weak currency appear to be limited. The OECD estimates that foreign trade will only contribute 0.35 percentage points to overall growth this year. 

The Chinese economy recorded strong GDP growth of 1.6 per cent quarter-on-quarter in the first quarter, slightly exceeding the consensus – driven by a recovery in industrial production and rising exports. However, according to Bloomberg, the consensus expects slower growth of 0.9 per cent quarter-on-quarter in the second quarter. However, there have been no signs of an end to the crisis on the property market, so the risk to growth prospects is likely to remain for the foreseeable future. In view of the great importance of the property market, the Chinese government appears to be taking measures to stabilize it again. For example, there are plans to buy around USD 1 trillion worth of existing empty flats and turn them into affordable housing. However, given the high volume of unsold flats, it is difficult to assess the extent to which this will be sufficient and actually have a discernible impact on the property market. The continuing weakness on the property market is weighing on consumer confidence and thus on the propensity to spend. However, the question arises as to whether it would not be better to expand the social security systems. Private households would then have to make fewer personal provisions and could use a larger proportion of their income for consumption.