Don’t underestimate inflation

There is a lot of economic divergence at the moment, but rates don't really seem to have decoupled. Why?

François Collet: What I see is exactly that kind of high divergence in terms of macro versus high convergence in terms of fixed income markets. And I think that's a huge opportunity to take exposure, because at the end of the day, this higher divergence is going to fuel divergence in response from monetary policy or even from fiscal policies. And this is going to have a meaningful impact on rates markets. So what we believe is that today, the US economy is on a very strong footing with rising inflation, which warrants a very cautious approach to the US fixed income market. We should tend to have a short exposure toward US fixed income. While on the other hand, we are seeing European growth staying quite low. Core inflation in the Eurozone has been steady for the past year and a half, and we have seen no impact from the Middle East conflict. Meaning that we believe the ECB hiking cycle is a short-lived one, and that we can face that market anomaly of higher rates in Europe by having higher duration in European rates. In simple terms: short US rates, long European rates.

Are you seeing something similar play out in Asia?

François Collet: Yes, indeed we are seeing divergence between macro and markets in Asia. I would give you two examples of that. First, on the widely held belief that governments are in a very difficult situation in terms of public finances — we strongly believe that the Japanese government is not among them. Yes, it is a government pursuing fiscal stimulus, but we are talking about a country coming from a very low level of fiscal deficit. It was 1.5% last year. Yes, it is going to be 3%, but 3% is a level that most developed market countries would be very pleased to see. So I believe that fiscal concerns at the long end of the Japanese curve are a fade. That is why we hold long exposure in JGBs at the long end of the curve.

Second is the divergence in macro in terms of trade. With the AI CapEx boom, we are seeing a lot of Asian economies benefiting from much higher trade surpluses. While that should prove very positive for their currencies, it is still not the case. We feel that most Asian currencies are undervalued and that this represents a very interesting buying opportunity.

Given the uncertainty, how important is flexibility at the moment?

François Collet: We are seeing very high uncertainty across many different countries. We are at a time where we are seeing deglobalisation and climate change having a huge impact — El Niño being one example. All of this is driving higher macro volatility and is a reason why we should maintain much more flexibility. Who knows what 2027 will bring? Will it be a continuation of 2026 with strong AI CapEx pushing global growth upward? Or will it be the start of a decline — the peak of the economic cycle — with central banks hiking rates to a level that begins to impact demand? It is very difficult to answer that clearly. So I still think investors should keep risk at a measured level to have the opportunity to navigate this very difficult environment.

What is the market underappreciating at the moment?

François Collet: I strongly believe that the most important underappreciation is inflation. We are seeing large levels of deficit in most developed market countries. There are plenty of ways to reduce these high debt levels, but most of them are painful. I strongly believe that central banks will be very pleased to see inflation running slightly above their targets. And that is exactly what is happening. This year you are seeing inflation well above target — around 100 to 200 basis points above — while inflation expectations remain anchored at target. That is exactly what central banks are seeking to achieve. Inflation is clearly underappreciated by the market.