A quiet summer, but rising yields cloud the outlook

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While equity markets and economic growth benefited from a relatively calm summer and solid corporate earnings, the bond market tightened significantly. Between persistent inflation, fiscal deficits, and rising interest rates, here is an overview of the risks, reasons for hope, and the Swiss perspective for the coming months.

While equity markets and economic growth benefited from a relatively calm summer and solid corporate earnings, the bond market tightened significantly. Between persistent inflation, fiscal deficits, and rising interest rates, here is an overview of the risks, reasons for hope, and the Swiss perspective for the coming months.

On financial markets, the summer proved rather quiet, marked by a slight uptick in global equities. Corporate earnings publications were once again strong, with average profit growth beating expectations. Global economic growth figures also provided reassurance, supported in part by investments in technology and AI.

However, conditions are deteriorating on the bond market. Interest rates continued their upward trajectory, driven by stubbornly high inflation (around 3% in both the US and Europe), a lingering conflict in the Middle East—keeping oil and gas prices high, not to mention the knock-on effects on ocean freight costs—and persistently high budget deficits.

Faced with this reality, markets are logically demanding higher compensation to lend to governments. For instance, France is now paying over 4% on its 10-year bonds. As for central banks, the balance of probabilities leans toward further policy rate hikes to combat inflation. This was clearly articulated last week by the new US Federal Reserve Chair, Kevin Warsh.

This could soon become problematic amid fiercer competition for debt issuance between sovereigns and corporates, particularly those investing heavily in AI. This sector is increasingly driving US economic growth, making it crucial not to derail this momentum. Market pressures were such that in August, the US Treasury Secretary had to step in by shifting toward short-term borrowing and buying back long-term government debt in an attempt to push yields down.

 

Between risk factors and reasons for hope: caution remains the watchword

In summary, caution remains paramount. The main risks for the coming months include:

  • A continued rise in long-term rates (driven by high inflation from energy, transportation, and agricultural commodity prices)...

  • ...and further policy rate hikes by central banks;

  • A continuing stalemate in the Middle East;

  • Political tensions linked to the US midterm elections, the French presidential election...

  • An "AI crisis," marked by massive investments that fail to deliver expected returns.

 

And the reasons for hope:

  • Corporate results have so far exceeded expectations, showing robust profit growth (over 20% this year in the US and 15% in Europe);

  • Heading into the midterm elections, Trump would have an incentive to find an exit ramp with Iran, which would lower energy prices, inflation, and ultimately interest rates;

  • Numerous countries are pushing ahead with stimulus plans and measures supporting investment and growth, whether through spending on infrastructure, technology, or defense.

 

The swiss view: accelerating growth and a weaker franc

From Switzerland, the perspective of our Geneva-based partner: A positive surprise in the second quarter, with economic growth accelerating to 1.5%, up from 0.4% in the first quarter. Figures were largely driven by the chemical and pharmaceutical industries, though the services sector also gained ground. These strong figures failed to reverse the Swiss franc's weakness, as it lost about 3% against the euro over the last three months.