May 19th, 2025 - US government bonds are not so safe any more.

In yet another blow to the "US supremacy theme", Moody's removed the AAA rating from the US government bonds. They are now rated Aa1 and for the first time in history, the US does not hold a triple-A credit rating from at least one of the three big agencies. It was S&P who first in 2011 stripped the country of its pristine rating, while Fitch took the move in 2023. Moody's said that at current rate, the fiscal deficit will reach 9% of GDP in the next decade. It is interesting to note that there are two US corporations which currently enjoy the AAA rating, which means that they are now safer than the US treasuries: Microsoft and Johnson & Johnson.

There are reasons for USD bond investors to be nervous, after two fantastic years, which probably made them forget the horrible 2022. That was when the "transitory inflation" suddenly became a real problem and the FED, as most major central banks, raised interest rates relentlessly, causing a steep sell-off in bond prices and significant paper losses for bonds. And lest we forget , this sell-off brought down a couple of regional US banks and the market turmoil led to UBS having to save Credit Suisse from taking its depositors down with it. Any significant rise in US government bond yields will have a negative impact on US banks' balance sheets, at a time when Trump wishes to relax the capital requirement rules for them.

Trump's erratic behavior with the tariff policies has inserted volatility back to the system, not only because inflationary pressures are building up again, but also because major international investors who are creditors to the US government are having second thoughts, whether to continue financing it, both on economic and political reasons. The US government's deficit is running at the highest level ever outside of war periods, and the Debt/GDP ratio is north of any level that would make creditors (i.e. bond holders) feel at ease. With the US government debt now below AAA among all major rating agencies, there will be major financial institutions, pensions and endowments that might have to reduce the rate at which they buy those securities.

Inflationary pressures are building up and future inflation expectations continue to move higher. Walmart, the largest US retailer, announced that it is raising prices for all the products affected by tariffs , following Ford and other companies which are planning to do the same. It is worth noting that the preliminary May estimate of longer-run inflation expectations from the University of Michigan survey moved to the highest level since March 1991, up 0.2 pp to 4.6%. At the year-ahead horizon, expectations rose 0.8 pp from April to 7.3%, the highest since November 1981 ! It should also be noted that the consumer sentiment series in the same survey remained very depressed. Overall sentiment slid 1.4 points to 50.8 the second lowest reading on record going back to 1952 !

Thankfully, the US April inflation numbers did not show a dramatic change yet. Core goods (excluding transportation) prices increased by 21bp which is among the largest increases in the past couple of years, but it was far from causing panic. Headline inflation rose by 22bp for the month, bringing the annual change down to 2.3%, the lowest since the inflation surge in 2021. Core prices remained elevated however, at 2.8% on annual basis, but it is also the lowest level since 2021. Services prices (excluding rent) were negative, as 55% of the items were in deflation (negative monthly price growth), the highest percentage on record. Overall we see the reversal of the recent trend, where consumer goods prices were falling, but services were still moving higher.

The much-awaited April Retail Sales in the US were mixed, but not a disaster. They increased by 0.1% m/m vs consensus for 0.2% rise, but March's was revised to a 1.7% increase from 1.4%. But the Control group sales (which feed into the GDP calculation) posted a surprise decline, down 0.2% vs expectations for a 0.4% rise. Looking into the details, autos were unsurprisingly a bit of a drag after the March sharp increase in autos sales (+5.3%), ahead of the tariffs. Growth in sales was driven primarily by restaurant-bars (+1.2%) and building materials-garden stores (+0.8%). Big declines were seen in sporting goods stores (-2.5%) and miscellaneous stores (-2.1%).

Global equities had a solid week, led by a resurgence of US mega caps. The S&P500 rose by 5% and it has recovered all its year-to-date losses, while Nasdaq rallied by 7.2% as semiconductors were well bid again. The European market's performance was more muted, but with a decent 2% gain on average for the main indices. The German DAX is now up almost 20% this year, hitting yet another record high. Healthcare was the only sector left behind as investors are still trying to gauge how Trump's intentions will affect their profitability. The euphoric sentiment in equities also does not help the sector, which belongs in the so-called defensive parts of the market. We like the current levels of Roche, Novo Nordisk and Sandoz, to scoop up their unloved shares.

Chart of the Week : Emerging markets exposure has been very beneficial to portfolios, this year.

The below chart shows the performance of the Fund which we had selected in late December for our portfolios (blue line) vs the benchmark (MSCI Emerging Markets, green line) on a year-to-date basis. It is up almost 15% vs a 6% rise for the index, a whopping 11% outperformance. One has to also take into account that in the same period US equities have produced no return , while Europe is up about 6%. There are reasons to believe, as we have said several times, that the US exceptionalism which started more than ten years ago and got a boost during the pandemic, is coming to a (temporary ?) end. China's technological advance in electric vehicles and lately in Artificial Intelligence has drawn the attention of international investors who are under-invested in the region and over-invested in the US. And China might be a large part of the Emerging Markets exposure (about 35%) but there are other regions that are booming such as India, the Middle East and parts of emerging Europe, Greece being one of them. We can't claim that this investment position will continue outperforming at the same rate for the remaining of the year, but we remain very positive on the asset class.

Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

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• Sources: Chart of the Week : FactSet