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Markets brush off Moody’s, but the deficit dragon stirs

Equity markets barely flinched as Moody’s stripped the US of its last AAA rating. But under the surface, the bond market stirred, reminding investors that debt complacency comes with a deadline.

The Allocatr Editorial Team

Markets hold the line, for now
Moody’s downgrade of US sovereign debt from Aaa to Aa made a brief splash—and then vanished. The S&P 500 closed up 0.1%, the Nasdaq flat, and the Russell 2000 down just 0.4% after dipping as much as 1.5%. Even bond yields, which initially jumped to 4.56%, eased to 4.45% by close.

European indices drifted sideways, with OMX30 up 0.2% after a late surge. Futures across the continent pointed higher on Tuesday morning—EuroStoxx 50 +0.4%, DAX +0.3%, FTSE +0.4%.

Ritholtz Wealth Management summed up investor sentiment bluntly: “This Moody’s action is largely symbolic. The government deficit isn’t a problem—until markets decide it is.” History offers a grim reminder. In 1987, amid rising deficits and trade tensions, equity markets suddenly snapped. One October morning, the S&P 500 fell over 20% in a day. The catalyst? Hard to say. But it’s never just one thing.

And that’s the point. Downgrades might not trigger panic—but they add weight to a growing stack of risks.

Bond market whispers, investors should listen
The real story isn’t the equity market’s shrug. It’s the bond market’s unease.

The 10-year Treasury yield spiked on the downgrade before retreating—but don’t mistake that for confidence. With upcoming bond auctions and fiscal uncertainty, the market is bracing. The parallel with the UK in 2022 is unnerving: Liz Truss’s unfunded tax cuts sent gilt yields soaring, forced the Bank of England to intervene, and toppled a Prime Minister in under 45 days.

America isn’t Britain—but debt dynamics rhyme. Trump’s proposed tax cuts—an extension of his first-term policies, plus new defence and border spending—would increase deficits by over $3 trillion in the next decade. That’s more than 10% of GDP. The numbers are slippery too—many provisions are ‘temporary,’ but in practice, no Congress likes raising taxes.

Even with tariff revenue, the math doesn’t work. And tariffs undercut growth, cancelling out the intended stimulus.

Meanwhile, JP Morgan’s Jamie Dimon warned investors not to ignore the threat of stagflation from tariffs. It’s not that markets are overreacting. It’s that they aren’t reacting at all.

Asia sends mixed signals, while Europe watches Washington
Across the Pacific, markets were buoyed by expectations of progress in US-China trade talks. Hang Seng led gains as CATL surged on debut. China’s central bank cut its 1- and 5-year loan prime rates by 10 basis points—expected, but notable. It follows a broader easing trend: 7-day reverse repo rates and reserve ratios were also trimmed this month.

Japan, however, showed the flip side. A 20-year bond auction received the lowest demand since 1987. Next week’s 40-year auction is now a litmus test for confidence in Japanese fiscal stability. The yen market isn’t used to rejection. That’s changed.

Back in Europe, bond yields remain stable, but the memory of Truss’s budget fiasco keeps policymakers cautious. Brexit negotiations inched forward with minor concessions on food standards and student exchange—welcome, but economically marginal. Germany’s April PPI and eurozone consumer confidence are on deck, but not expected to move the needle.

The US calendar is equally light. The Philadelphia services index will be watched after April’s plunge. Any recovery may mirror the industrial rebound earlier this month.

The real risk isn’t in the data. It’s in the drift.
Moody’s didn’t tell investors anything they didn’t already know. But complacency is a dangerous companion. The US now has no AAA ratings from the three major agencies. Deficits are rising. Congress shows no appetite to fix them. And a President with a proven sensitivity to bond market jitters is heading into an election year with promises of tax cuts and tariff hikes.

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As the ECB prepares its eighth rate cut, global capital starts pivoting toward Europe, even as tariffs loom.

Five signals Europe is back in favour

After a decade of trailing Wall Street, Europe’s equity markets are drawing renewed interest. Not because of a sudden surge in growth, but because the US now looks more politically erratic, economically inflated, and less investable to global institutions wary of trade wars and ballooning debt. In May, the Stoxx 600 logged its best month since 2005. Beneath that headline, five shifts in investor positioning, macro data and central bank policy suggest that Europe may be carving out a new role in global portfolios, not as the growth engine of the world, but as a credible hedge against American exceptionalism.

1. Big money is rotating into Europe

European equities are catching inflows not seen in nearly a year. Calastone data shows UK investors pulled £525 million from equity funds in May, but European funds bucked the trend, attracting £369 million in net inflows. In contrast, US-focused equity funds saw their second worst month since September 2023, with a mere £115 million in inflows. The shift is not driven by European euphoria. It’s driven by American disillusionment.

Large players like Apollo Global Management and BC Partners are backing the move. Deutsche Bank upgraded its Eurozone GDP forecast from 0.5% to 0.8%, citing resilience in the face of US tariffs averaging around 10%. Germany is forecast to move from 0.3% growth in 2025 to 2.0% by 2027 as fiscal stimulus begins to bite.

The narrative is slowly flipping. Where investors once saw structural stagnation in the Eurozone, they now see geopolitical insulation, central bank sanity, and room to surprise on the upside.

2. The ECB isn’t bluffing. It’s cutting, again

The ECB is expected to cut rates by 25 basis points today, taking the deposit rate to 2%. That will mark 200 basis points of cumulative easing — a significant swing given that core inflation is no longer threatening to spiral. There’s a growing view that the ECB might pause in July, especially as the US trade outlook remains in flux. But for now, the message is simple: Europe is easing deliberately, while the Fed stands frozen.

Sell-side consensus sees another cut in September, bringing rates to 1.75% and likely ending the cycle. But some expect one or two more reductions, depending on how much drag the latest tariff regime creates.

3. Macro data still noisy, but improving beneath the surface

Europe’s macro data remains choppy, but important signals are turning. German factory orders rose 0.6% month-on-month in April — below consensus, but still positive. The underlying details matter more: orders in electronics and optics jumped 21.5%, bolstered by large contracts. Orders in aircraft, ships, and military equipment rose 7.1%. While machinery and electrical equipment fell sharply, overall domestic orders rose 2.2%, underscoring a fragile but broadening recovery.

Elsewhere, Eurozone construction PMI disappointed, but Italian retail sales beat expectations. UK construction PMI showed contraction slowing. In Asia, Japan’s real wage growth remained negative, while China’s Caixin services PMI held steady. It’s an uneven picture, but European figures suggest momentum is building — especially when stripped of frontloaded activity ahead of tariffs.

4. Sector leadership is shifting, not just tech anymore

Europe’s top-performing sectors this week were not the usual suspects. Basic resources led gains, powered by Chinese export restrictions on rare earths — a reminder that industrial metals are as much about geopolitics as demand. Construction and materials surged, thanks to corporate moves: BALCO-SE signed a major steel balcony deal, KRX-IT expanded its US roofing investment to $1 billion, and HOLN-CH bought a Canadian precast firm. Even Holcim’s smart building push through a Dutch acquisition speaks to renewed confidence in industrial capital spending.

Healthcare also rallied, buoyed by news that FYB-DE’s biosimilar drug won Brazilian approval, and Goldman Sachs upgraded Bayer, citing litigation clarity and Pharma upside. Travel and leisure, by contrast, lagged, Wizz Air fell sharply despite strong earnings, pointing to FY26 uncertainty, while Norwegian Air and Finnair dipped on modest traffic growth.

5. Trade tensions are a headwind — but also a catalyst

The trade backdrop is deteriorating. The US has doubled tariffs on EU steel and aluminium to 50%, while the EU prepares countermeasures potentially targeting US maize, bourbon and even Boeing aircraft. The planned €21 billion retaliation package is on hold, for now.

Yet the same tensions that weigh on sentiment are fuelling Europe’s relative appeal. The EU’s firm stance contrasts with the unpredictability of US policy. A BoE survey found that just 12% of UK firms view US trade policy as a top uncertainty source, down from 22% in April. Over 70% said recent US trade changes would have no impact on sales or capex, suggesting that Europe’s economic base is more insulated than headlines imply.

A reluctant renaissance

Europe is not roaring. But it is rising in the ranks of global portfolios, not for what it is, but for what it is not. It is not lurching toward fiscal cliffs. It is not pushing 50% tariffs overnight. It is not caught between monetary hawkishness and political dysfunction. In a world suddenly starved of certainty, that may be enough.

For now, European equity markets are firmer, and the capital flows are following.

From Balkan banks to Italian small caps: what ties the top performers together.

Top five equity funds with 20%+ annualised returns and Sharpe above 1

In a year when much of global equity performance has clustered around mega-cap AI and european defense stocks, a group of actively managed European and emerging markets equity funds has delivered standout results. Each has posted more than 20% annualised returns while maintaining a Sharpe ratio above 1.0 over the past three years. The common denominator? A meaningful overweight to financials and a willingness to stray far from benchmark country weights.

Here are the five funds that stand out, and what drives their returns.

1. Axiom European Banks Equity (Luxembourg)

Annualised return (3Y): 45%
Sharpe ratio (3Y): 1.39
AUM: EUR 230m
Key exposures: European financials (75%), benchmarked to STOXX Europe 600 Banks

Axiom’s fund doesn’t hide its intent—it’s benchmarked to the European banks index and sticks to it with conviction. What separates it from a passive tracker like BNP Paribas’ offering is active stock selection and tactical overlay through derivatives. The fund is heavily tilted toward large-cap banks across the EU, Iceland and Norway, with room to hedge currency risk when needed. In a year when rising net interest margins and cost control have powered bank earnings, Axiom’s focused strategy has paid off.

Source: Factset

2. Lemanik High Growth (Italy)

Annualised return (3Y): ~25%
Sharpe ratio (3Y): 1.05
AUM: €136 million
Key exposures: 48% Italian equities, 34% financials, 30% industrials

Despite its generalist “high growth” label, Lemanik’s top holdings reveal a bias toward financials and industrials in Italy. While it’s benchmarked against MSCI Italy, the manager actively excludes much of the FTSE MIB in favour of smaller and mid-sized companies—at least 21% of holdings are required to be outside Italy’s top indices. That tilt toward under-researched, locally rooted firms appears to have created alpha, particularly in a recovering domestic economy.

Source: Factset

3. Apollo Balkan Equity

Annualised return (3Y): ~21%
Sharpe ratio (3Y): 1.14
AUM: €3 million
Key exposures: 24% Slovenia, 23% Croatia, 35% financials

While small in terms of market cap, it turns out the Balkans have been a quietly explosive pocket of equity performance. With strict minimums for direct stock exposure (at least 51%) and a regional focus few others attempt, this fund has benefited from strong bank earnings, relatively low inflation, and some repricing of country risk. The fund’s volatility is high, but so is its upside. Notably, over 50% of the portfolio is invested in just three countries.

Source: Factset

Portfolio Exposure

Source: Factset

4. BNP Paribas Finance Europe ISR (France)

Annualised return (3Y): ~28%
Sharpe ratio (3Y): 1.23
AUM: EUR 96m
Key exposures: Insurance 50%, Banks 35%

Unlike the other funds, this product has the specific mandate to replicate the STOXX Europe 600 Banks index. That makes it a pure play on the sector’s cyclical revival. Investors who simply wanted clean, low-cost exposure to the rising rate environment and improving European credit cycle have been rewarded. Its returns track the benchmark tightly, with tracking error capped at 1%, and only minimal use of derivatives for hedging.

Source: Factset

Portfolio Exposure – Heavy on insurance

Source: Factset

5. T. Rowe Price Emerging Europe

Annualised return (3Y): ~30%
Sharpe ratio (3Y): 1.29
AUM: USD 677m
Key exposures: 27% Turkey, 19% Greece, 63% financials

The outlier in terms of geography, T. Rowe Price’s Emerging Europe fund is a concentrated bet on banks and growth stocks in politically complex markets. Turkey and Greece dominate, but the fund also touches on frontier exposures like Kazakhstan and Ukraine. With at least 80% of assets in emerging Europe and a heavy emphasis on bottom-up stock selection, the fund has found strong upside—at the cost of elevated volatility. The high financials weighting reflects a belief that banks remain the most reliable growth lever in the region.

Source: Factset

The takeaway

All five funds differ in strategy and structure, from Luxembourg UCITS to Austrian retail funds, from passive replication to deep regional conviction. But most share a common thread: exposure to financials, tolerance for regional or index deviation, and a willingness to look beyond large-cap comfort zones. Whether by choice or mandate, that positioning has delivered both strong absolute returns and solid risk-adjusted performance, something few large-cap global equity funds can claim in today’s crowded field.

Hardly a signal of recession or rate cuts.

Atlanta Fed GDPNow: Q2 2025 growth estimate raised to 3.8%

Resilient spending, nervous sentiment, and the shadow of fiscal reckoning.

CEO conf calls: Three contradictions at the heart of the U.S. economy

Despite a year marked by geopolitical volatility, stubborn inflation, and rising long-term yields, the U.S. economy continues to confound expectations. Consumers are spending, employment is holding, and the dreaded recession has yet to arrive. But beneath the surface of these strong headline numbers, three contradictions have emerged—each shaping investor behaviour in different ways and exposing fault lines that may not hold forever.

1. Consumers are spending like it’s 2021, but feeling like it’s 2008

The most striking tension lies between consumer sentiment and consumer behaviour. According to executives at American Express and Mastercard, spending trends through May are almost indistinguishable from Q1—solid and consistent. Visa, too, confirms that U.S. payments volume is tracking better than expected, and Bank of America reports that $1.7 trillion has moved out of consumer accounts into the broader economy year-to-date, a 6% increase from last year.

Yet this activity is set against a backdrop of deep pessimism. As Amex put it bluntly: “Consumer sentiment is in the toilet, but they’re just complaining as they go spend.” TransUnion adds that while employment and wage growth remain strong, “the consumer is very worried.” It’s a paradox that underscores the stickiness of post-COVID wealth buffers and behavioural inertia—consumers may not feel good, but they’ve learned to keep moving.

2. The labour market is tight, but not overheating

Employment remains the bedrock of the U.S. economy. From Equifax to Mastercard, corporate leaders see little weakness in the jobs market. Unemployment remains low, wage growth is outpacing inflation in some areas, and delinquencies are “reasonably controlled” according to TransUnion. Even elevated interest rates haven’t dramatically dented consumer borrowing habits—many have adapted to higher costs after the zero-rate COVID years.

KeyCorp, whose retail clients boast an average FICO score of 790 and wealth AUM of $61 billion, sees no signs of financial strain. Non-interest-bearing accounts are still 26% above pre-COVID levels. The picture is of a workforce that is employed, creditworthy, and still engaging with the economy—even if uneasily.

3. Resilience masks a growing fiscal drag

While short-term indicators are encouraging, long-term risks are quietly building in the background. Goldman Sachs highlights a shift in bond market focus from inflation to the U.S. fiscal deficit. As deficits persist and debt issuance grows, there’s rising concern that long-term yields will continue to climb—not due to growth expectations, but because of supply and fiscal uncertainty.

The risk is straightforward: higher long-term rates increase the cost of capital, which could act as a structural brake on future investment and economic expansion. If the consumer is the wind in the sails of the economy, the budget may soon become the anchor.

The takeaway

The U.S. economy isn’t in a soft landing or a hard one—it’s flying on one engine while the other sputters. Spending holds, jobs remain plentiful, and corporate earnings show resilience. But the data also reveals an uneasy balance between strength and strain: confidence is brittle, fiscal risks loom, and monetary tightening hasn’t finished echoing through the system. Investors and policymakers alike are navigating a landscape defined less by immediate crisis than by the slow erosion of certainty.

Across the S&P 500, analysts are slashing earnings expectations at a pace not seen in years. This reflects growing discomfort over sticky inflation, rising trade friction, and a creeping sense that the earnings rebound is stalling before it truly began.

Analysts slash Q2 earnings forecasts at fastest pace in years

EPS estimates under pressure across the board

In the first two months of Q2, analysts lowered earnings per share forecasts for S&P 500 companies by 4.0%, from $65.55 to $62.91. That’s not a routine adjustment. It exceeds the average cut seen over any comparable period in the past five, ten, fifteen or even twenty years. For reference, the 20-year average cut for this stage of the quarter stands at 3.1%.

Not a single sector escaped the knife. Energy bore the brunt, with analysts slashing Q2 EPS estimates by 18.9%. For the full year 2025, the picture doesn’t improve. EPS forecasts have dropped by 3.5% since December, again more than the typical five-month downdraft. Materials have been hit hard too, down 11.8%, while Energy again leads the decline at -17.6%. The only sector where optimism hasn’t eroded? Communication services, where EPS estimates actually rose 2.3%.

This isn’t just cautious housekeeping. It reflects real concern that pricing pressure, weakening demand, and higher input costs, some policy-induced, are colliding at precisely the wrong time. And the street is finally pricing that in.

S&P500 Earnings revision trend

Source: Factset

Markets digest tariff whiplash and mixed macro signals

US equity markets, while choppy, ended May on a broadly positive note. The S&P 500 and Nasdaq clocked their best monthly performance since November 2023. Yet the path there was uneven. Big tech couldn’t hold its footing late last week, Nvidia and Tesla both declined, and cyclicals like energy, semiconductors, and asset managers fell behind. Treasuries firmed, the yield curve steepened, and safe havens like gold lost ground.

Trade politics are dominating the risk conversation. A fresh volley from Donald Trump accused China of violating trade agreements and floated new tech sanctions. At the same time, whispers of a possible Trump-Xi phone call suggest the usual choreography of escalation and détente. But markets have seen this playbook before, and patience is wearing thin.

Meanwhile, macro data is sending mixed signals. April’s core PCE inflation landed at 2.5% year-on-year, a post-2021 low, but personal spending came in soft, up just 0.2% month-on-month. Consumer sentiment ticked up, aided by perceived trade optimism, but inflation expectations remain unstable. The May Chicago PMI slipped to its weakest since January, further complicating the picture.

Europe braces for tariffs and a final ‘easy’ cut from the ECB

European equity markets opened the week on a softer note. The DAX gave back 0.3% after hitting record highs last week. Broader indices, including the STOXX 600 and CAC 40, nudged lower. The European Commission made clear it is ready to retaliate against Trump’s plan to double tariffs on steel and aluminium, warning that the move threatens to unravel months of trade diplomacy. That threat, initially aimed at 1 June implementation, has been temporarily shelved, but not resolved.

This week’s European Central Bank meeting is shaping up as a pivotal one. The ECB is expected to deliver a 25 bp rate cut, bringing the deposit rate to 2%. But it’s likely to be the last straightforward move for a while. Inflation data supports easing, but rising consumer inflation expectations and ongoing supply chain frictions muddy the outlook. The market expects the easing cycle to end by September, pricing a year-end deposit rate of 1.75%.

Structural factors—such as a tight labour market and ageing demographics—may continue to exert upward pressure on inflation, even as near-term growth slows. Some analysts warn that without a material growth undershoot, future cuts could become politically or economically costly.

A market groping through fog

The broader picture is one of dislocation. Earnings expectations are falling, not just adjusting. Trade threats are headline material again. Central banks are nearing the end of their room to manoeuvre. And yet, market sentiment hasn’t broken, just softened.

This is not a crisis moment. But it is a pivot. Investors, analysts and policymakers alike are facing a more complex backdrop than they were even six months ago. The soft landing narrative still exists, but it’s starting to feel like a theory waiting to be disproved.

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