No hero for Net Zero

One notable topic has been gaining attention this week (and it’s not cooking oil imports!)

After trade fears escalated at the end of last week on Trump threatening 100% tariffs on China, the past several days has witnessed a more conciliatory stance, with the US president choosing to narrow his focus to cooking oil imports. This trade narrative with China appears to echo past moves over the last year.

In this respect, there is a medium-term narrative of supply chain disengagement and a move towards a bipolar geopolitical economy. However, in the near term, there are key interdependencies, and the US remains reliant on Chinese imports of critical minerals, meaning that Trump will be inclined to tread a pragmatic line, not wanting to disrupt the US economy or financial markets in an excessive manner.

By contrast, where the US President sees an opportunity to leverage outcomes and policy change through the use of tariffs, such as with respect to the conflict in Ukraine, this is an area where he will feel he has more of a free hand to act.

Having (tentatively) achieved one of his aims in ending the conflict in Gaza, this could see him redouble his efforts to achieve a breakthrough with Russia, and to this end, there is a clear understanding in the White House that if it can stop the flow of money then this will make it increasingly difficult for Putin to continue to pursue his aims.

Elsewhere in the US, the government shutdown continues to roll onwards, starving investors of economic data for the time being. The US administration has been looking at measures to pay Federal law enforcement officers from Pentagon funds and through other means.

Meanwhile US air travel is becoming more routinely affected, as those who are required to work without pay appear to be calling in sick in increasing numbers, compounding existing staff shortages. This is prompting some concerns that an enduring shutdown could raise safety issues with respect to air travel, and it can be seen how this concern is also leading to some deciding they may be better off cancelling or deferring their travel plans.

In this way, the economic drag from the shutdown may start to escalate and pressure to get a deal done at the end of the month will surely build, with protests likely to increase by the time a second consecutive paycheck is missed. Moreover, the presence of additional downside risks, coupled with economic uncertainty, means it is very likely the Fed cuts by 25bps at the end of this month, with a follow-up move also likely in December.

Beyond this, we have turned more sceptical on 2026 rate cuts on a presumption that the economic outlook remains robust. This could give us an opportunity to fade rate cutting expectations, but it remains too premature to implement such a view for the time being.

In France, Prime Minister Lecornu achieved the backing of a majority of the French Parliament, cementing his position just a week after he tendered his resignation. By scrapping Macron’s proposed pension reforms, it appears that he has a pathway to an agreement on a Budget, though clearly this will deliver materially less fiscal consolidation than had been hoped for, with a fiscal deficit to remain around 5% of GDP.

In the near term, the reduction in political risks may enable French spreads to retrace some of their recent losses. The main catalyst towards material spread widening was if efforts to agree a way forward continued to be stymied and this led to fresh Parliamentary elections that National Rally would appear strongly placed to do well in. With this risk off the table, or at least receding for now, so this may see a reduction in volatility.

However, it remains very possible, or even likely, that the French credit rating is cut to A by S&P and/or Moody’s in the coming weeks, reflecting the medium-term trajectory of credit deterioration. From this perspective, should 10-year OAT spreads rally much below 70bps, this could offer another entry back into a short position on French credit, but for the time being, we hold no strong view, having closed a spread widening trade when spreads breached 85bps.

Gilt yields outperformed over the past week, in the wake of relatively soft UK employment data, which also hinted at some underlying moderation in wage growth. This has helped feed hopes that the BoE can continue cutting rates into 2026, with 50bps easing discounted by next summer.

Meanwhile, comments from the ruling Labour Party that everything remains on the table and that spending cuts are still being considered alongside tax hikes also helped to improve gilt market sentiment, taking 10-year yields towards the lower end of the range they have traded since March this year. As we reflect on this, we think that should yields continue to rally and test 4.4% in 10’s, this could be an attractive area to sell, on the view that inflation and political risks are hard to discount.

That said, the advance of the Reform Party in the polls actually seems to have closed off any likelihood that Andy Burnham could mount a challenge to the PM. In order to do this, he would first need to stand for Parliament in a bi-election and at the current point in time, it is hard to think of a single seat he would actually be placed to win, relative to a Reform candidate.

Elsewhere, we remain long in 2-year UK swaps, having previously thought BoE rate cut chances were underpriced, given the dovish mindset of the BoE Monetary Policy Committee. We also remain short in the pound, which gave up ground against the euro over the past week.

In Japan, JGBs and the yen have stabilised over the past week, even as political volatility remains elevated. The breakdown in the LDP-Komeito coalition creates uncertainty with respect to the election of a Prime Minister, with Sanae Takaichi not guaranteed this post, given that the LDP lacks a majority.

From our perspective, we are doubtful that the various opposition political parties and factions in Japan will be able to come together in a coherent fashion, and therefore a minority LDP government remains the most likely outcome, with policies implemented on the basis of a confidence and supply administration.

This may suggest to us there will be some fiscal easing, but of a magnitude more modest than perhaps Takaichi herself would like to introduce. She may also have to temper opposition to BoJ monetary policy normalisation. In this respect, there seems no way that the BoJ can (or will be allowed to) hike at the end of this month. However, a December move should not be ruled out.

Sentiment in credit markets has tempered relative to the second half of September, in the wake of several high-profile idiosyncratic issuer events. In private markets, the fallout from the bankruptcy of First Brands has come as a shock to some investors, who had been lured by the thought that they are investing in a stable and low risk asset class (whose assets are conveniently not marked to market).

Yet credit impairments in private debt have been on an upward trajectory for some time, with a default rate rising to 5.5%, based on the latest available data in Q2 this year. At the same time, it has also been striking that where credit events have occurred, this has gone hand-in-hand with a weakening of covenants and investor protections, inferring larger losses on default than have historically been the case.

Meanwhile, the backdrop in public markets remains more constructive. Leverage remains more modest, and although defaults are also trending higher, this is from a very low base. With the economic backdrop remaining benign and interest rates in the US moving lower, we think that the macro backdrop should help to contain credit concerns in the months ahead. Consequently, should we see a backup in spreads, we are more inclined to add beta directional risk in IG corporate credit.

Elsewhere, a move lower in oil prices has helped to dampen inflation fears over the past few weeks. In the past several days, weakness in oil has weighed on the Norwegian krone, but we see this as exaggerated, given the underlying strength of the Norwegian economy. Meanwhile, the USD has surrendered some of the gains made in the middle of last week, as Fed rate cut enthusiasm has ticked higher over the past several days.

Crypto assets suffered heavy losses at the end of last week as position closing was triggered in illiquid trading markets over a holiday weekend. It is a reminder that although the lure of markets, which trade 24/7, is quite appealing, there are hidden dangers when trades are being managed by algorithms in the absence of any clear circuit breakers.

With major coins such as Ethereum gapping 15% lower during a 30-minute period last Friday night, it was also a reminder that the risk versus return of this asset class may not be particularly appealing when considering the potential volatility, even before associated security risks such as the theft of holdings from supposedly secure digital wallets.

Looking ahead

It is slightly difficult to highlight a clear market catalyst in the course of the week ahead. It seems we are set to remain starved of US economic data releases for the time being and Fed speakers will also become silent ahead of the blackout for the next FOMC meeting.

In Europe, French politics may also be quieter, whereas in Germany there remains a sense that economic numbers remain disappointing for the time being, as the auto industry continues to struggle and as industry is yet to start feeling the benefits of intended fiscal expansion and expenditure on defence.

However, one notable topic gaining more attention appears to be a building desire to pivot away from some of the nihilistic net-zero commitments in Europe, which have crippled industry and consumers alike, at a time when much of Europe is paying 4x the amount for its energy versus industrial competitors overseas.

Even delaying 2050 by 10 years could make a large difference and come as a welcome relief, and at a time when politics is shifting in a rightwards, populistic direction across the continent, this seems an increasingly likely direction of travel. Something that certainly won’t be popular with certain climate activists in Europe!

^{* The information contained in this material is correct as of the publishing date of this article and is subject to change frequently.}