Summary
Middle East conflict drives up oil volatility more than crude oil prices: the introduction of the US into this conflict raises the stakes for the global oil market and economy. However, the latest ceasefire has calmed oil prices, allowing global stocks to return close to all-time highs.
Domestic US Treasury bond demand stimulated by bank deregulation: the bond market remains the key financial market to watch, given rising US deficits. We advise benchmark or below-benchmark maturities in government and corporate bonds and buying on weakness.
Continued pressure on US dollar: despite the 13% appreciation of the euro vs. the US dollar this year, we expect a further long-term decline against major currencies and against gold. The potential repatriation of capital from the US to Europe and Asia remains a powerful force.
Upgrade European equities to Positive: eurozone economic momentum has improved, we begin to see lower uncertainty over US tariffs, and we expect economic benefits from the German infrastructure & defence spending plans. European and German mid-caps should benefit from stronger domestic economic momentum.
Residential property rallies: lower ECB benchmark rates boost mortgage demand, while rental demand remains robust in key European cities. Expected average annual return over the next 5 years is 7%-8%, based on a 4% rental yield and above-inflation rental growth.
Upgrading European Equities to Overweight
From progress on trade towards….
Most recently we have noticed some major progress with several factors which so far prevented us from turning more positive on European equities. We now see the stars aligning for European equities to resume their outperformance as uncertainties fade and upside risks to growth emerge. Tariffs have been a Damocles sword hanging above the profitability of European companies. Apparently, major progress has been made in negotiations during the last couple of days as both EU and US officials voiced optimism that a deal could be reached before the deadline (9 July) to avoid an economically damaging escalation. US Commerce Secretary, H. Lutnick, even went as far as saying “Europe has done an excellent job, they’re working hard. I’m optimistic — I think we can get a deal now.” We think that this de-escalatory rhetoric is a positive sign as well for the ongoing investigations of the US Commerce Department on certain sectors. The risk of sector specific levies applied under Section 232 of the Trade Expansion Act looks lower if a trade-agreement has been reached. A deal potentially addresses at least some of the issues those investigations may uncover. Thus, it could prevent those levies from being implemented or at least lower the applied level. We would highlight the fact that Section 899 has been dropped from the OBBBA (One Big Beautiful Bill Act) in this respect as a positive sign as well.
..one big beautiful spending plan
With the overhang from trade looking substantially less gloomy, we think that the market focus may eventually shift to the positive economic backdrop in Europe. At this week’s NATO summit, member states committed to a significant structural shift in defence spending, targeting 5% of GDP by 2035. Echoing this, the Germany published plans to increase defence spending by over 70% by 2029—from EUR 95bn this year to EUR 162bn—equivalent to approximately 3.5% of GDP.
This surge in spending is part of a bigger fiscal reform agenda in Germany, looking to boost investments in infrastructure, lowering taxes and cutting red tape. Indeed, Germany’s 2025 draft budget and medium-term fiscal outline delivered an upside surprise to this year’s combined defence and off-budget investment spending of around EUR 8 billion. With investment spending tending to have a higher fiscal multiplier, a faster deployment should be net positive for the growth outlook. It points to upside risks to our GDP growth forecast of 0.5% for 2025 and 1.0% for 2026.
Prefer domestic exposure but keep some powder dry
German equities offer a compelling mix of valuation support, earnings momentum, and policy tailwinds. With ~1/3 of revenues derived from Germany and consensus EPS growth of ~20% in both 2025 and 2026, the MDAX remains attractively valued despite its strong YTD gains.
Despite increasing the weight of European Equities within our equities allocation, we keep a Neutral rating on equities in our overall asset allocation. This is due to (i) high US valuations, (ii) the risk of a more severe US economic slowdown and (iii) the residual risk of trade talks failing. We are optimistic that Europe should be able to outperform in a potential US-born correction, thus we´re comfortable about starting to build an EU overweight now. Nevertheless, we prefer to keep some powder dry as chances are that a resurgence in volatility may present investors with more attractive opportunities to increase their overall equity allocation.
A tenuous Israel-Iran ceasefire
Middle East conflict spurs oil market volatility
The intensification of the Israel-Iran conflict in recent days has sparked a surge in uncertainty around the security of global crude oil and natural gas supplies. The Brent crude oil benchmark price initially jumped 20% from its end-May level to USD 79/barrel, while CBOE oil price volatility surged to USD 69 (vs. a long-term median of USD 35). This reflected a higher risk of a triple-digit oil price in the event of any long-lasting disruption to seabound oil supplies from the Gulf.
Now a ceasefire is in place
Following the surprise US attack on Iranian nuclear facilities, a tenuous ceasefire between Israel, Iran and the US has now been put in place. As is typical with such ceasefires, observance is not 100% by all sides and the relative peace remains fragile.
The reaction in global oil and natural gas prices has been immediate: Brent crude has slipped USD 11 to USD 68/barrel, while the European TTF natural gas benchmark has eased back from a recent peak of EUR 42/MWh to under EUR 36.
The Iranian regime looks to retain power
The current Iranian Ayatollah has been in power for 36 years since 1989. The overriding immediate goal of this Islamic Republic’s regime is to retain domestic power, even as its influence in the broader region has been eroded by the fall of the Assad regime in Syria, and the Israeli attacks on Hamas and Hezbollah. Equally, it is not in the interests of the Israeli government to conduct a long drawn-out war with Iran, given the vulnerability of Israeli key energy and water infrastructure sites to Iranian missile attack.
Oil continues to flow without interruption
To date, there have been no attacks on the region’s critical oil infrastructure, nor has Iran attempted to close the Straits of Hormuz in spite of the symbolic declaration by the Iranian parliament that Iran should do so. Crude oil and Liquefied Natural Gas (LNG) have continued to flow from the Gulf principally to Asia.
Given that Iran continues to ship crude oil to China via the Straits of Hormuz, it is not in Iran’s economic interest to disrupt shipping in this vital channel given the risk of alienating such an important trade partner.
Recall that Saudi Arabia and the United Arab Emirates have substantial spare oil production capacity of 6 million barrels/day, allowing them to keep the global oil market well supplied even if there is a disruption to Iranian oil exports.
Oil market fundamentals augur for an oil price around USD 60 or potentially even lower
The consensus expects the world to have abundant supplies of oil by the end of this year, as OPEC+ plans to raise oil production further in July on top of the quota increases in May and June. Given these higher production quotas, BNP Paribas Global Markets forecast the Brent crude oil price to fall further to USD 62/barrel by the end of this year. This is in line with President Trump’s desire for lower oil prices, to provide relief to American households via lower living costs. This lower oil price would have a positive impact on global growth, as higher oil prices act as an effective growth tax on oil-importing nations.
Short-term oil volatility should have little longer-term impact
Watch Brent crude oil, European TTF gas prices
The key risks to global oil and LNG supply come in the form of:
- a.a potential Israeli attack on Iranian oil export terminals on Kharg Island, plus the risk that
- b.Iranian military action serves to close the Straits of Hormuz to oil tanker traffic (through which oil exports from Saudi Arabia, the United Arab Emirates and Iran all pass).
If the current ceasefire falls apart, then there is the threat of renewed US attacks on Iranian nuclear infrastructure – a good reason for Iran to respect the calming of hostilities with Israel.
What matters is the duration of any oil price spike
Crude oil prices remain 20% lower than a year ago, while US gasoline pump prices are 16% lower than a year ago. For there to be a durable impact on inflation, oil prices need to remain at elevated levels for months rather than days.
This was notably the case in the wake of the Russian invasion of Ukraine in February 2022. At that time, Brent crude rose from USD 70/barrel at the end of 2021 to peak at USD 120 in early 2022, then staying above USD 90 until the end of that year. The drag on global growth that resulted from this persistently elevated oil price was a key factor behind the slump in global stock markets for much of that year.
Oil price spikes have often resulted in strong stock performance
If we analyse periods since 2008 when oil price volatility has been elevated, we observe that the subsequent 3, 6 and 12-month performance of global stocks has typically been far better than average. For instance, following a surge in oil price volatility to a reading of over 50, the average subsequent 6-month return of global stocks has been +10%, and +21% over the following 12 months. Once again, buying stocks at a time of heightened geopolitical uncertainty is statistically a good strategy to follow.
Conclusion: while geopolitical uncertainty has evidently increased given the latest Israel-Iran attacks, a good entry point into stock markets may surprisingly be close at hand.
“Bond vigilantes” pressure governments into action
Government spending concerns bond investors
US and Japanese 10-year government bond yields took a breather in June, easing back modestly to 4.2% and 1.4% respectively. In both cases, bond investors remain concerned by a combination of elevated government spending and high existing government debt burden as a percentage of GDP.
Japanese debt/GDP has marginally declined since 2020 but is still an incredible 246% of GDP, while US debt/GDP has grown from just over 60% of GDP in 2008 to 126% today. Trump’s “Big Beautiful Bill” contains further tax cuts which will likely drive this debt/GDP ratio even higher in the coming years.
Japan’s Ministry of Finance to alter bond issuance
Given the sharp rise in ultra-long JGB bond yields since September last year, the Japanese Ministry of Finance has altered its bond issuance schedule to include a much lower share of super-long bonds, favouring instead short-term Treasury bills. This shift in issuance strategy should simultaneously cap the interest cost of new debt to the Japanese government, while also relieving pressure on 30- and 40-year bond yields through lower new issuance at these maturities.
US to proceed with banking deregulation to stimulate domestic bond demand
The US Treasury Secretary Scott Bessent has confirmed that the Supplementary Leverage Ratio of US banks should be eased, allowing banks to buy more Treasury bonds for a given amount of capital. Expect further measures to stimulate US domestic Treasury bond buying to be unveiled in the coming months.
The Federal Reserve: more dovish in 2026?
As part of this shift on bond flows, the Federal Reserve is likely to end their current policy of selling bonds to shrink their balance sheet (quantitative tightening) in the near future. Since mid-2022, the Fed has reduced their balance sheet by a cumulative USD 2.3 trillion (25% of peak balance sheet size).
This could be a prelude to the Fed returning to the policy of bond buying (quantitative easing) that was employed notably in the wake of the Global Financial Crisis (2008-14), and again around the COVID pandemic (2020-22).
The interest rate futures market prices a Fed Funds rate 1.2% lower by end-2026 than today, with the majority of interest cuts expected once Jerome Powell’s term as Fed President ends mid next year. The market assumes that the next Fed President, to be appointed by President Trump, will adopt a “dovish” interest rate policy that will favour employment and economic growth over a strict 2% inflation target.
The likelihood then, is that the combination of US fiscal (directed by the US Treasury) and monetary policy (directed by the Federal Reserve) will allow the US economy to “run hot”, generating 5-6% nominal GDP growth annually in order to allow the tax base to grow at a similar pace. This strategy should help to ensure the sustainability of US federal debt in the absence of substantial spending cuts.
Conclusion: we advise benchmark or below-benchmark maturities in government and corporate bonds, with a buy on weakness strategy.
Real estate focus: attractions of residential property
Lower interest rates stimulate mortgage demand
The two most important factors determining the evolution of demand in residential housing markets are i) the strength of the employment market in terms of employment level and wage growth, and ii) the cost of financing as determined by short- and long-term interest rates.
As is typically the case, the current recovery in European residential property markets is uneven. Those regional markets with a combination of i) stronger domestic economic growth, and ii) higher sensitivity to variable interest rates via residential mortgage interest rates, such as Spain and Sweden, are recovering faster. Recent interest cuts by the European Central Bank and the Swedish Riksbank should reinforce positive mortgage demand in these markets.
In Q1 2025, Spanish house prices climbed over 12% on a yearly basis, while Swedish house prices returned to all-time highs, up 10% y/y. In contrast, French house prices only advanced by 1% in Q1 y/y, with French long-term fixed mortgage rates not moving much and remaining above 3%.
European listed real estate performs well in 2025
Since the start of this year, listed European REITs have returned 9.1%, slightly ahead of the STOXX Europe index. This follows a relatively poor 2024 where European REITs returned only -3%.
Strong demand drivers for residential property
Institutional real estate investors have traditionally concentrated on 3 main segments for investment: offices, retail (both shopping centres and high street retail) and industrial/logistics (largely warehouses). However, residential is today a fast-growing segment within these large real estate investment portfolios, given the relatively defensive and counter-cyclical characteristics of residential property. When people cannot afford or are too cautious to buy in uncertain economic times, they continue instead to rent.
Attractive residential property supply-demand characteristics in big European cities have been enhanced by structural demand growth from short-term rental properties dedicated to Airbnb in cities such as Barcelona and Amsterdam.
In terms of rental yield, at 4.0% the European residential sector yields less than prime offices (4.7%) or prime Logistics (4.3%) according to BNP Paribas Real Estate. But its diversification characteristics in a real estate portfolio are attractive, as are the prospects for rental growth (in excess of underlying inflation) and from revaluation as mortgage rates decline. The 5-year average total return from European residential property should thus fall into the 7%-8% range. With inflation likely to average close to 2%, this suggests an attractive 5%+ real return from residential property.
This compares favourably to other real estate segments, and particularly attractive compared to prevailing bond yields and cash deposit rates.
Global Chief Investment Officer