Tactical Asset Allocation – Monthly Update

Our framework continues to suggest the global economy is in a slowdown regime, with growth above its long-term trend and decelerating. The underlying drivers of the current regime have evolved, however, as easing energy prices and a more explicitly hawkish stance have resulted in falling market-implied inflation expectations. Rising real rates now reflect tighter financial conditions rather than inflation risk. This reinforces an ongoing deceleration in growth, and a regime increasingly characterized by policy constraint rather than inflation uncertainty. As a result, we maintain an overweight to equity risk relative to fixed income with an emphasis on geographical and sector diversification within asset classes.

Our macro process drives tactical asset allocation decisions over a time horizon between six months and three years, on average, seeking to harvest relative value and return opportunities between asset classes (e.g., equity, credit, government bonds, and alternatives), regions, factors, and risk premia.

Macro update: Inflation risks moderate as growth risks build

Outperformance in risky assets has paused over the most recent month, despite strong fundamentals continuing to outweigh geopolitical risks. Positive AI super-cycle momentum became apparent in Q1-2026 earnings, as 85% of S&P 500 companies exceeded earnings per share (EPS) estimates. The information technology sector led, reporting 54% earnings growth. As Q2 earnings season begins, that positive momentum is expected to continue. As of now, 111 companies in the S&P 500 have issued EPS guidance, 63 of which are positive — higher than both 5- and 10-year norms. 

This fundamental strength coincided with positive developments in the Middle East. Multiple ceasefire and peace deal negotiations have transpired since our last update, and critically, the Strait of Hormuz has resumed the flow of tankers. As of writing, on a weekly average basis, roughly 18 tankers cross the Strait per day. That’s significantly higher than the complete shutdown of energy traffic over the last four months, but still significantly lower than pre-conflict levels. While the opening of the Strait remains paramount to global energy supply, damage to key energy infrastructure should not be overlooked. The timeline associated with the rebuilding of energy infrastructure remains unknown, and any uptick in military activity continues to have ramifications for global energy supply, risking higher energy prices for longer than originally anticipated.

Our measure of global economic growth, based on leading economic indicators, continues to register above trend. Regionally, the US remains the most resilient, with multiple sectors across the economy measuring above trend, including consumer sentiment and the housing sector. Developed non-US economies remain above trend, although gradually slowing, with similarities to the US, including weakness, despite monthly improvements, in consumer confidence. Our framework remains in a slowdown regime, given above-trend global economic growth alongside a continued deceleration in global risk appetite (Figures 1a, 1b, 1c, and 2).

Our inflation momentum indicators have meaningfully decelerated, driven primarily by falling energy inputs (Figure 3). This easing in underlying price pressures, combined with increasingly hawkish global central bank action such as an interest rate hike by the European Central Bank (ECB) and stricter inflation-fighting rhetoric from the Federal Reserve (Fed), has contributed to lower near-term inflation expectations. Additionally, short-term inflation swap markets have declined by nearly 60 basis points since the start of the month. This signals a material reduction in priced inflation, with breakeven inflation rates in cash bond markets moving in the same direction, albeit influenced by concurrent shifts in real yields.

Importantly, the recent repricing of inflation expectations has coincided with a rise in real interest rates, representing a shift in the balance of macro-related risks. The start of the US-Iran conflict brought energy-driven inflation as the primary macro headwind. The notable decline in inflation momentum driven by falling energy prices, confirmed by falling breakeven inflation rates (Figure 4a), suggests that these supply-side headwinds are easing. Simultaneously, increasingly restrictive central bank policy has become the dominant force, pushing real yields higher and tightening financial conditions. Within the US, the Federal Reserve reaffirmed its intolerance of higher inflation, which led to markets pricing an increasingly hawkish near-term rate path, as demonstrated by derivative market pricing coinciding with the increase in real yields (Figure 4b). This combination of falling inflation expectations and rising real yields represents a transition from inflation-led uncertainty toward policy-driven constraint. These dynamics shape the balance of risks for asset allocators: higher real rates act as a headwind to risk-taking, and the disconnect between nominal yields and inflation expectations over comparable horizons presents an opportunity for duration to act as a portfolio diversifier. 

Our US dollar signal has evolved over the month too, reflecting improvements in international economic data as energy prices have abated. Consumer confidence and economic sentiment survey results have improved, particularly in Europe, as energy prices have begun to stabilize. For example, average European mid-grade gasoline prices have fallen more than 7% since the start of June, coinciding with stronger-than-expected readings in European Commission sentiment surveys. Improved sentiment, a resilient labor market, and a stable consumer backdrop provide support for non-US economic growth dynamics, reducing the appeal of the US dollar. As a result, moderating US dollar strength supports a preference for developed non-US relative to US markets and developed relative to emerging market equities. Looking ahead, should the flow of energy continue to increase towards pre-conflict levels, downward energy price pressure should be a tailwind to international economic activity.

In summary, the current mix of above-trend economic growth and a modestly decelerating trend in risk sentiment supports continuation of the slowdown regime. While this environment doesn’t point to a cycle-ending contraction, the balance of risks suggests diversification remains warranted. Historically, periods of above-trend but slowing growth have been associated with modest yet positive returns across asset classes, along with performance convergence in growth-sensitive and defensive assets. This convergence continues to shape our tactical view and is reflected in the balanced and targeted investment positioning outlined below (Figures 5 to 8).

Investment positioning 

Within this context, we maintain an overall risk-neutral stance relative to the benchmark, reflecting continued emphasis on risk-management. This positioning is designed to preserve optionality and emphasize diversification, allowing portfolios to remain positioned for further upside while identifying relative value opportunities within asset classes. Within this framework, we remain moderately overweight equities relative to fixed income, with an emphasis on defensiveness rather than cyclical acceleration.

• In equities, we overweight defensive factors such as quality and low volatility. They’ve historically performed well during slowdown regimes due to more stable cash flow profiles and lower sensitivity to changes in growth dynamics. At the sector level, we favor exposures with defensive characteristics and durable fundamentals, including information technology, health care, and consumer staples, at the expense of more cyclical areas. From a regional perspective, we incrementally reduce our preferences for the US relative to developed ex-US markets, and developed relative to emerging markets.
• In fixed income, we maintain a moderate underweight to overall credit risk. This reflects a balance of risks that appears less favorable for spread-based compensation than alternative sources of return within a diversified portfolio. We also maintain exposure to interest rate duration as a risk management tool and a hedge against downside growth risks. Given recent moderations in inflation momentum and market-implied inflation expectations, we reduce our preference for inflation-linked securities in favor of nominal Treasuries. While nominal yields have remained relatively stable, declining inflation expectations have pushed real interest rates higher, reflecting a tightening in financial conditions. With this backdrop, we now favor nominal duration over inflation-linked securities. Higher real yields incrementally increase the likelihood that a continuation of moderating economic growth ultimately leads to lower nominal yields.
• In currency markets, we’ve adjusted our bullish stance on the US dollar to now reflect an underweight positioning. Recent positive international economic growth surprises reduce the appeal of the US dollar, and a convergence in global short-term rates neutralizes the US dollar’s appeal from a carry perspective. Within developed markets, we remain underweight the Australian dollar, British pound, New Zealand dollar, Swedish krona, and Swiss franc, while maintaining overweight positions in the Canadian dollar, euro, Japanese yen, Norwegian krone, and Singapore dollar. Within emerging markets, we favor higher yielding currencies with relatively attractive valuations, such as the Indian rupee, Indonesian rupiah, Malaysian ringgit, Taiwanese dollar, and Thai baht, funded by underweights in the Chinese renminbi, Czech koruna, Mexican peso, Philippines peso, and South African rand.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations), and investors may not get back the full amount invested.