Eyes on the ball

The outlook continues along the divergent trend of late, driven by growth, or sadly, in some instances, a lack thereof. It is still to be seen how and when noises from leaders internationally actually start to really bite, or if at all. Nonetheless, it is important to consider some of the potential outcomes and what it means for all of us.

Macro

With rapid decision-making and unexpected change comes volatility. Given the flavour being far-reaching, with tariffs no longer limited to a subset of trading partners in the US but now to raw materials and beyond, expectations and price moves are beginning to span far wider parts of financial and physical markets, and globally.

“Fears of a global trade war put gold back in the spotlight; still considered a safe haven and breaking through to new highs over the past several days.”

Much of this new buying has come from China, where a pause on the purchase of US Government debt is also raising the question once again of how sustainable continued net issuance might be as one of the largest hoarders reallocates reserves. The euphoria and dollar strength (or everything else weakness) has turned and is rightly being questioned with negative sentiment around longer-term US growth feeding through to expectations as more countries look to retaliate against proposed import duties.

Despite a slowdown in growth across much of the world prior to these new challenges, one might think risk, credit, and rate expectations to all have been adversely affected. For now though, this is simply not the case.

Risk

VIX, a measure of fear and volatility, has continued to behave itself. Stocks not having such a bad start despite growing uncertainty around both the health of the consumer in multiple jurisdictions, along with employment. We’ve survived earnings season and those early and mostly positive indications out of much of the financial sector have fed through to much of the remainder of the large listed firms. AI and more broadly tech (if one can still separate the two?!) remains volatile of course and continues to make up a significant proportion of some of the US majors in particular.

“Productivity is the only way we get real growth for all.”

It continues to be interesting to see how this plays out and feeds into performance. In the US, index gains are hovering between 1.5-5%, which may seem light given the backdrop of an economy that continues to power ahead. By another measure though, being price to earnings, the ratio is high at above 26 (versus a range of around 19-23 over the last five years), meaning there remains a large amount of expectation and future growth priced in. Should sentiment turn, we may well be in for outsized drops. European bourses, on the other hand, are performing well, with gains ranging from 7.5% (UK) to almost 11% (Germany and Spain). An interesting aside is that execution is increasingly happening off-exchange in “dark pools” where algorithms facilitate block trades (where these larger orders might ordinarily move the market). One thing is for certain: less liquidity and transparency can be a bad combination.

Credit

Frankly the market remains pretty benign. This is generally a good thing. We have remained higher for longer, which does affect refinancing rates adversely as new issuance is typically coming in at a higher level of debt servicing, affecting those less able to balance their books, putting revenue generating businesses at an advantage. Off the back of this one might expect to see divergence here.

“China’s distressed debt levels have ballooned to a whopping $160Bn in the domestic real estate sector alone.”

With a slowdown in growth there and a more challenging environment for exports this does not bode well for both holders of credit from the region and the domestic economy more broadly. As the second largest economy globally, this is likely to have repercussions as imports would also be expected to continue to drop off.

EUR

Helpfully, economic and employment sentiment have both improved on a consolidated basis. Growth remains uneven and the economy certainly slowed towards the end of 2024. The largest economies have experienced either mild contraction or stagnation. This goes a long way to explaining the current pricing of an additional three 0.25%  cuts before the year is out, taking the total for 2025 to 1% should markets be right, following the initial easing at the end of January.

“Whilst much of the tariff noise from the US has focussed on where net imports originate from, with the broader policies now potentially affecting specific industries including steel and aluminium, Europe has vowed to respond with equal and opposite measures”

. Overall, the trade surplus the EU currently enjoys is firmly in Trump’s sights, where it is deemed “unfair”. We have been here before. In Trump’s first term, the US already hit the $7Bn of aluminium and steel sourced from the EU. Retaliation came with fairly specific targets including Harley Davidson and Levi’s. Staple goods in many a household I’m sure. Backpaddling and concessions from both sides left the spat with a net gain for the US last time around…

GBP

Nobody was surprised to see a 0.25% reduction in the base rate earlier this month. Why then have we seen some relatively significant inversion since? Well, those once calling for no change with inflation not being under control and growth healthy have been flipped.

“In one instance, Catherine Mann, known for being strongly against easing, actually called for a 0.50% cut this time around.”

Her view should be noted given the change in stance, pointing to prices being under control sooner than expected, along with signs of growth becoming non-existent and employment likely to suffer in the near term. In numbers, since the beginning of the year where roughly two 0.25% cuts were priced in (or projected), we are now apparently going to need an additional 0.25% off the base rate to stimulate the economy sufficiently before the year is out.

USD

Whilst growth and employment remain strong and for the most part we have seen dollar strength post-election off the back of policy shift, some are starting to question how sustainable this might be. On this very theme, on Tuesday we heard that the Treasury is looking to scale issuance back in treasury bills, as once again the debt ceiling is approaching fast and requiring our attention once again. Headroom has been disappearing, and fast. A government shutdown this early in anybody’s tenure should be embarrassing. Then again, we are dealing with different characters that are not shy of force to create change. Not always a bad thing either, frankly, although very subject to circumstance!

Irrespective of this, the US is not immune to rates being higher for longer either, as debt servicing costs must also be considered. The latest figures, which take us to December, put this nominally at $308Bn. Big. To help contextualise further, as a percentage of federal government spending for the year it represents 17% of the budget.

“Living within one’s means is one of the most important lessons in life.”

Anyway…the Federal Reserve remains the outlier, both by skipping any easing at their first meeting in January and the curve barely pricing one full cut before January 2026 as the Fed continues to struggle to keep inflation below 3%, let alone achieve its target 2%!

So what?

We are likely to see continued volatility given all that is currently in play. Continued de-escalation of conflict would of course be something to celebrate. and beneficial to markets. It is not, though, a magic bullet given all the other balls in the air. Growth feels harder to come by here, and I am sceptical that AI can both come in time and have a large enough impact to spare us some tricky quarters ahead. With this in mind, we still enjoy real rates and returns, something to take advantage of when one can, provided of course, that this is done in prudent fashion. Return is good, the best flavour being risk-adjusted with downside protection, especially given our destination is unknowable.