Equity markets are performing well currently, with most regions having surpassed the levels they reached prior to Donald Trump’s initial tariff announcements in early April. Despite being a major focus of the US president’s anger, the Asian and Emerging Market regions are leading the way when viewed in pound sterling terms. Not far behind are UK equities, which have seen the FTSE 100 briefly touch 9,000 points for the first time in history. US equities are also powering ahead, but given the falling value of the US dollar, such gains are smaller for a UK-based investor.
Such optimism is in large part coming from Trump being more conciliatory on global trade than he previously appeared, while robust growth in both the US and China, the world’s two largest economies, is also playing its part.
While these gains are justified in many areas, there are also plenty of developments that should raise caution.
Low Growth, High Inflation
Economic data is weakening in the UK. GDP data has shown contraction for the past two months, with April’s -0.3% followed by a lower-than-expected -0.1% for May. Part of this is due to a weakening jobs market, which can at least in part be attributed to the rise in taxes and employment costs introduced in last autumn’s budget. More interest rate cuts are expected from the Bank of England in the coming months, but with inflation also going in the wrong direction, with a surprise rise to 3.6% in June, the capacity to materially cut rates in an effort to support economic growth is constrained. Add to that the government’s costly U-turn on welfare reforms, and the ability of Rachel Reeves to balance spending against tax receipts becomes all the more challenging, suggesting more growth-sapping taxes will feature in this year’s budget.
In the US, challenges are also mounting. Inflation reached 2.7% in June – below the UK’s level, but a significant increase on recent months and suggesting Trump’s tariffs are starting to feed through into higher prices. This would suggest that Jerome Powell, Chair of the Federal Reserve, is right not to cut interest rates, but this is a position which is angering Trump.
Political Interference
The president is being increasingly bold in his criticism of the central bank and is publicly considering whether to fire Powell. As with most central banks across Western democracies, interest rate decisions are meant to be independent of political policy, and arrangement provide markets with confidence that interest rate decisions will be taken for the good of the economy and not merely to assist a political agenda. By threatening to intervene in this way, markets are getting more worried, and this is a factor in the weaker performance of government bonds over recent months.
Direct political intervention is not the only challenge for government bond markets, however, with US government spending plans also causing consternation.
Mountains of Debt
This topic is not currently headline news, but it is an issue that could one day become so. Government debt is equal to approximately 100% of GDP in the US. While high by historic standards, this is not out of line with some other major economies, with both France and the UK at around this level. Bond investors are anxious over the affordability of servicing this debt, with a crisis similar to the panic which followed Liz Truss’ ‘mini-budget’ the most obvious possibility, yet this has not yet developed into any market trauma.
While politicians in the UK are gravely concerned about this, in the US there is no such hand-wringing, even in spite of the credit rating agency Moody’s downgrading US debt, stripping it of its cherished AAA rating. The IMF forecasts that the UK government deficit will be 4.5% this year. In contrast, the US deficit is forecast to be 6.5% and is not expected to shrink in the coming years. This means that US debt is forecast to balloon over the next decade.
Trump’s recent ‘Big, Beautiful Bill’ is a primary concern in this, which is expected to add $3 trillion to the federal debt. Concerns over Trump raising the nation’s debt have been around since he was re-elected, but the balm to markets was Elon Musk’s Department of Government Efficiency, which had initially promised to cut $2tn from the government’s costs. Yet, with Musk having now left the government after claiming cuts of just $170 billion, it is clear that the idea of cost saving hasn’t taken hold in the White House.
These developments haven’t triggered a crisis yet and are unlikely to in the coming year, yet the more debt levels are ignored, the greater a problem they will ultimately become. Without addressing the problem now, a greater proportion of the federal budget will be required for debt servicing in the future, leaving less money for public spending. A longer-term risk, therefore, and one that would pose the greatest challenge to longer-dated bonds, but also to the US dollar – even if its position as the global reserve currency will afford it more security than would otherwise be the case. For investment strategies, therefore, in Future Money a preference for short- and medium-dated bonds is maintained, while dollar-based assets are also viewed with caution.