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Global stock and bond markets remain in limbo as the 90-day delay in the implementation of the US trade tariffs ticks down towards July 9th. As expected, it has been a volatile period with not just the tariffs, but the US Federal Reserve Bank, China tensions and the US Budget Deficit all in focus during the last month. Since the “Liberation Day” when the reciprocal tariffs were first announced, we have had the market-turning 90-day delay (ex-China), a threat to fire Fed Chair Jerome Powell, which was then reversed within a few days. Tariffs on China ratcheted up to 145%, as China matched each new US tariff with measures of their own. Then markets again had a reprieve as Chinese tariffs were moved down to more practical 30%.Then it was the turn of the EU. Allegedly frustrated with a lack of progress Trump introduced 50% levies on EU imports. A few days later these measures were also reversed. There seems to be a pattern here. Trump throws a metaphorical “hand grenade” into diplomatic talks and then back tracks. Markets are quick to see patterns, and the stock market impact of each new pronouncement does seem to be smaller each time. So far only one trade deal has been done, an easy one with the UK. The big deals with Japan, South Korea, India and the EU will probably go to the wire. If Trump ultimately folds, as he seems to do, why rush? With markets preoccupied by the trade talks, there is the danger that they are looking in the wrong direction as a new crisis unfolds. One of the three key market drivers, interest rates have taken an unexpected turn up.
Global Bond Yields
There are two types of interest rates. The official rate set by the Central Bank; in the case of the Bank of England it is the Base Rate. The other is the market rate; a range of interest rates set by the markets for a government’s debt (their mortgage). Just like a mortgage, if your credit rating is good then you get a better rate than someone who is already heavily in debt and is spending more than they earn. Also, the longer you want to borrow for then the higher the rate of interest. Central bank rates are currently too high. In the UK, the Base Rate is 4.25%, when inflation (ex the April utility increases) is running at around 2.5-2.75%. With inflation at this level interest rates should be at most 3.5-3.75%. Understandably, Central Banks are slow to cut rates as they simply do not know where the US tariffs will end up. So, what is going on with the market rates of interest which have all displayed a big jump in interest rates with the UK 30 year currently at 5.4%, the highest since 1997, just as Tony Blair took over from John Major? The problem for the Bond markets globally is simple, governments are either spending a lot more than they expected to (UK, Germany), cutting tax revenue yet not cutting expenditure (USA), or belatedly unwinding decades of Quantitative Easing (Japan).The UK is easiest to explain. The now infamous first Budget of Rachel Reeves raised government spending on public sector salaries and long-term infrastructure projects (Green Energy), neither will have any positive short-term impact on GDP growth. It then harmed the private sector with big tax increases. Thus, curtailing growth. If the economy does not grow, then neither does tax revenue (the government’s salary). Using the “asking the Building Society for a mortgage” analogy, the UK did not get a pay rise, increased its monthly outgoings, thus having a bigger overdraft at the end of each month and now needs an even bigger mortgage to make ends meet. The bigger mortgage means issuing more Gilts and thus the market demands a higher interest rate.
Big Beautiful Budget Bill Act
In the US Trump’s “Big Beautiful Budget Bill Act”, which is still progressing through Congress as we write, will mean tax cuts, particularly for the wealthy, accompanied by cuts to welfare but not enough to offset the reduction in revenue, hence the US Budget Deficit (overdraft), which has already grown to 6% of US GDP will increase (unless growth accelerates), thus, taking the US Government Debt to GDP, (mortgage), to 124% (UK 96%) i.e. negative equity. The Trump election promise was that the shortfall will be funded by tariff revenue and savings found by Elon Musk’s Department of Government Efficiency (DOGE). The suspicion in the Bond markets is that tariffs will not raise enough funds to offset the extra overdraft and with the departure of Elon Musk it is now clear that the promised DOGE savings are likely to be nowhere near the amount initially forecast. Nevertheless, unlike the UK, the US Budget Act should stimulate growth. The same is true for Germany where the extra debt will stimulate manufacturing growth through increased defence expenditure.
Earnings Growth
Markets can move higher in the face of higher bond yields, if growth (another of the three key market drivers), is positive and preferably accelerating. Here, markets, at least for now, are in the dark. Analysts cannot make accurate forecasts until trade agreements are signed. Some of the S&P 500 biggest companies are dependent on China for supplies e.g. Apple, one the largest, could see profits decimated on the whim of Donald Trump. Amazon and many others cannot give accurate profit guidance until they know exactly what tariff they will have to pay. The assumption is that the “Trump Put” remains live and big Tech will be spared from the worst of the tariffs, as long as they offer to invest their spare billions of dollars in US manufacturing. Markets therefore remain optimistic, until proven otherwise.
Market Sentiment
This chart is from Absolute Strategy Research’s most recent quarterly survey of global asset allocators responsible for trillions of dollars’ worth of investments. This is composite forward-looking indicator that includes cyclical elements, equity valuations, bond yields, credit spreads etc. What this shows is that market’s sentiment stays at below average levels. Crucially, this is a long way from market exuberance. It is also suggestive that we are still at an early stage of the new cycle, with the potential for sentiment to move sharply higher. What it cannot tell us is when it will move higher and what the trigger will be? It does tell us though that, should good news, on any of the three key market-drivers i.e. interest rates, inflation, corporate earnings growth arrives, then low sentiment has the potential to push equity returns considerably higher. However, much will depend on the decisions made by just one man.
Markets
In the very short-term markets are hostage to the statements from Donald Trump. The probability is that as we get closer to the July deadline the news flow will increase even further. Equity markets do believe that ultimately that US tariffs will end up around the 10% level, which is equivalent to normal currency market movements. China and the EU are the big deals that markets will be watching for. In the meantime, there nervousness in the bond markets will continue. There is no evidence of wholesale overseas (especially Chinese) selling of US Treasury Bonds. Much will depend on 10 Year US Treasury yields staying below the psychologically important 5% level. That in turn may depend on the dollar and whether it can regain some strength? Both are dependent on the US Big Beautiful Budget Bill Act and the tariff talks. Since the initial bounce following the 90-day tariff pause markets have tended to trade sideways awaiting news. Few are prepared to commit money to investment markets with so much uncertainty surrounding each of the three key market drivers. In the UK there is a risk that Reeves might “double down” on
her first Budget in the imminent Spending Review, thus taking a significant risk with the UK equity and bond markets. Normally, June marks the start of the summer doldrums for markets with usual “sell in May” headlines. With all that is going on in the world, traders and investment managers that have sold in May might easily be wrong-footed in such a complex and fast-moving global economy.
