The three things investors should know about this week.
Heightened policy uncertainty seems to be affecting US risk assets more than EU risk assets, since the beginning of the year.
Meanwhile, investors have to deal with conflicting inflation strategies. A data-driven strategy would see more tame inflation. A tariffs-are-a-threat strategy might suggest a more aggressive approach when it comes to duration positioning.
The rates market, already jittery in the past year, could experience further volatility in the next few months which could challenge bond managers and funnel even more money to inflation-friendly stocks and Gold. Conversely, an end to uncertainty could quickly unwind these trades and see a dramatic fall in long yields.
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Summary
Uncertainty manifests in many ways. For example, even as US large caps finally broke out of their three-month trading range last week, all it took was a cautious outlook from Wal-Mart, a US consumer bellwether, after soft consumption data for January, for the index to come off again. Despite initial worries about non-US financial and real assets in the present paradigm, the year has started with, caution for expensive US tech stocks, the Dollar and positively for Gold, EU banks and defence stocks, as well as Chinese tech. A lot of it comes down to inflation. Headline data which shows prices picking up but underlying data, suggests a more benign picture. Tariffs are really what keeps investors on edge. In other words, the recent inflation resurgence may have been easier to dismiss (or may not have happened at all if not for re-stocking efforts ahead of tariff threats) if not for the US President’s emphatic pursuit of trade sanctions.
So how can investors deal with such inflationary uncertainty? A resurgence in inflation may well depress bond prices even further and result in higher borrowing yields. More importantly, because of the uncertainty around tariffs, and decent underlying data on prices, bond markets are treating tariffs and trade wars as a one-off, with some mild inflationary effects for 1-2 years. It’s a challenge for managers who were long on duration in anticipation of lower rates. The rates market, already jittery in the past year, could experience further volatility in the next few months which could challenge bond managers and funnel even more money to inflation-friendly stocks and Gold. Conversely, an end to uncertainty (either by the actual imposition of tariffs or by reaching mutually agreed resolutions) could quickly unwind these trades and see a dramatic fall in long yields.
Week ahead
The week ahead will see a lot of discussions around Germany’s governing coalition, as well as Mr Merz’s plans to resist pressure from the US and Russia. In terms of numbers, we would focus on US core inflation (PCE) data by the end of the week, as well as statements from various Fed officials.
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Another week of geopolitical and geoeconomic reordering ended, and another one undoubtedly begins. Consequences range from profound to utterly forgettable, and we will likely not be able to tell one from the other for some time. Treasury Secretary Scott Bessent’s optimism about his 3-3-3 target (3% GDP growth, 3% deficit, 3 extra million oil barrels per day), is simply failing to translate into market optimism. The US President has decided to “shake things up” in a way that, at least for a G7 economy, is probably unprecedented in modern times. This, understandably, creates uncertainty, which manifests in many ways.
For example, even as US large caps finally broke out of their three-month trading range last week, all it took was a cautious outlook from Wal-Mart, a US consumer bellwether, after soft consumption data for January, for the index to come off again.
One of the most difficult aspects of this new reality of ours is the “noise” (in the investment sense) that’s coming from the White House. So loud, that it is easy for investors to miss other important developments around the world.
For example, despite initial worries about non-US financial and real assets in the present paradigm, the year has started with
Caution for expensive US tech stocks
Caution for the Dollar, despite the Fed’s more cautious approach to interest rates
Positively for Gold (an uncertainty-friendly but non-yielding asset)
Positively for EU banks who may benefit the most from laxer regulation, which four EU central bankers backed last week.
Positively for EU defence stocks, as the Old Continent finds itself compelled to spend more (over 210 Billion Euros if it is to catch up to US spending) on its own military capabilities
Positively for Chinese tech stocks, who are now benefitting from Deepseek’s emergence
Another thing we could have easily missed is some improvement in the Chinese economy, suggested by some Chinese and implied by Japanese trade data (Japan is China’s largest trading partner).
Uncertainty is really the name of the game. And a lot of it comes down to inflation. Already many CFOs have said that they will pass on cost rises to consumers. Wal-Mart’s cautious outlook wasn’t a one-off. The CFO, John David Rainey, said that the company wouldn’t be “immune to tariffs”.
It’s a good time to remind people that tariffs, barriers and exits from free-trade organisations are protectionist measures designed specifically to benefit (or even the playing field depending on one’s point of view) local producers. This means that, without exception, they are, at least for the short term, inflationary as their whole point is to make sure local producers and workers are not undercut by lower-priced foreign goods or cheaper services.
In its first meeting of the year, the Fed made it clear that it would be pausing rate cuts in anticipation of data which would demonstrate the impact of the new administration’s policies on inflation and growth.
Last week’s FOMC Minutes confirmed this stance.
Right now, gauging inflation is very difficult. There are three layers
Headline data which shows prices picking up
Underlying data suggests that all other things being equal, the recent rebound in inflation may be seasonal and temporary. Chicago Fed President Austan Goolsbee suggested as much last week, as did the Bank of England Governor Andrew Bailey who said that he wasn’t worried about increasing wage pressures for the time being, and expected wage growth to drop to around 5.2% from 5.9%.
The unknown impact of (still fluid) tariffs on global supply chains, and how this may be tempered by lower demand.
In other words, the recent inflation resurgence may have been easier to dismiss (or may not have happened at all if not for re-stocking efforts ahead of tariff threats) if not for the US President’s emphatic pursuit of trade sanctions. (small note to self and others: “Trade Wars” in the wider sense is a situation where not only the US but every nation imposes tariffs on every other nation globally, which is what happened in the 1930s, as our Berlin Senior Economist Santiago Rossi kindly reminded me last week. This is not quite what we would expect to see happen this time around).
What inflation uncertainty means for investors
So how can investors deal with such inflationary uncertainty? Mr Trump’s strategy of keeping everyone on their toes is not very helpful for fixed-income investors. The US 10-year Treasury Bond is arguably the cornerstone of global financial markets. And it has suffered significantly since 2022. Even if we dismiss extreme ideas like the Mar-A-Lago Accords that have been making the Wall Street rounds last week (a forced elongation of US debt, tantamount to a Greek-style technical default of US debt), a resurgence in inflation may well depress bond prices even further and result in higher borrowing yields. More importantly, because of the uncertainty around tariffs, and decent underlying data on prices, bond markets are treating tariffs and trade wars as a one-off, with some mild inflationary effects for 1-2 years. Longer-term repercussions for supply chains and output gaps don’t seem to be priced in at this moment.
Consumers, however, seem worried.…
What does this mean? It’s a challenge for managers who were long on duration in anticipation of lower rates, for one. And it’s not just Dollar duration. Sterling and Euro investors are in a similar boat whether they realise it or not. Fears of capital flight from the Euro and the Pound towards higher-yielding Dollar accounts could stay European Central Bank President Christine Lagarde’s and Bank of England’s Governor Andrew Bailey’s hands. The rates market, already jittery in the past year, could experience further volatility in the next few months which could challenge bond managers and funnel even more money to inflation-friendly stocks and Gold. Conversely, an end to uncertainty (either by the actual imposition of tariffs or by reaching mutually agreed resolutions) could quickly unwind these trades and see a dramatic fall in long yields.
We are in the “shock and awe” phase of change, where the repercussions of significant change are purely speculative. But, make no mistake, they will come. The question for fund managers is how many of them they will right, and how many parts of the market they might find themselves chasing.