Heating up? Political tension holds, whilst market calm returns.

It certainly doesn’t feel like we are just a couple of weeks away from the seasonal slowdown that would normally accompany summer in the Northern Hemisphere. Anything written on the current fast-paced to-ing and fro-ing along with a hopefully successful ceasefire is unlikely to remain relevant for long, thus, as is tradition, we shall look to focus on direction and insight from parts of the market most relevant to our venerable readership.

Macro 

With the beginning of the summer break comes the end of the first half of the year. We’ll need a little patience to see how companies have performed following the first full quarter after the Liberation Day tariff disruptions. More than usual, it will be interesting to see how firms far and wide are thinking about impact on both demand and pricing, as well as exposing those most dependent on global or fragmented supply chains. What we have certainly already been seeing though is the impact of regulation on the size of bank balance sheets, as is always the case. There are reasons to think inventory in financial institutions has been growing off the back of more widespread chatter over requirements to reduce balance sheets for just one day. With this comes the need to find new homes, be it temporary or more permanent. Repricing is real, but for some unpalatable. In particular, Europe and the UK have no channel for much of the flow into more balance sheet efficient structures, unlike our US cousins, where sponsoring is really becoming a thing, along with additional facilities providing helpful backstops in times of need. Along with the fast-paced and volatile situation in the Middle East and beyond, it will be quite the close to H1. Tuesday’s announcement that NATO members would commit to spending 5% of GDP on defence - quite literally a double-edged sword. Whilst positive for growth, it does represent another data point highlighting that we are living in more dangerous times. Historically, rearmament has often come right before a war. Hoping of course for this not to be the case, rather a deterrent to prevent more conflict. 

Risk

In many ways I am sure many will be pleased to see the back of the last six months. Headwinds persist though, not just in the form of potential escalation but of course those pesky tariff tantrums. Stocks, though, remain the bastion of optimism. As of the time of writing (particularly relevant in the current climate) year to date returns across all European, along with North and South American markets, are holding on to gains from the 2024 close. There was one outlier with Sweden marginally in the red, although many more bourses continue to flirt with year to date losses (in particular the US). The outperformers look to have so much room that not ending the year up could only be caused by a major catastrophe. Germany, Italy, and Spain are enjoying over 15% in value creation thus far…let’s hope the reporting period does not give reason to doubt this positive momentum. Looking East, the Nikkei is struggling to gain ground thus far this year whilst other major bourses sit in the green, albeit by amounts that could be wiped out in just a few short sessions. One outlier though is the Hang Seng, up over 22%. Sounds great, apart from the fact that it still sits 30% below the all-time highs of February 2021. 

Credit 

The price to borrow has held in well thus far. Whilst various indices tracking the cost to insure against default rose, much of the move has reversed, for now at least. Whilst this is good, as we know, liquidity in both primary issuance and existing secondary supply is important to keep an eye on here. Gone in 60 seconds springs to mind…Much has been put on the slate for this last full week of June, and it is to be seen of course to what degree this sees the light of day. Optimism for a pause in conflict witnessed in the price of oil along with stocks has seeped into the world of bonds as well. June volume for new issuance sat just above $70bn prior to a flurry of activity earlier this week. Unofficial sources have been keeping the financial press informed, indicating that we are still likely to see greater issuance versus the four year average of $93bn for the month of June, now seen as hovering around a grand total of $105bn for ’25.

EUR 

The ECB delivered exactly as expected, cutting 0.25% and with that taking the deposit facility rate to 2.00%. Why? Well…continued easing both existing and expected inflation along with a slowdown in growth. To put this into context, this is a halving of the headline rate from the peak seen until the end of May last year. The positive to take from this is the reduction in inflation, finally coming in below target with May CPI (consumer price index) at 1.9%. The question remains though at what point this easing is actually stimulative and at what cost? Worth paying attention to a potential resurgence in price increases. Looking at market expectations, it feels like we are close to the bottom here, with one remaining cut priced and to come either for Christmas or at the first meeting of 2026. With one of the lowest funding rates around, there continues to be strong issuance in the currency by firms from outside the Eurozone.

GBP

The Bank of England held rates at 4.25% last week with a 6-3 split: three members calling for a 0.25% cut to 4.00% with the balance looking to hold for now. Despite one year CPI  increasing from 2.6% to 3.4% in May versus March, the market still expects a cut to come in August (odds at a comfortable 86% chance at the time of writing). Whilst the minutes also highlighted reduced external shocks leading to greater stability, this became old news fast following heightened conflict which has added some downward pressure on future expected interest rates. The labour market is loosening which when thinking about inflation at least is a positive. Wage rises, particularly in services, has been a bugbear for the Bank and has fueled much of the increase in prices for some time now. But what about growth? It remains weak, with headwinds persisting given heightened uncertainty. Stagflation remains a real potential outcome and one the Bank would dearly love to avoid. Nobody wants an economy where unemployment is high, growth stagnant, and prices spiralling out of control. For now, expectations are for rates to be 0.50% lower by the end of the year, with another 0.25% of easing come April next year. 

USD 

Despite the administration calling for a reduction in rates the Federal Reserve rightly remains independent in thought and in action. Last week rates were once again left in place, with the potential for an additional cut being expected in September at the earliest. The labour market remains healthy, with unemployment holding at 4.2% from the most recent data released just last week. Whilst apprehension remains, it is reassuring to see signs of strength in this part of the economy. Payrolls remain on the up, albeit at a lesser pace, suggesting a cooling at worst for now. Dollar weakness has continued. Mounting debt and expected cuts making exporting cheaper. Perhaps not such a bad outcome to help stoke demand, all subject to a successful rebalancing in terms of trade. Less positive is the reduction in foreign ownership of US bills and bonds. Additional supply and fewer buyers can only lead to more expensive borrowing. Not great given debt servicing has surpassed $1 trillion per annum (and double the amount just 5 years ago) with net interest payments making up over 15% of total federal spending. Doesn’t quite feel like the conditions that would lead to a record high on the NASDAQ, yet that is exactly where we find ourselves…as of the Wednesday open at least. 

So what? 

For now, and despite the outcome from more recent escalation unknown, volatility has been contained and calm ensuing. With mounting debt burdens, a still unclear renegotiation around global trade ongoing, and reasons to think drivers of inflation are re-emerging, it remains a time to lead with caution and patience. Given the above, it is hard to believe that we are at the bottom of the rate cutting cycle in several of the major economies. Having the ability to both reduce risk whilst also hanging on to higher rates for longer by way of terming out makes a bunch of sense here right now. 

*TreasurySpring’s blogs and commentaries are provided for general information purposes only, and do not constitute legal, investment or other advice.

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