Taking a beat: Why caution remains warranted in today’s economic environment

Quite the list of developments and, judging by where we find markets, much optimism has returned. Feels like we are closer to peace across the board and even in the few short weeks since last putting pen to paper. Whilst controversial, it also appears as though the rather blunt trade negotiations are working their way through the global system. Whilst this is great, what else is out there we should be keeping an eye on? 

Macro

It’s not often that two of the G7 elect new leaders in a three-week window. There is hope though, that along with fresh mandates comes stability. Prime Minister Mark Carney, former Governor of the Bank of England and prior the same in Canada, does come with a strong background in all things economics (having also spent years at Goldman Sachs). Thus, one would like to think this sets Canada on a better footing. Storm clouds have been forming with over 1.5 million of the 40 million population out of work and April seeing further cuts. An unemployment rate of 6.9% is bad for a plethora of reasons. Added to that one of the highest household debt levels for an advanced economy, along with youth unemployment double the headline, with a dependency on energy and commodity exports, makes for quite the bumpy road ahead. With job creation lacking and a large welfare state, a good outcome in trade negotiations will be important. In Germany, new Chancellor Friedrich Merz also has his work cut out. The electorate voted for action to be taken against illegal migration and getting the economic powerhouse back on the front foot. Quite the reversal from just a few short years ago when neither were true. An alliance of convenience to gain a majority, forming a government with the centre left to keep the main opposition of what many have branded the far right, continues to feel vulnerable. Do a good job on delivering what has been asked by its people and there is a chance. With thousands of additional officers monitoring borders, the idea of frictionless travel across the continent, a core premise of the European project, continues to be tested, but not spoken about. If the DAX (the main German stock index) is anything to go by though, optimism is high, outperforming the rest of not just Europe but globally, currently sitting up an impressive 19%!

Risk

Most other indices have also shown strong signs of recovery. Since the turn of the year almost all majors are back in the green. If shares are anything to go by, the main victims of Liberation Day tariff negotiations indicate it is the East (Tokyo, Shanghai and Sydney) that is not going to get away painlessly, although even those now single-digit losses appear to be bouncing right back. Even US markets have also fully recovered, although impressively the S&P 500 is at a 2025 high, closely followed by the Dow Jones off less than one percent. According to the IMF though at least, looking at data released early May, the biggest loser is, well, the US. Growth has been revised down by a whopping 0.9%. Worryingly, according to Factset (a leader in financial data), at least 7% of total revenue in S&P 500 companies comes from China. It’s no surprise the weekend saw some backtracking and, for now, time-limited reduction in headline tariffs. Either way, this might lead to divergence of inflationary pressures as Chinese goods are rerouted to the rest of the world whilst the US seeks to replace them from other less cheap jurisdictions.

Credit

Following on from even the most prime of borrowers not attempting to issue after the joys of tariff uncertainty, things couldn’t be looking (much) more different. Even the raciest of high yield (or least creditworthy) borrowers are back in business, with the market the busiest it has been this year in the first week of May. Much of this has been in Europe where rates continue their aggressive downward trajectory, buyers far and wide looking to lock up at what are perceived to be great rates before they are gone. In the US, one hears increasingly of “pretend and extend”. Lengthen the time allowed to repay, and pretend there’s no issue. Let’s see how this movie finishes up, hoping for a happy ending here, not sure that’s the genre though! Interestingly, once again there is a pocket of the financial sector that it is important to pay attention to. Unrealised losses in bank balance sheets in the form of investment securities are back on the up, at almost half a trillion dollars according to data from the Federal Deposit Insurance Corporation (or FDIC).  Remember the SVB debacle? That is where it all kicked off...crystallisation is not your friend here. 

EUR

April saw a 0.25% cut and there is more to come. According to the latest market-implied rates, we will be through 1.75% before the year is out, meaning roughly another two cuts to come, with the next being June or July at the latest. Helpfully, polls are indicating the ECB will undershoot the 2% inflation target sooner, but with all that is happening, caution would be prudent, as pressure on prices does feel inevitable. Spending needs to be ramped up in defence, oil and gas are well off their highs, and a strong Euro makes exporting less competitive. Throw in a more fragmented environment for global trade and there are good reasons to save some ammunition (by way of rate cuts) for what may yet come to pass

GBP

It's a similar story for Sterling, where 0.25% has been taken from the headline interest rate with two more cuts expected to come this year, albeit from a higher nominal figure and currently sitting at a still healthy 4.25%. According to Megan Greene (Monetary Policy Committee voting member), speaking on Monday, wage (in particular pesky services) and broader inflation remains too high and thus pausing would be the most prudent course of action. Expectations for the medium term have been creeping up, and in all the uncertainty one thing is for certain. Defence has become the best offence. Whilst the UK has of course put itself in a good position having certainty on trade with the US, it is yet to be seen how the biggest trading partner, the EU may fare. Silver lining? Greater barriers for EU products in the US may lead to cheaper imports into the UK. Helpfully the pound is on the rebound and, as a net importer from both jurisdictions, the UK might well circumvent some of the pain that may materialise.

USD 

Away from the main noise, Scott Bessent (US Secretary of the Treasury) made a rather alarming announcement in a letter to the House of Representatives Friday. The US may run out of money sooner than expected, and as soon as the ill-timed Congressional recess in August. One would expect resolution prior, but one thing is for certain: we are living in unusual times, to put it nicely. The Federal Reserve held rates despite the President testing the independence of the central bank and the setting of monetary policy. Two cuts on the table of 0.25% apiece, with September and December currently earmarked by traders. Some positive news from the IMF though, as the US federal deficit is set to decrease from 7.3% of GDP last year to 6.5% for ’25. Monday saw the latest trade data with the budget surplus rising 24% year-on-year to $258 billion for April. $500 million a day is worth getting up for, albeit a far cry from the $2 billion promised by the President. Sustainable though? Well, following news of that renegotiation with China, the answer is a resounding no. Time will tell how this all pans out…

So what?

It is reassuring to see peace back on the agenda and progress being made in various parts of the globe. Renegotiation of the global terms of trade is also starting to work itself out. The question remains though, as ever, for how long and to what degree this new current state of affairs can hold. More than much of the last several decades, it does feel as though it could all be entirely different in an instant. Where one can get certainty, it’s worth grabbing with both hands before it too is gone. 

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