Markets React as Trump Pauses Tariffs and Central Banks Adjust Policies

What do we need to know for the week ended on 10th Feb 2025

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💡 Highlight 💡

• Trump paused tariffs on Mexico: Global equity markets reacted positively, with US stocks rebounding as the tariff pause eased immediate trade concerns, particularly benefiting trade-sensitive sectors.

• BoE reduced interest rates by 25 basis points: The Bank of England’s rate cut to 4.5% aimed to support the slowing UK economy, though markets remain cautious amid persistent inflation pressures.

• The dollar strengthened: The dollar index rose to 108.2 as Trump’s tariff pause reduced trade uncertainty, while the pound and euro weakened due to contrasting monetary policies and economic outlooks

After a volatile start to the week, with investors struggling to determine the equity market's direction, President Donald Trump’s unpredictable approach to tariffs has once again taken center stage, creating uncertainty in financial markets. This ongoing tariff saga is testing investors' ability to manage risks, as many find that strategies employed during Trump’s first term are providing little guidance in this increasingly complex environment.

One emerging trend among investors is a shift in focus toward less saturated areas of the stock market, such as mid-cap stocks. These segments often perform well during periods of Federal Reserve rate cuts, as they are less impacted by overvaluation concerns compared to large-cap stocks like the technology giants, which have already experienced significant price gains. The high valuations in megacap tech stocks leave them vulnerable to sudden disruptions, even as their earnings and cash flows remain strong. This has led some investors to explore alternative sectors that may offer a better balance between risk and reward.

Macro risks, like Trump’s tariffs, often create widespread movements in the stock market, as seen in 2018 when trade tensions with China and uncertainties around the Federal Reserve’s policies drove equities lower in unison. At that time, the S&P 500 posted its worst annual decline since the 2008 financial crisis, and stock correlations spiked, indicating that macroeconomic forces were overshadowing company-specific fundamentals.

In contrast, the current market environment is more fragmented. An index of three-month implied correlations from Cboe, a measure of how much stocks move together, is near record lows. This suggests that investors are paying more attention to company-specific fundamentals rather than broader macroeconomic trends. While this indicates a healthy market, it also encourages greater risk-taking as investors move away from the safety of broad market strategies and focus on individual stock selection.

The most significant challenge for investors in this environment is interpreting the Trump administration’s unpredictable trade policies. Tariff announcements and reversals continue to whipsaw markets, making it difficult to anticipate their long-term impact on corporate earnings and global supply chains. Adding to this complexity is the Federal Reserve’s cautious approach, as stronger-than-expected labor data and inflation expectations delay the timeline for further rate cuts.

1. United States: Inflation data and Federal Reserve commentary will dominate focus. Trade tensions with key trading partners, including China and the European Union, remain a central risk, particularly as reciprocal tariffs threaten global trade flows.

2. United Kingdom: Investors are weighing the implications of the Bank of England’s rate cut alongside corporate earnings. Slowing economic growth and persistent inflation remain top concerns.

3. Eurozone: With inflation rising to 2.5% in January, the European Central Bank’s cautious rate-cutting approach will be closely monitored. Trade tensions with the US and signs of economic weakness in Germany and France add further pressure.

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US Market Insights

The US economy began 2025 with mixed signals. Inflation showed scant signs of easing, with core consumer prices expected to rise again in January, underscoring persistent price pressures. Meanwhile, job growth slowed but remained robust enough to support a resilient labor market. The unemployment rate dipped to 4.0%, and wage growth outpaced expectations, reinforcing the Federal Reserve’s decision to hold off on further rate cuts for now.

Debt Derivatives Show Resilience Amid Tariff Risks

President-elect Trump’s looming tariffs on imports from China, Mexico, and Canada have stirred concerns about trade disruptions. Yet, Credit Default Swaps (CDS) remain surprisingly stable. These tight spreads reflect market confidence in corporate fundamentals, indicating low perceived default risk. Normally, such tariffs would widen spreads due to heightened economic uncertainty, but the market seems to believe that strong earnings and a robust labor market will offset potential damage. However, this stability could signal complacency, as spreads may widen abruptly if risks materialize.

Outlook and Risks

The labor market's strength and stable CDS spreads suggest resilience, but risks remain. Inflation expectations are rising, as shown by the University of Michigan consumer sentiment survey, which reported the highest year-ahead inflation outlook since 2023. If tariffs impact corporate margins or trigger retaliatory measures, economic fundamentals could weaken, pressuring both equity and credit markets.

Investment Suggestions

Equity investors should adopt a cautious stance, focusing on defensive sectors such as healthcare and utilities, which may better weather trade disruptions. For those with higher risk tolerance, mid-cap stocks offer potential upside as they historically perform well in a stable rate environment. Fixed-income investors might explore opportunities in high-quality corporate bonds, as tight CDS spreads indicate strong credit quality. Longer-duration Treasuries could also benefit if inflation expectations or economic risks prompt the Fed to adjust its rate policy later in the year. Balancing defensive positioning with select opportunities will be key in navigating the uncertain environment ahead.

Equity Markets

Opportunities:

• Defensive Sectors: Sectors such as healthcare, consumer staples, and utilities offer stability amid macroeconomic uncertainties. These sectors tend to perform well during periods of slower economic growth due to consistent demand.

• Value Stocks: Companies with strong cash flows and stable earnings, particularly in financials and industrials, present compelling opportunities for long-term investors seeking resilient performance.

• Growth Opportunities: For risk-tolerant investors, technology stocks in areas like semiconductors remain attractive for their innovation-driven growth potential, though careful stock selection is key to navigating heightened volatility.

Risks:

• Megacap Tech Vulnerability: While megacap tech stocks have rebounded strongly, their high valuations leave them exposed to macroeconomic shocks or shifts in Federal Reserve policy.

• Geopolitical Headwinds: Sectors like industrials and manufacturing remain sensitive to ongoing tariff uncertainties, particularly with President Trump’s reciprocal tariff threats.

Fixed-Income Markets

Opportunities:

• Treasuries: The elevated yields on US Treasuries, such as the 10-year yield hovering around 4.5%, present an attractive opportunity for income-seeking investors and those seeking safe-haven assets. Short-term bonds offer higher yields with lower price volatility.

• Corporate Bonds: High-quality corporate bonds from firms with strong balance sheets provide appealing returns for investors seeking moderate risk exposure, particularly as inflation remains persistent.

Risks:

• Long-Dated Bonds: Longer-term Treasuries and corporate bonds remain vulnerable to rising yields, which could erode the value of existing holdings.

• Tight Credit Conditions: While credit default swaps indicate market confidence in corporate fundamentals, complacency around economic risks may lead to sudden volatility if conditions deteriorate.

Commodities

Opportunities:

• Gold: As a hedge against inflation and geopolitical uncertainty, gold has surged past $2,680 per ounce, making it a safe-haven asset of choice for investors.

• Energy Stocks: Despite WTI crude oil's recent declines, energy companies with diversified operations and strong cash flows offer long-term growth potential amid fluctuating oil prices.

Risks:

• Volatility in Crude Oil: Prices remain vulnerable to global trade tensions, particularly President Trump’s tariff disputes with key trading partners, and geopolitical disruptions in oil-exporting nations.

Real Estate

Opportunities:

• REITs: Defensive REITs in sectors like healthcare and logistics are less sensitive to rising interest rates and offer consistent income potential.

• Residential Real Estate: Housing market resilience, driven by supply shortages and consistent demand, provides opportunities in areas with strong rental potential.

Risks:

• Commercial Real Estate: Rising borrowing costs and reduced economic activity weigh heavily on commercial properties, particularly in office spaces.

Currency Markets

Outlook:

The dollar index remains strong, bolstered by rising inflation expectations and the Federal Reserve's cautious approach to rate cuts. President Trump’s trade policies and tariff announcements have added to the dollar's upward momentum, as global uncertainties encourage capital inflows into the US.

Opportunities:

Investors with international portfolios may hedge against further dollar strength by diversifying into non-USD-denominated assets or sectors poised to benefit from a robust dollar.

Risks:

Further strength in the dollar could pressure US exporters and multinational companies, potentially dampening equity market returns in those segments.

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UK Market Insights

The UK economy is navigating a challenging environment as it grapples with stubborn inflation, muted growth, and a disconnect between the Bank of England's (BoE) rate cuts and borrowing costs for households. Despite three consecutive rate reductions since August, the BoE’s easing cycle has struggled to translate into lower borrowing costs for mortgages, personal loans, and credit cards, leaving household finances under pressure.

Growth Outlook Clouded by Mixed Data

The BoE’s recent 25bps rate cut to 4.5% comes amid expectations of sluggish economic performance. Fourth-quarter GDP projections are split, with forecasts ranging from a slight contraction to modest growth. The Halifax House Price Index indicates some resilience in the housing market, with prices rising 0.7% month-on-month in January, though the annual growth rate of 3.0% is the slowest since July 2024.

Conversely, the UK Construction PMI fell sharply into contraction territory at 48.1 in January, signaling a slowdown in housebuilding and broader construction activity due to delayed projects and economic uncertainty. Meanwhile, the Composite PMI edged up to 50.6, driven solely by service-sector growth, as manufacturing and construction continued to falter.

Borrowing Costs Remain Elevated

Despite the BoE’s efforts, borrowing costs remain high:

• Mortgage rates for 75% loan-to-value mortgages rose to 4.8% in January, reflecting lender caution and persistent housing market risks.

• Personal loan rates have stayed elevated at 6.7%, likely due to tightened lending standards and perceived economic risks.

• Credit card rates remain unchanged at an exceptionally high 24.6%, showing little responsiveness to monetary easing.

This disconnect between rate cuts and actual borrowing costs underscores the strain on household finances, limiting the effectiveness of monetary policy in stimulating consumer spending.

Global Influences and Fiscal Challenges

UK markets remain heavily influenced by US developments, with 10-year gilt yields closely tracking US Treasury yields. President Donald Trump’s loose fiscal policies and restrictive Federal Reserve stance have kept US long-term yields high, which is feeding into UK bond markets. S&P Global Ratings estimates that 80% of US Treasury yield movements are reflected in UK gilts.

The rise in UK swap rates and gilt yields complicates Chancellor Rachel Reeves’ plans to boost economic growth and meet debt-reduction targets. The divergence between short-term rate cuts and long-term yield increases highlights the challenge of loosening financial conditions in a globally interconnected market.

Outlook and Risks

Looking ahead, the UK economy faces continued risks from global trade tensions, inflation pressures, and a fragmented domestic recovery. With the BoE’s rate cuts failing to significantly reduce borrowing costs, policymakers may need to explore additional fiscal measures or targeted interventions to support households and businesses. However, with persistent risks from elevated inflation and global financial markets, the road to recovery remains uncertain.

For now, the BoE faces the difficult task of balancing its inflation-fighting mandate with the need to revive a moribund economy. As borrowing costs remain stubbornly high, British households are yet to feel the benefits of monetary easing, leaving confidence fragile and growth prospects subdued.

Equity Markets

• Opportunities: UK equities, particularly in defensive sectors like utilities, consumer staples, and healthcare, could provide relative stability as economic uncertainty persists. These sectors tend to perform well during slower growth periods due to consistent demand.

• Risks: Domestically focused stocks in the FTSE 250 may face headwinds from higher borrowing costs for households and businesses, which could dampen demand. The construction sector, as highlighted by the sharp contraction in the PMI, appears particularly vulnerable.

Fixed-Income Markets

• Opportunities: Rising gilt yields present a compelling opportunity for fixed-income investors, as higher yields provide better returns for long-term bonds. With the 10-year gilt yield at 4.5%—the highest since 2008—investors seeking income or safe-haven assets may find value in high-quality UK government bonds.

  • Corporate bonds from well-capitalized firms with solid fundamentals are another area to explore, offering higher yields compared to gilts but with manageable risks.

• Risks: Longer-term gilts and corporate bonds remain sensitive to global macro risks, especially movements in US Treasury yields. Persistent inflation or stronger-than-expected global economic data could drive yields even higher, potentially eroding the value of existing bonds.

Real Estate

• Opportunities: The modest rebound in house prices, alongside strong mortgage demand, reflects some resilience in the UK housing market. Investors focusing on residential real estate may find opportunities in areas with supply shortages or strong rental demand.

• Risks: Elevated borrowing costs and ongoing challenges in the commercial real estate sector pose risks. The contraction in construction activity and delayed project decisions highlight underlying weaknesses in this market.

Currency Markets

• The pound’s decline to $1.243 signals continued vulnerability due to fiscal uncertainties and the BoE’s dovish stance compared to the Federal Reserve. Investors with exposure to international markets may benefit from this weaker currency by investing in export-driven companies or hedging against further pound depreciation.

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EU Market Insights

The Eurozone and Germany are sending mixed signals as 2025 begins, reflecting challenges in industrial activity, construction, and global trade dynamics. While some areas show signs of resilience, others continue to highlight economic vulnerabilities, particularly amid global macroeconomic uncertainties.

Eurozone Construction: Slowing Decline but Persistent Weakness

The HCOB Eurozone Construction PMI rose to 45.4 in January from 42.9 in December, indicating a softer downturn but still below the expansion threshold of 50. Italy was a bright spot, showing slight growth, while Germany and France recorded slower declines. Housing activity remains the weakest segment, followed by commercial and civil engineering projects. Rising input costs and worsening supply chain delays pushed costs to a 12-month high, while new orders continued to drop, particularly in Germany. Pessimism about future activity continues to weigh heavily on the sector, limiting any immediate recovery.

Germany’s Trade and Industry: A Mixed Bag

Germany’s trade surplus widened significantly to EUR 20.7 billion in December, its largest since August 2024, driven by a surprising increase in exports. Sales to EU countries were particularly strong, with a 6.7% rise in exports to the Euro area. However, exports to major third countries such as the US and the UK fell, reflecting global trade uncertainties tied to US tariff policies and weak external demand.

On the industrial side, production fell sharply by 2.4% month-over-month in December, reversing a 1.3% gain in November. The decline was led by the automotive and machinery sectors, while pharmaceuticals showed strong growth. This contraction in capital and intermediate goods production adds to concerns about broader industrial health, although modest growth in consumer goods production offers a small silver lining.

Regional Inflation and Labor Market Dynamics

Adding to the mixed economic picture, Eurozone inflation rose to 2.5% in January, driven by higher energy costs, while core inflation remained unchanged at 2.7% for the fifth consecutive month. In Germany, industrial stagnation has raised questions about the region’s ability to sustain growth, particularly given sluggish consumer sentiment. With consumer confidence declining across the Eurozone, markets remain wary of additional downside risks stemming from weak demand and potential US tariffs under the Trump administration.

Global Factors and Policy Risks

The region’s economic challenges are compounded by global uncertainties. The Trump administration’s renewed focus on tariffs, including delays in levies on Mexico and Canada, has created volatility in global markets. Trade tensions with the US, coupled with China's retaliatory tariffs and probes into US firms, remain significant risks for the Eurozone’s export-driven industries. Additionally, the Federal Reserve’s cautious stance on rate cuts has pressured global yields, including German Bunds, complicating the ECB’s ability to stimulate growth further.

Investment Outlook and Strategies in the Eurozone

Equity Markets

• Opportunities: Export-driven companies benefiting from strong EU demand, such as those in consumer goods and pharmaceuticals, offer more stability amid weak global trade. Defensive sectors like utilities and healthcare may also provide relative safety as broader industrial activity slows.

• Risks: Construction and industrial sectors remain vulnerable, with housing activity and capital goods particularly weak. Companies heavily reliant on non-EU markets, such as the US and UK, may face headwinds from trade disruptions and slowing demand.

Fixed-Income Markets

• Opportunities: Rising yields on German Bunds and Eurozone bonds provide attractive opportunities for fixed-income investors seeking stability. High-quality corporate bonds with strong fundamentals are another area to consider, especially in sectors less exposed to global trade tensions.

• Risks: Persistent inflation and global trade uncertainties could push yields higher, eroding the value of existing bonds. Investors should focus on shorter-duration bonds to mitigate interest rate risks.

Real Estate

• Opportunities: While the construction PMI remains in contraction, residential real estate in Italy shows signs of growth. Investors could explore opportunities in regions with supply shortages and steady rental demand.

• Risks: Rising input costs and supply chain delays weigh heavily on construction, while delayed client decision-making on major projects underscores ongoing uncertainty in commercial real estate.

Currency Markets

• Outlook: The euro’s recent weakness, falling below $1.04, reflects concerns over slowing industrial activity and global trade risks. This presents potential opportunities for investors exposed to non-EU currencies, particularly the US dollar, as rate differentials widen. However, further tariff escalations could create additional downward pressure on the euro.

  Source: CNBC, Bloomberg, FTnews, TradingEconomics and Reuters.

  
  

Market Indicator - 8 Feb 25

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