Chris Iggo
Investors await clarity on US policy
US policy uncertainty and its outlook implications remain front and centre. In the case of adverse outcomes, US assets remain most at risk, given the threats to growth, inflation and interest rates. Markets reflect this with US equities and long-duration bonds underperforming in 2025. Over the summer there could be more policy clarity. Investors should be prepared for a meaningful level of import tariffs and a budget that underscores medium-term fiscal sustainability risks. In fixed income, short-duration strategies have endured less drawdown and delivered positive year-to-date returns. Resilient fundamentals should help sustain credit assets’ performance with limited interest rate risk. Being at the centre of the trade war; US and greater China equity indices have performed poorly. Few countries are exempt from trade risks but equity markets with the lowest valuation multiples should fare better as uncertainty persists. The UK, Canada, Australia and Eurozone have the lowest drawdown risks given current valuations.
Central bank policy: Same shock, different answer
The pandemic reminded us that monetary policy is not well equipped to face economic asymmetries. For decades, the standard model has somewhat dodged the supply side issues in the economy, prioritising demand stabilisation instead. While the European Central Bank’s (ECB) Strategy Review will supposedly address this key issue, responses may vary. The Federal Reserve (Fed) is confronted with a US trade policy asymmetric shock, although the consensus was already expecting higher inflation and slower US GDP growth even before Liberation Day. In contrast, the ECB is facing a symmetric shock, i.e. slightly lower growth and inflation, which is easily manageable with standard tools. Therefore, the Fed’s reaction should differ from the ECB’s, at least in theory: Fed policymakers should carefully weigh costs and benefits of targeting price stability rather than full employment and vice versa. Against this background, markets believe that both the Fed and the ECB are likely to continue cutting rates during 2025.
Foreign flows into US credit: A pause rather than reverse
Concerns over foreign investment in US dollar credit have recently emerged, driven by the deflation of US exceptionalism narrative and the substantial appreciation of Taiwan’s dollar. A flood in US dollar supply, alongside limited demand drove the move, as investors returned to home equity markets and exporters repatriated deposits. Data shows that historically there has been no structural relationship between the US dollar and foreign investors holdings of US corporate bonds. Instead, other factors play an important role in driving foreign demand, such as global savings supply and limited competing domestic investment alternatives. For Asian investors, challenging foreign exchange (FX) hedging costs are not new, however US dollar credit purchases from life insurers could ease if they’re faced with headwinds to sell US dollar-denominated policies. Increasingly so if local investors think the dollar is overvalued, and more losses could be ahead. Equally, an FX hit to earnings could constrain insurers’ ability to continue to deploy capital into US dollar credit.
By Chris Iggo, Chief Investment Officer, Core Investments
