Please see below, an article from Tatton Investment Management analysing the key factors currently affecting global investment markets. Received this morning – 12/05/2025
Markets calm but trouble still bubbles
Despite India-Pakistan hostilities, markets remained calm – thanks to trade deal progress and a sense that global growth will resume. Friedrich Merz’s failure to get first-round confirmation of his chancellorship was embarrassing but proved a market irrelevance at the end of the week. An India-Pakistan war certainly wouldn’t be irrelevant, but markets don’t think it will come to that and are more interested in the triangle of trade deals: UK-India (signed), UK-US (announced), US-India (in the works).
Trump proudly portrayed the UK-US ‘deal’ as unfair to UK goods exporters, but given it doesn’t include services (which the UK sells much more to the US) Starmer is probably right that this is the best for now. The broader narrative is once again that Trump tariffs are just “the art of the deal”. We see economic headwinds increasing, but can’t deny tariffs have brought leaders to the table.
Meanwhile, the Bank of England cut interest rates – though not as decisively as hoped – and the Federal Reserve held steady, to Trump’s displeasure. UK rate cut expectations dropped, but Britian is still on course for lower rates. The Fed’s situation is tougher: Trump called chairman Powell “Too Late” to cut rates and support US economy, and he’s right. What he’s missing is that tariff uncertainty and a tightening labour market from immigration prevention are causing the delay.
The EU’s retaliatory tariffs and Trump’s film industry tariffs don’t fit the “art of the deal” narrative. Investors consider these idle threats – and they might be. But threats themselves can be enough to stifle business activity, as we’re already seeing.
This suppression of activity is a problem for the precariously balanced US jobs market and its tightening credit conditions. Next week’s senior loan officers survey will be telling, but debt financing for small companies is already burdensome. These problems can be avoided if Trump relents or the Fed cuts – but the president seems unwilling and the central bank unable. If nothing changes, things could get nasty.
Markets are pricing in a positive resolution – but, like in January they may be underestimating the risks.
India’s art of the trade deal
Despite conflict with Pakistan, Indian stocks are significantly up from a month ago. Markets are more focussed on India’s trade deals – one signed with the UK and another in the works with the US. The former has been brewing for three years, but was clearly hurried over the finish line by Donald Trump’s trade wars. This probably helped New Delhi get concessions from the UK (the politically unpopular national insurance exemption) in exchange for a relatively moderate, though still meaningful, lowering of its high import tariffs.
Removing the US’ 26% “reciprocal” tariff on India is the bigger prize, and a deal suits both governments. India gets to keep one of its biggest customers, and Washington gets access to one of the world’s fastest growing economies. Ironically, negotiations are made easier by India’s currently sky-high tariffs. They have plenty of room to fall and Prime Minister Modi wants to open up India’s economy anyway. Over the long-term, this could be the ‘beautiful win’ President Trump claims, but the short-term impact for Americans will be small, as the US trades much less with India than Europe or China.
The fact higher tariffs give you an easier start in negotiations is one of the main reasons Trump likes them in the first place – as the US-UK deal shows. But that ‘hard bargain’ approach perversely punishes regions where trade is significant and relatively open, and might therefore give the US’ most important trading partners a bigger incentive to retaliate, as we see with China and the EU.
It’s also incompatible with Trump’s other tariff aims. Tariffs that go up just to come down don’t provide stable tax revenues or incentives for business investment. India’s experience shows the tactical approach is currently winning out, but those other goals could come back to the fore.
Are US small caps facing a credit crunch?
Small cap US stocks suffered after “Liberation Day” tariffs, but the impact on their debt financing has gone under the radar. The total interest paid by US small caps, as a percentage of earnings, is now at its highest level since the early 2000s – thanks to the lagged effect of sharply higher interest rates since 2022. Smaller companies tend to have higher debt-to-earnings ratios, but total debts aren’t growing especially fast. Rather, more of that debt is having to be refinanced at sharply higher rates than many locked in pre-2022.
Smaller companies started the year thinking that Trump would cut taxes and regulation, while the Federal Reserve would keep cutting interest rates – which made them seem like safer borrowers and thereby lowered credit spreads (the difference between corporate and government bond yields). But Trump’s disruptive policies have instead rocked business and consumer confidence, dampened growth expectations and hence raised credit spreads once more. The real kicker, though, is that uncertainty around tariffs is preventing the Fed from cutting rates – even though there is an argument the US economy needs it.
A credit crunch could still be averted, if the Fed does cut fast or if Trump enacts his pro-growth promises – and both those scenarios become more likely the worse the economy gets. Without that relief, though, small caps will eventually come under stress. JPMorgan predict that default rates for the worst-rated companies will climb to levels seen after the dotcom bubble.
Defaults are a clear sign of recession – which many are now predicting for the US. If the squeeze on small cap credit continues, we will get dangerously close to that point. The Fed will no doubt watch what happens to small cap credit closely. They may be forced to act – regardless of what happens to tariffs.
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Alex Kitteringham
12th May 2025