Please see below, an article from Tatton Investment Management analysing the key factors currently affecting global investment markets. Received this morning – 16/06/2025:
Markets calm but not comfortable
Markets’ reaction to the war that broke out Friday, after Israel’s strike on Iran, has been mild. Global stocks have fallen slightly, while gold prices and the dollar have edged up. Oil prices climbed the most – and their future inflationary impact is probably why bonds fell as yields rebounded. Investors have become a little desensitised to geopolitical mayhem. You might call that resilience; you might call it resignation. In any case, we have said for a while that investors (particularly in the US) might be overly optimistic.
On the UK spending review, it was notable that Chancellor Reeves stuck to her fiscal rules, even though she probably would have got away with tweaking them. Bond yields fell, sterling strengthened and the FTSE 100 gained in response – a reaction any party’s chancellor would welcome. Despite weak growth, the UK has an opportunity to take advantage of US capital outflows – but our markets have a trading liquidity problem, which we’ll write more on soon.
US stocks held up decently, despite weaker earnings and lower than expected inflation. Trump will take that as tariff vindication, but really it suggests economic weakness. It means companies will struggle with higher input costs. Stocks can still grow in that sluggish environment (they did before the pandemic) but we shouldn’t expect the stellar returns of the last few years.
The other concern is that slower profit growth means higher equity valuations – which already look expensive compared to higher bond yields. There are reasons to doubt the bond valuation effect: there are more bonds than there used to be (see below) and they’re not easily substitutable for stocks. But eventually, higher bond yields make equities more vulnerable, either because companies need to raise capital (see Eutelsat) or sharply higher yields make everyone afraid. High yields are a big problem for equities if investors expect a recession. That’s a risk, but hasn’t happened yet.
Governments borrow more but could pay less
Markets are worried about government debt sustainability. We call government bonds ‘risk free’ because they can theoretically print money to pay back the loan (assuming they borrow in their own currency) but they are still risky by the usual understanding. We measure these risks in two ways: the term premium (long versus short-term yields) and swap spread (government yields minus central bank guaranteed interbank lending). Both measures have increased across most major economies, for a simple reason: government debt has grown much faster than private debt in the last decade.
That means governments are demanding more capital than companies. Or inversely, the private sector is deleveraging, relatively speaking, with corporates eating less of the capital pie. Corporates have also been issuing less equity for an unusually long time – despite the fact investors are happy to buy that equity. There are a couple of ways of looking at this. A Keynesian would say governments are making up for the shortfall in private sector credit demand; a supply-side economist would say governments are crowding out private investment by making borrowing rates too high to be profitable. The truth is probably somewhere in between.
Even a slight crowding out of investment could constrain long-term growth – depending on your beliefs about the efficiency of public versus private spending. Japan is arguably a cautionary tale here: its debt-to-GDP ratio is higher than any other large economy, plausibly one of the factors behind its decades of stagnation. China might be on that same path, with massive government debt expansion in the last decade and a weak private sector to show for it.
The interesting thing about these examples is that they show how higher government debt can actually mean lower yields – by lowering growth. That’s the opposite of what people usually worry about when they worry about growing government debt.
China exporting disinflation to Europe
Many expect US tariffs on China will mean Chinese exports being rerouted to Europe – and hence lower European goods inflation. This isn’t happening yet, but Americans’ rush to buy ahead of tariffs is distorting the data. Chinese exporters have room to grow their European consumer share, but JPMorgan analysts point out that changing market shares don’t affect official inflation statistics in the short-term. Europeans buying more Huawei and less Apple only lowers inflation if Huawei prices fall. JPM see the bigger short-term impact coming from the euro’s 7% appreciation against the renminbi. But even this currency impact is relatively small.
Changing market shares eventually impact inflation by changing the weightings of different goods. That could take a while, though, and it would require a consistent shift towards buying Chinese. This could be difficult, because European politicians are already worried about Chinese ‘dumping’ of electric cars. There’s nothing sinister about China selling cheap goods after overproducing, but ‘dumping’ is a politically persuasive story. German carmakers and British steel producers have already lobbied for import controls on this basis, and politicians will get more sympathetic the more China exports.
That’s good news for Washington, which wants European anti-China tariffs to be included in any US-EU deal (and successfully put them in the UK-US deal). European leaders have been reluctant to go along with the US trade war on China in the past, but the difference now is that domestic European pressures could push them in the same direction.
We think it’s likely, therefore, that the EU will put up some trade barriers with China – albeit not the 145% tariffs Trump likes to post on social media. Potential EU tariffs will probably be more commensurate with the scale of Chinese ‘dumping’, which is likely why bond markets aren’t expecting significant European disinflation.
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Marcus Blenkinsop
16th June 2025