Paranoid

Deal or no deal? 

The US trade deals announced ahead of the 1 August deadline look similar in design – a 15% across-the-board tariff and an acknowledgement from the exporting nation to increase its investment in the US. The naïve idea being that tariffs will force a redirection of US spending away from foreign goods towards US-produced goods, and that investment funds will help build capacity in the US to manufacture those products. If successful, the US trade deficit should come down and there would be inflows on the balance of payments capital account in the form of direct and portfolio investments. Under such an outcome, one would expect the dollar to be strong, not only due to a lower trade deficit and increase investment inflows, but from a sentiment point of view as well – America is winning and is exceptional.

Never simple 

Life, and economics, is never that straightforward. There is no perfect substitution from imports to domestic products. Instead, import prices will rise and that will mean lower profit margins for companies that import intermediate goods or final goods to distribute into the US market. And it is likely to mean higher prices for US consumers and, therefore, higher inflation. Foreign suppliers might see some decline in demand and may reduce their selling prices, and subsequently endure a hit on their profits, but it is hard to model exactly where the costs will fall. The June inflation report showed some increase in imported goods prices. Some second quarter (Q2) earnings reports have been explicit about the tariff impact on profits and forward guidance (Ford, General Motors, Mercedes, Walmart, Diageo and UPS to name but a few).

Follow the money (is there any?) 

The supposed investment funds to be invested in the US, cited as part of trade deals with the European Union (EU) and Japan, are short on detail. Do they really indicate an increase on existing direct and portfolio investment inflows to the US? According to data from the Bureau of Economic Analysis, foreign direct investment flows from the EU into the US in 2024 amounted to $176bn while there was $39bn from Japan. Trade agreements’ headline numbers are bigger, but there is no specific time horizon. There are also questions about who will fund these investments and into what sectors they will be directed – energy and defence are the most cited. But for now, they look aspirational rather than concrete. One must also ask whether all the dollars that flow into the US in the form of direct investment will be spent on US domestic output. Surely, there will be some leakage into imports which undoes some of the desired tariff effect. At this stage, sketchy high-level talks about huge investment flows into the US do not pass the sniff test as an investment strategy.

And still there is downside 

Market euphoria is missing the impact of an effective 18% tariff rate (current estimate by the Yale Budget Lab) on the US economy (GDP growth 0.5% lower over 2025-2026). Inflation is going up which means the Federal Reserve (Fed) will keep interest rates higher than would otherwise have been the case. Core personal consumption inflation rose to 2.8% in June, widening the gap between current inflation and the Fed’s target. It kept rates unchanged on 30 July and Fed Chair Jerome Powell again pointed to inflation uncertainty because of trade policies, striking a moderately hawkish tone. Market pricing suggests just a 42% chance of a September rate cut, down from over 90% as recently as the end of June. A year ago, markets were pricing that rates would be down to between 3.0% and 3.2% by June 2026; today the pricing is above 3.5%. That could even be questioned as Powell, playfully, even suggested the Fed could have raised rates in response to higher inflation.

Expansion is the read 

Headline Q2 GDP numbers supported the bullish sentiment, showing an increase in the seasonally adjusted annualised rate of growth from -0.5% in Q1 to 3.0%. Both quarters saw a meaningful impact from trade uncertainty – imports and inventories rose in Q1; both fell in Q2. Leaving aside trade, domestic demand is not that strong. Yes, consumer spending did bounce back a little to an annualised growth rate of 1.4% from 0.4% in Q1, but private fixed investment was weak, admittedly after a strong Q1. The combined annualised growth rate for consumer, private investment and government spending was -2.0%, the weakest since the pandemic – although the key weakness in investment spending was in “structures” which is quite lumpy from quarter to quarter. There is not enough in the GDP data to get the Fed to cut rates especially with unemployment still below the level assumed consistent with stable inflation, and inflation itself being above the Fed’s target. Bond investors might need to look beyond September for a US rate cut to boost total returns from holding Treasuries.

And IT is the lead 

The one clear bullish takeaway from the GDP report is the strength of capital spending on technology. Spending on IT processing equipment is up 19% in the first half of the year compared to the same period in 2024, while software spending is up 8%. This is very consistent with what we see at the company level – Meta’s hiring of artificial intelligence (AI) engineers, Nvidia’s huge semiconductor sales, and so on. Tariffs might be a drag on growth and an inconvenience for the Fed, but technology spending is a hugely positive driving force for the US economy.

Stick with risk but be careful 

So we are back to the same old story for markets. Growth is positive, rates are stable, corporate earnings are growing and there are few evident credit problems. The icing on the cake is that AI is driving earnings in the technology sector. Of those companies which have reported so far, earnings growth for the S&P 500’s technology sector is coming in at more than 20%. So, portfolios exposed to US technology stocks, high yield, and some inflation protection will be doing well for US dollar-based investors.

For European markets the outlook is less clear. There will be an impact from US tariffs on European profitability. That is a headwind to growth and may have been a factor in the drop in the quarterly growth rate of Eurozone GDP to 0.11% in Q2, from 0.57% in Q4. However, lower rates in Europe and potential stimulus from Germany’s fiscal policy should see growth improve a little in coming quarters. Equity analysts continue to expect earnings growth for the Euro Stoxx universe of companies to run at an annual rate of 7.6% with the 2026 earnings-per-share consensus estimate at €40.20 compared to €36.10 for this year. According to Bloomberg, European earnings growth is running at 15% for Q2 so far. The argument for European equities remains strong when US valuation measures are flashing “risk”. Year-to-date, European indices and selected emerging market equity indices have provided better risk-adjusted total returns than the US, despite the strong performance of American equities in recent months.

Credit premium still worth it

In bond markets the outperformance of credit versus duration persists and is likely to for some time. Credit spreads are narrow and there are some concerns over the level of leveraged long credit exposure that exists in the market (through short credit default swap trades). But a credit blow-off requires a trigger and credit markets have been super-resilient to far. They did react negatively to the Liberation Day shock but have since fully recovered. It would take a rapid deterioration in US growth data, or the Fed raising rates, or a worsening geopolitical situation (what is Donald Trump going to do to Russia?) to get enough of a risk-off turn in sentiment to push credit spreads a lot wider. When it happens, it could be violent – given positioning – but for now with solid macro- and micro-fundamentals and healthy income demand, credit remains a favoured asset class.

Metal and rock

I was never a Black Sabbath fan, but I was still saddened by the passing of Ozzy Osbourne. The outpouring of love for the Prince of Darkness in his hometown of Birmingham reminded me of similar scenes in Brixton when David Bowie died in 2016. At the same time, Oasis are bringing the Britpop days of the 1990s back – with enormous success and rave reviews. The UK might be an ex-growth fiscal basket case, but no one holds a candle to us in terms of popular music icons. Long live rock and roll and enjoy the summer holidays.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 31 July 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.