US growth holds, but political uncertainty looms

Apparently it was Lenin who remarked, “There are decades where nothing happens; and there are weeks where decades happen”. And after the last month or so, we’ve been left wondering if we’re living through one of those “weeks”. 

In the US, President Trump addressed Congress to highlight that his administration was only just getting started. In Europe, German politicians committed to significant increases in both infrastructure and defence spending – requiring constitutional changes. Geopolitical relationships on issues like Nato and Russia-Ukraine have been called into question.

There are times when financial markets look past a lot of political noise. This hasn’t been one of them. Equity investors, particularly in the US, have looked at tariff announcements as a potential risk to growth. Fixed income investors in Europe pushed up bond yields on European government debt, on concerns that the additional spending would require more debt issuance.

At first glance, investor focus on politics and government policy seems well-placed. You’d think that higher tariffs would hurt economic growth, with implications for corporate earnings at least in the short term. And higher government spending in Europe could be positive for growth, but will almost certainly require new debt to finance it. The EU looks like it will try to find ways not to include that debt when calculating its fiscal rules, but if governments are issuing more debt, you still need investors to buy it. And that probably means that bond yields will stay higher for longer.

As for whether we’re entering a new era for markets it’s too soon to tell, but there are a few comments we can make. 

The frequent shifts on tariff policy from the US makes it difficult to assess what the true impact will be. For now, though, it does seem that tariffs will be part of the landscape, but the US, at least for now, will probably view its commitment to Europe differently from previous administrations and European countries will need to spend more on defence going forward as a result. 

On fiscal policy, there’s a lot of noise around cutting the US government budget deficit, which would excite US bond investors. The challenge has always been that the majority of the spending is in categories deemed mandatory – things like social security, Medicare and Medicaid and interest payments. And defence spending makes up half of what is usually called “discretionary”. 

We are already beginning to see pushback at the local level to the changes that have been implemented – things like cutting federal workers. So, it will be interesting to see whether the administration, and its partners in Congress, are willing to really make tough decisions to cut the deficit. History would suggest we won’t see much of an impact. 

What does this all mean for markets? There are a few points we’d make. First, the macro backdrop remains fairly healthy. Growth is still positive, albeit still fairly pedestrian in Europe, and inflation has fallen close to target. That said, policy uncertainty is quite high – and we think that’s impacting consumer sentiment in the US. Even if tariffs ultimately don’t rise too much, we could see slower spending growth from households and businesses. We think that merits a slightly more cautious stance in portfolios and we’ve made some changes to portfolios to reflect that. We will provide a more detailed analysis of these adjustments in the coming days.

On the European side, policy shifts are likely to be supportive for spending and growth, at least in certain categories. How to pay for that spending is an important question. Germany’s low starting debt levels should allow it to increase spending quite comfortably – on defence and infrastructure, but other European sovereigns may not find it quite so easy. All of that could be supportive for European earnings but leave bond yields a bit higher. 

As always, we’d be wary of trying to time the market. We think it’s important to stay invested for the long term, even during periods of volatility, and to maintain a well-diversified portfolio. 

Want to know more about our take on US policy shifts and market trends? Watch our latest market update for key insights.