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Markets last week
Summary
Downside economic surprises pushed US bond yields lower, with the US 10-year yield falling to 4.21% a low for the year and down from 4.80% in mid-January
US equity markets declined for a second week, with weakness in large-cap tech stocks
Broader equity market performance remains resilient, with 287 out of the 503 stocks in the US index gaining
The US broke Ferguson’s Law in 2024, spending more on debt servicing than defence for the first time since 1934, raising long-term fiscal sustainability concerns
Trump’s economic strategy, aligned with the so-called Mar-a-Lago Accord, prioritises tariffs, burden-sharing, and a weaker US dollar to maintain US dominance while shifting costs to allies
European defence spending is set to rise by €500bn over three years, bringing total spending close to 3% of Gross Domestic Product (GDP)
The UK announced its largest defence budget increase since the Cold War, but further expansion is unlikely given fiscal constraints, sticky inflation, and stagnant growth
Trump is set to impose major tariffs on Mexico, Canada, and China, tomorrow pushing the average effective tariff rate above 10%, the highest since World War II
The European Central Bank (ECB) is expected to cut rates to 2.5% on Thursday bringing policy closer to equilibrium, while markets anticipate further easing to support struggling European economies.
Market Review
US economic data: noise or signal?
Economic data has been noisy in recent years which has made it difficult to decipher. This has led to instances of market mispricing and short-term volatility, particularly in treasuries. In recent weeks data has consistently surprised to the downside, which has led to a rapid decline in bond yields. Last week, the US 10-year yield fell to 4.21%, its lowest this year, down from 4.80% in mid-January. It’s difficult to judge whether this data is more noise, or the start of a sustained downward trend. Markets will remain sensitive to economic surprises until further evidence is available as well as reacting to the unusually high degree of policy uncertainty coming from the White House.
The US equity market declined for a second consecutive week, with particular weakness at the top-end of the market (in terms of size and valuation). Technology and technology related stocks underperformed while the broader market performed well, in fact out of the 503 stocks in the index 287 gained while only 216 fell. This broadening out of market leadership has been a defining characteristic year-to-date and is supported by easing financial conditions (falling interest rates).
Europe, defence and the Mar-a-Lago Accord
In 1767, Scottish enlightenment thinker Adam Ferguson warned of the dangers of excessive national debt. Historian Niall Ferguson recently repurposed this idea into 'Ferguson’s Law,' stating that any great power spending more on debt servicing than defence risks structural decline. This law can be applied throughout history, and last year the US broke Ferguson’s law for the first time since 1934. Without a colossal decline in government spending and simultaneous fall in borrowing costs this fiscal predicament will only worsen in years to come.
Trump’s approach of wielding economic policy as a strategic tool, referred to as the ‘Mar-a-Lago Accord’, involves aggressive tariffs. Trump’s focus on burden-sharing, linking trade policy with national security, suggests an effort to shift costs onto allies while weakening the US dollar, pursuing a smaller government and ultimately escaping Ferguson’s Law. All while maintaining US dominance. For Europe, this means boosting defence spending and navigating trade barriers while managing their own fiscal impasses.
Most European countries are in violation of Ferguson’s Law (fiscally prudent Germany is an exception) but with pressure from the US and their potential withdrawal of support for Ukraine the European Union is set to increase defence spending by €500bn over the next three years. This would bring total spending close to 3% of GDP across the bloc. Expectations for higher government debt issuance to fund military expansion are already putting relative upward pressure on bond yields and bond vigilantes remain a threat to overburdened states.
Similarly, following Prime Minister Starmer’s trip to the White House, the UK announced the largest defence budget increase since the Cold War, although the actual rise from 2.3% to 2.5% of GDP over the next two years remains modest. The UK’s constrained fiscal position, combined with sticky inflation and stagnant growth, makes further increases in defence spending unlikely without substantial tax hikes or spending cuts elsewhere.
In the long term, these developments could reshape the geopolitical landscape; which could be Trump’s goal.
The week ahead
Tuesday: Trump tariff deadline
Our thoughts: Trump is set to impose major tariffs on Mexico, Canada, and China, raising the average effective tariff rate from around 4% to over 10%, the highest since World War II. This marks the early stages of his policy agenda, which remains aligned with the so-called Mar-a-Lago Accord.
Thursday: ECB rate decision
Our thoughts: The ECB is expected to cut rates further this week, bringing the policy rate to 2.5%. This would leave rates just shy of the expected long-term equilibrium—the level that is neither accommodative nor restrictive. Markets anticipate further cuts to push policy into accommodative territory, aiming to support struggling core European economies.
Friday: US employment data
Our thoughts: Given the recent downward surprises in economic data a weaker payrolls could add to US growth fears and the downward pressure on bond yields. Economists expect that 160k jobs were created in February with the unemployment rate stable at 4.0%.
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