The Two Weeks That Will Be (2nd March 2025)
1. Everyone
“End our huge deficits, reduce our taxes, and let America’s economy grow unencumbered by the cost of defending those who can easily afford to pay us for the defense of their freedom“. No surprise these are the words of Donald J Trump. But perhaps a surprise to know they appeared on 2nd September 1987 when the then-real estate magnate paid almost $100,000 to run them as part of a full-page advert in major newspapers. “Let’s not let our great country be laughed at anymore“, it concludes:
In 1990 he gave an interview to Playboy Magazine where he was asked to play a game, what’s the first thing a President Trump would do upon entering the Oval Office? He replied “A toughness of attitude would prevail. I’d throw a tax on every Mercedes-Benz rolling into this country and on all Japanese products, and we’d have wonderful allies again”. He went on to talk about how Gorbachev was weak and that a President Trump “would believe very strongly in extreme military strength… He wouldn’t trust the Russians; he wouldn’t trust our allies; he’d have a huge military arsenal, perfect it, understand it“.
Forty years haven’t changed the man’s opinions. Trump failed to mention collective security when speaking at the NATO Summit in Brussels in May 2017. He imposed tariffs in 2018, lifted some in 2019, left others in place (which Biden extended). He implemented significant – but temporary – tax cuts in 2018 which he now wants to make permanent.
Scott Bessent got the memo. The Treasury Secretary for DJT 2.0 was straight off the blocks with his 3-3-3 plan for a 3% budget deficit, 3% GDP growth and increasing domestic oil production by 3m barrels per day.
But the market doesn’t like the memo. Boosting oil production can’t happen overnight and whilst growth would be welcome, the scale of the Covid-era fiscal response has created a Pavlovian reflex that believes higher growth cannot be achieved by reducing the deficit. Didn’t we have to increase deficits to ensure growth returned in the face of the global shutdown? And how are we going to pay for all the debt if the government steps back? How is this even possible when the higher inflation and concomitant higher interest rates mean the government must divert even more money to paying the interest bill on the debt? And won’t tariffs simply drive inflation higher, which is exactly what has been upsetting everyone so much the past few years? Ditto immigration reducing the labour supply?
This is a pickle.
We are in such a muddle because although Trump has stayed the same for forty years, the markets have not. Ever since the introduction of QE and the decade long disinflation following the financial crisis, these questions didn’t really matter. The usual laws of political economics change when the central bank buys up bonds and inflation is relatively stable. Trump’s second term is taking place under entirely different dynamics, with interest rates rising alongside higher inflation and a reduction in a much bigger Fed balance sheet:
And these dynamics themselves have only been around for a few years. The Fed lurched from mega easing to mega tightening. Just as they thought job done on inflation, along comes a President with a reflationary mandate. This has contributed to unease amongst investors. They had just about swallowed the end of a 60/40 balanced portfolio because they were forced to accept that bonds were no longer a boring investment thanks to all that inflation. Now they are questioning the performance of the equity side of their allocation in a world of higher tariffs and shifting geopolitics. There are just too many moving parts having spent the last few years simply following a FOMO strategy full of Nvidia.
Data is not much use so early on in the new Trump term, so although there will be gnashing of teeth at any disappointment in the jobs report on Friday and on inflation on Wednesday 12 March, they are unhelpful staging posts whilst Trump performs electroshock therapy on the economy. The Fed will happily take a passive back seat and leave the Orange Man to dominate the headlines, so don’t expect Powell to offer much more than a sense of wait-and-see when he speaks on Friday.
At some point this will all get to being too much and weary whipsawed punters will prefer to liquidate some positions and wait until the dust has settled. They’ll blame it on Trump. “Too unpredictable” they will scream, despite the fact he’s saying and doing everything he said he would do.
2. Geopolitics
It’s not Trump who is being unpredictable – rather, it is everyone else. Tariff beatings will continue until morale improves. Those who play along with Trump will eventually see tariffs lifted. Those who choose not to be in his gang will be punished. This isn’t isolationism, it’s simply that he has a very clear view of the US as a shining liberal democracy on the hill. He doesn’t think the EU shares that vision, hence his recent comment that “the European Union was formed in order to screw the United States. That’s the purpose of it, and they’ve done a good job of it”.
This is why JD Vance began his Munich Security Conference speech by appealing to “our shared values“. It’s not simply about money for defence, he argued, as “how will you even begin to think through the kinds of budgeting questions if we don’t know what it is that we’re defending in the first place?…. What is the positive vision that animates this shared security compact that we all believe is so important?” This is why, he argues, the EU must ensure there is free speech.
You might feel emotionally quite upset by the actions and words of DJT and JD. That’s deliberate. They think they’re in a fight for the soul of democracy. Their opponents consider they are in just as righteous a fight. As a rational investor, you need only accept the reality of the new regime: everyone is going to be spending more on defence at a time when huge debt and stretched public services had already hamstrung dysfunctional governments and disappointed a fractured electorate. In short, more volatility ahead.
3. The ECB
At least the central banks can still push the interest rate lever. The ECB can be nothing but dovish. Eurozone nations will be ramping up debt whilst growth remains anaemic. On Thursday the ECB will therefore cut 25bp as expected and Lagarde will signal more to come.
The new German government hasn’t even been sworn in but must respond to the effective end of NATO. Hence Merz is thought to be considering an unprecedented move to top up the special defence fund by up to EUR 200bn before the incoming legislature takes its seats. Even the outgoing Finance Minister, the SPD’s Jorg Kukies, said it would send a “questionable political signal if constitutional amendments were now made with an old majority”.
But if he waits any longer he will be tied up in the unhelpful electoral result of both the far right and far left being able to prevent debt brake reform thanks to a one-third blocking majority. Whatever happens he will still have to square the circle of campaigning on a promise of fiscal prudence whilst dealing with the realpolitik of demands for higher defence spending from a core member of the EU. It has already created something of an open goal for the AfD’s leader Alice Weidel to complain of “electoral fraud” and accusing Merz of “throwing all his election promises overboard on day one”. If the German public fail to appreciate Merz’s pragmatism then his chancellorship will struggle with his lack of mandate, further risking that voters move to extremes.
4. The UK
Labour voters must be intrigued to see their government taking a pragmatic turn, embracing defence spending at the expense of international aid. The Minister for International Development, Anneliese Dodds, resigned in protest. Her resignation letter was a shot across the bows at Rachel Reeves, pointing out that she “expected we would collectively discuss our fiscal rules and approach to taxation…. it will be impossible to raise the substantial resources needed just through tactical cuts to public spending“. These aren’t simply the words of a disgruntled leftie. Dodds was Starmer’s first choice as his Shadow Chancellor and has played a loyal game. But her concerns will be felt by others on the backbenches she now joins. The public might not care too much about the reduction in international aid, particularly when they find out that even the reduced budget will see half of it spent on housing asylum seekers in the UK. But it is the latest decision in a list that many Labour MPs will think they didn’t come into politics to deliver, such as the cuts to the winter fuel allowance, inheritance tax on farmers and the rise in national insurance contributions.
This list will get longer. The decision to increase defence spending also has the impact of reducing Rachel Reeves’ famously wafer thin headroom. This means even tougher decisions are to come once the OBR provide their update on 26th March. Although as Reeves herself admirably admitted in an interview with The Sunday Times, “I don’t need an [Office for Budget Responsibility] forecast to tell me that we need to do more to boost productivity in and reform our public services. I don’t need an OBR forecast to tell me that we need to make the state more lean and agile. And I don’t need the OBR to tell me that we need to reform our welfare system to get people into work and to get a grip with the rising welfare bill. We need to do those things regardless of the future fiscal headroom”.
The market has already decided that “making the state more lean and agile” translates to public spending cuts, of whatever size is necessary to meet the fiscal rules. Given this assumption, Gilt auctions should go without incident on Tuesday, Thursday and Wednesday 12th March. The final OBR update to the Chancellor comes on Tuesday. The Treasury had already asked unprotected departments to show savings under two scenarios: (i) spending unchanged in cash terms; (ii) an 11% reduction. One of the protected departments had been overseas aid, demonstrating just how frequently the goalposts are shifting in the Chancellor’s plans.
It’s a mad scramble to make sure the numbers add up. Hence Reeves also announced a change to the remit of the new National Wealth Fund so that it can be used for defence as well as infrastructure projects and a UK-Ukraine bilateral loan agreement which uses the appreciation of frozen Russian assets. She has also asked officials to look at creating a bank set up purely for defence spending, so that it stays off country’s national balance sheets. France and Germany will surely be happy to do anything that stays off the books.
She is certainly operating at speed. The opposition have been left floundering. Conservative leadership candidate and former Foreign Secretary James Cleverly was spotted supporting Diane Abbott with a “well said!” at last week’s Prime Minister’s Questions. Recent events present an opportunity for Starmer to take the initiative and rewrite the narrative. Far from being the passive government constrained by financial markets that we have seen to date, he can establish his role as the leader of the nation that bridges divides between the US and the EU during an international emergency. Whether his own MPs can accept their ideological priorities will fall by the wayside, sacrificed to the new reality, we will have to wait and see.
5. Japan
Amidst all of this, the BOJ’s Ueda and Uchida speak on Wednesday. They have been keen to proceed with balance sheet and interest rate normalisation so it’s likely they persist with their hawkish tone. With gamma having dropped in the S&P500 thanks to the recent options expiry date, this leaves the market more susceptible to any decrease in global liquidity.
