Who would be a central banker? Setting interest rates to create a Goldilocks economy - not too hot, not too cold - is never easy. But throw in conflicting inflation and growth data and an unpredictable US President and the task looks even more challenging.
The Fed’s dilemma
Three of the world’s main central banks will set rates this week. The most important, of course, is the US Federal Reserve (Fed), where the job is arguably the hardest. That’s because the Fed’s professed reliance on the data looks harder to justify in a world where what’s really driving policy decisions is Donald Trump’s seemingly random trade war and tariff policies.
Last week saw an unexpected fall in US inflation. That argues for lower interest rates and the odds of three, rather than two, rate cuts this year have shortened. However, at the same time as growth fears mount so too are concerns that the President’s torrent of tariffs will ultimately prove inflationary. That will probably stay the Fed’s hand this week. Most investors expect rates to stay on hold at between 4.25% and 4.5%.
Things are no easier in the UK. The Bank of England will unveil its thinking on Thursday and, like the Fed, will probably leave rates as they are - at 4.5%. The backdrop is different but equally mixed. Inflation at 3% is higher than the Bank would like, driven by still strong service sector inflation and wages. But last week we learned that the UK economy shrank in January, against hopes for modest growth.
The other decision - again no change is expected - is in Japan. It’s a different story there too. Inflation is rising but that’s seen as a good thing after decades of deflation. With two rate cuts already in the bag, the direction of travel remains upwards in Japan as it belatedly normalises policy in line with the rest of the world.
Uncertainty plagues stock markets too
It’s not just central bank policy that is struggling to keep up with the Trump whirlwind. Stock market investors, too, are battling to make sense of the rapid-fire policy shifts in Washington. That’s hit hard a market that was priced for perfection after the new President returned to the White House. The glass has turned decidedly half empty as the positive tax cuts and deregulation narrative has morphed into a darker tariffs, inflation and growth slowdown story in recent weeks.
The S&P 500 index moved into correction territory briefly last week, 10% below its most recent high, before rallying strongly on Friday. Looking beneath the surface, the US market performance is uneven. Both the large Magnificent Seven tech stocks and the more economically sensitive small caps measured by the Russell 2000 index have fallen heavily, while the equal weighted mid-to-large caps in between have held up much better.
That makes sense. Smaller companies are vulnerable to inflation and lower growth. The large caps meanwhile became over-valued during their long outperformance. Diversifying within the US has made sense just as it has on a global scale as investors continue to rotate out of the US and into other cheaper markets.
Is China investable again?
One of the most striking opportunities this year has been in the previously out of favour Chinese - and especially the Hong Kong - market. The main Chinese index, the CSI 300, is back in positive territory for the year to date and Hong Kong’s Hang Seng is up 20%. There are two main drivers. First, DeepSeek has shown that China can compete with the US in artificial intelligence (AI), and at much lower cost. Second, the authorities have clearly swung behind a big boost to consumption.
Last week Beijing said it would be encouraging a return to population growth after three years of declines and it restated its intention to support GDP growth of about 5% in the world’s second largest economy. Consumer stocks bounced on hopes for more stimulus. Drinks company Kweichow Moutai and electric car market BYD both rose 6% on Friday.
Meanwhile, Europe remains in the spotlight as investors bet on higher defence and infrastructure spending, especially in the region’s economic powerhouse Germany. Europe is rapidly shifting its spending priorities as it accepts that the decades in which the US provided a reliable security backstop are now in the past.
Gold - the ultimate safe haven
The biggest beneficiary of rising uncertainty so far this year has been gold, which last week broke through the US$3,000 barrier to hit a new all-time high. Gold always does well at times of tension and unpredictability. It rose through US$1,000 in 2008 during the financial crisis. It rose above US$2,000 during the pandemic. So perhaps it is no surprise that it should clear US$3,000 as Donald Trump reshapes the global economy and turns his back on globalisation and international co-operation.
