Monday Digest
Posted 21 July 2025
Higher and higher
Markets keep rising on incoming liquidity. Growth optimism is improving, helped by strong early Q2 earnings reports. Volatility – both in measured and implied terms – has fallen dramatically, but measured more than implied (the cost of insuring against losses). That means you can profit by selling options and buying the broader market – a recipe for grinding higher.
Chancellor Reeves’ deregulation speech at Mansion House wasn’t well received – but that was more about what she didn’t say (no mention of tax rises) than what she did. Her comments about encouraging risk-taking and getting savers invested in the UK stock market were valid; we’ve argued them before. Follow-through is key, but the City’s pessimism seems a little misplaced. The only thing she did say about fiscal policy was that the fiscal rules are iron-clad. That’s nothing new, but repeating it for bond traders at the back of the room never hurts.
Donald Trump reportedly penned Fed chair Powell’s letter of dismissal – nominally over misconduct but pretty obviously over his refusal to cut rates to the president’s liking. Bond markets were unmoved by this assault on Fed independence (the slight rise in US yields was about stronger growth). We suspect they have faith in the Fed’s institutional strength. Removing the committee chair won’t change the views of the committee – and there’s little suggestion that Trump’s next appointee will follow his rate-cutting orders.
Chinese stocks had a strong week. The media put it down to better growth and nicer Trump – but we think the underlying story is again about liquidity. Chinese households have cash and the government is encouraging them to buy stocks, rather than low-yielding savings or property. That supports stock prices even if company profits are weak.
That doesn’t necessarily mean international investors will flock to China (the risk of stranded assets remains), but even if they just move to a “neutral” allocation, it will be strong fuel for Chinese stocks. Like everywhere, liquidity keeps things grinding higher.
Sticky inflation won’t stop UK rate cuts
June’s inflation print – 3.6% year-on-year – was above expectations and the highest in 18 months. Core and services inflation accelerated too, causing markets to slightly dial back their bets for an interest rate cut at the Bank of England’s meeting next month. Markets still see a 0.25 percentage point cut as likely, though. The UK economy is weak and unemployment is rising, as April’s rise in employer national insurance contributions bites. Global input prices are also subdued, largely thanks to Chinese deflation. And while housing inflation looked bad in June’s report, it has decelerated recently.
The fact consumer inflation is high when producer price inflation is subdued tells us companies are moving costs onto customers. They can do so because consumer demand is surprisingly resilient, despite mounting job losses. Pantheon Macroeconomics think the UK economy isn’t as weak as some suggest, with lasting support from last year’s public sector wage rise. Backing that up is the fact that both consumer confidence and retail sales numbers have stabilised in recent months. This could be to do with the fact that total wages aren’t declining, despite layoffs. If that pattern holds, the BoE will have a tough time cutting rates further.
The BoE faces a dilemma. On the one hand, cutting rates while inflation pressures remain undermines the central bank’s credibility (inflation has been above the 2% target for four years). On the other, rising unemployment could quickly spiral into recession if rates stay too restrictive. Last Thursday’s payroll data gave no clarity which way it will go: June’s layoffs were sharper than expected, but May’s job losses were revised down significantly.
June’s inflation won’t stop the BoE from cutting rates next month, but it’s a challenge. Investors can at least take comfort that the challenge is strong consumer demand – ultimately a growth positive.
US inflation: tariffs or growth?
US CPI gained 0.3% month-on-month in June, taking annualised inflation to 2.7%. That’s either in line with or slightly above economists’ expectations, depending who you ask. Core CPI (more important for the inflation trend) came in slightly below expectations at 0.2%. Donald Trump’s tariffs had some inflationary impact – on clothes and furnishings – but it was mild. Tariff effects were subdued by the weakness in global producer prices, coming from Chinese deflation. The most interesting part of June’s inflation report, though, was the New York Fed’s survey showing a fall in consumer inflation expectations.
Markets’ main concern about tariffs has been that they will hurt growth through compressing consumer demand. We worried that this might happen during a weak employment market, but recent employment data has improved. The New York Fed’s survey also suggests that Americans feel more secure in their jobs and finances. It’s early days, but this suggests that tariffs might not hurt demand too much after all. The outlook for real (inflation-adjusted) US growth has improved.
Stronger growth is good for US stocks. For international investors, though, what happens to the dollar is just as important. The currency has weakened greatly year-to-date, dragging down sterling returns on US stocks, but dollar weakness has mellowed recently. We have argued before that the dollar is due a short-term rebound – as low growth was the main downside, and that’s now easing.
But the longer-term case against the dollar remains. The ‘twin deficits’ problem (fiscal and current account) is a drag on the dollar, and it gets worse if US asset returns stop being as exceptional. Trump wants to address one of those deficits (by reducing imports) but his tax cuts are widening the second. The growth and inflation story is dollar positive for now, but that might not last.