Financial markets have regained some ground since the April wobble and an average managed pension fund is just a couple of per cent down for the year as a whole. So is it time for those with investments to relax? Quite possibly not. Here are four key things to watch.
1. The July factor: Share prices recovered and bond markets steadied after Donald Trump partly reversed his “liberation day” threat of blanket tariffs, made in early April. And now a US federal court – as well as a district court – has ruled that he exceeded his powers by imposing such sweeping tariffs.
An appeal court later put the trade court decision on hold and there will be further hearings on this, which will determine Trump’s short-term leeway on blanket tariffs. If he loses, the administration said it is confident it may move ahead using different pieces of legislation, though this remains to be seen.
Trump also retains the power to impose or increase specific tariffs on national security grounds – such as those on steel and aluminium, pharmaceuticals and computer chips. In other words, he has plenty of power still to act and upset markets. He has already doubled steel and aluminium tariffs from 25 per cent to 50 per cent.
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When he delayed the bulk of his liberation day tariffs, Trump set a 90-day deadline for negotiations. That expires on July 8th for most countries and July 9th for the EU. The run-up to this date and what happens as the deadlines expire looks like a key risk point for the financial markets.
For now they seem to be pricing in a relatively benign outcome. That may well see them left exposed, at least in the short term.
The wider uncertainty, of course, is whether tariffs are in effect negotiating tools to be used by Trump, or we are heading for the risk of longer-term tariffs and ongoing trade wars. Tensions between the US and both China and the EU do highlight that trade tensions could well persist and tit-for-tat tariff wars remain possible.
2. The US dollar: Last year, all the talk was of the US dollar heading towards parity with the euro. Now it is on the slide. In February, the euro was trading at around 96/97 cent to the US dollar. Now it is around 88 cent.
In turn, PwC pensions partner Munro O’Dwyer points out, this has cut the returns on the US investments of pension funds – meaning that, for the year to date, most managed funds remain slightly behind where they were at the start of the year, despite a strong recovery in equity markets in recent weeks.
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The dollar factor bears watching for investors. There has been some nervousness in putting cash into the US market, given the haphazard nature of Trump’s policies. Measures in the budget bill currently before Congress also allow the US to target foreign investors coming from countries which the Trump administration feels are treating US companies unfairly. While this may not apply to investors in US treasuries, it is also causing some nervousness.
On the flip side, the US is a massive financial market and will inevitably continue to be one investors will not ignore. In short, not only are share and bond markets set to be volatile, but also currency markets. The fate of the dollar is a key focus.
3. Bond markets: Bond market investors are taking an active role now in watching debt and deficit trends in big countries and penalising those that seem to be facing particular risks by seeking higher returns.
The US has been in the sights of the so-called “bond vigilantes” and will remain so, due to its massive national debt.
The budget bill, if passed by Congress, will only add to the deficit – already close to 6.5 per cent of US GDP – in the years ahead due to higher spending, plus tax cuts aimed at the better off.
A wobble in the US bond market was key to forcing Trump to postpone much of his liberation day package. And signs of weaker growth would only make the numbers even more challenging.
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Last Friday, JP Morgan Chase chief executive Jamie Dimon warned that the US bond market could “crack” under the load of higher debt and US long-term interest rates are now trading at close to 5 per cent. If growth slows further, pressure will grow. This is a key area to watch in the weeks ahead.
It is also worth keeping an eye on the UK. The Labour government has had to reverse in part its threat to cut winter fuel payments and is also debating other welfare measures. That it is even heading into this territory suggests nervousness over the prospects of a re-run of the disastrous bond sell-off after the September 2022 mini-budget during the short period in which Liz Truss held office as prime minister.
Some Labour MPs are calling for higher taxes on the better off to try to close the gap but, with little leeway in her budget sums, UK chancellor Rachel Reeves is walking a tightrope. As in the US, a cut in growth forecasts could mean further trouble.
Jitters in the bond markets would likely spread to other financial markets and to economies more generally, given their central role in banking and finance.
4. The impact of uncertainty: International growth forecasts are being cut not only because of fears of the impact of tariffs and trade wars, but also the slowdown in activity as big investors – and to an extent households – wait to see how things pan out. The combination of the two this week led the OECD to forecast the lowest level of international growth since Covid-19, with the rate set to fall below 3 per cent and lower growth in most of the big developed economies.
It pointed out that despite Trump pulling back on some tariffs, the average US tariff rate on all imports was now 15 per cent, its highest level since the second World War. Notably, the OECD warned that “historically elevated” equity valuations are increasing vulnerabilities to negative shocks in financial markets.
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For investors, it will thus be important to watch growth indicators in the months ahead to see the extent of the damage.
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And how should investors respond to this uncertainty? O’Dwyer of PwC told The Irish Times business podcast this week that, in terms of pensions, the normal “lifestyle” and fund management strategies are designed to guard against undue risk, for example by moving out of riskier equity investments when the person is approaching retirement age.
In contrast, for younger pension holders, it is generally better to stay invested in riskier areas for the bulk of their career, as this has generally paid off in terms of staying ahead of inflation. Trying to outsmart the experts by taking these decisions on an individual basis is risky, he warns.
The average Irish managed pension fund has fluctuated over the past couple of years, but is still up by around 20 per cent over the past five years.
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Killian Buckley, director of global investment selection at Davy, underlined in a recent note to clients “the importance of not overreacting to newsflow by switching out of equities and into cash”, or adopting an overly defensive position.
To do so recently would have risked missing out on a 16.7 per cent recovery in the S&P 500 index of US shares between April 9th and May 26th, he said, which more or less wiped out the initial share slide after the liberation day announcement on April 2nd.
All that said, volatility has returned to stock markets after a period when a few big tech-based stocks – the so-called Magnificent Seven – had driven the market upwards. This puts a big emphasis on active management of portfolios. For pension funds, the risks to bond markets and uncertainty over interest rates adds another factor to the mix.
This does present ongoing risks for investors as Trump’s agenda plays out and markets continue to try to understand where it is all leading.
