The last few weeks have seen some major economic and geopolitical changes with US president Donald Trump increasing tariffs on a number of countries while seemingly preferring warm diplomatic relations with Russia rather than allies like the European Union (EU) and Canada. These developments have had a negative impact on global equities and although bonds have not performed quite as well as may have been expected in this environment, they have still provided some ballast to multi-asset portfolios.

US Treasury yields have fallen in 2025 as markets have become more concerned about the disruptive nature of Trump’s economic policies and the risk that they lead to slower growth, or even a recession. This would push the Federal Reserve (Fed) into more rate cuts although the inflationary impact of tariffs could stay their hand. Last week the US 10-year Treasury yield increased 1 basis point from 4.30% to 4.31%, but it remains 26 basis points lower year-to-date.

However, at the same time, European bond yields have risen sharply due to the defence and infrastructure plans announced by the new German government. While the 3 basis point increase in the German 10-year bund last week is fairly minimal, it’s 51 basis points higher year to date. This divergence between the US and German 10-year yields has left the UK gilt market somewhat caught in the middle. Last week the 10-year gilt yield increased by 2 basis points, taking its year-to-date gains to 10 basis points.

There was a lot of media attention on the UK gilt market around the time of the October budget, as Rachel Reeves’ plans saw yields tick higher. However, domestic developments at the time were in effect playing second fiddle to global events, and in many ways they still are. Plans for increased European spending on defence have been the chief cause behind higher bond yields on the continent in recent weeks and even though the UK is no longer still in the European Union, it is having an impact in London.

German borrowing costs have moved sharply higher with the expectation that chancellor in-waiting, Freidrich Merz, will deliver a largescale financial package to revamp the country’s defence and infrastructure. Merz is looking to get the reforms through parliament before newly elected MPs take their Bundestag seats on 25 March. This has provided a counter force to the slowing US growth story, leaving UK bonds little changed.

Credit spreads have widened in most markets as investors worry about the impact of Trump’s policies on growth and corporate profitability. This is not too surprising as credit spreads typically widen when growth slows, and it should be made clear that they are still quite tight by historical standards.

Central banks are somewhat caught between slowing growth and potentially higher inflation pressures. Both the Bank of England (BoE) and the Fed are expected to cut rates this year, but the process is likely to be gradual. There is not expected to be any change at this week’s meetings, although market participants will be watching for hints as to what lies ahead. At the time of writing the market is currently pricing two 25 basis point Fed cuts this year and a similar amount in the UK.

Overall, we believe that bonds are a good diversifier in portfolios and will perform well if the US economy were to slow materially this year. Yields are at historically high levels so look compelling to us at a time of heightened geopolitical uncertainty.

The fact that starting yields are currently quite high also gives investors something of a cushion against any further moves up in rates. For example, the current UK 10-year gilt has a yield to maturity of roughly 4.65% at present, so yields would have to move higher by around 70 basis points, to 5.35%, to generate a negative total return over 12 months.

At present we favour a relatively larger overweight position in fixed income than equities. We believe that current yield levels are attractive and that bonds would provide a further buffer should economic growth slow further. A recession is not our base case, hence why we like being overweight equities, but should one transpire then fixed interest investments are expected to outperform.

We also like hedge fund investments to provide additional diversification benefits, particularly in an environment where growth slows substantially and/or inflation moves significantly higher.  

Weekly economic announcements:

Last week the MSCI All Country World index fell 1.8% (-0.3% YTD), moving into negative territory for the year but ended off its lowest levels of the week. Continued trade policy uncertainty from the US is weighing on sentiment, with new tariff announcements from the Trump administration.

United States

The latest look at US inflation was the main economic data point last week, with the US consumer price index figures showing a slightly slower than expected increase. The headline CPI year-on-year print of 2.8% for February was the lowest reading since November, suggesting that last month’s acceleration may have been merely down to the January effect. The core (ex food and energy) reading year-on-year rose by 3.1% in February, the slowest pace of increase since April 2021.  

This provided some positive news on the inflation front and was supported by the producer price index (PPI) which showed headline prices unchanged and core prices declining for the first time since July. Both these figures were lower than the consensus forecast for a 0.3% increase.

Softening consumer confidence is a potentially growing concern though, with the University of Michigan consumer confidence figure falling for the third month in a row. The print of 57.9 was the lowest level for over two years. At the same time, inflation expectations increased, rising to 4.9% from 4.3% prior. While there appears to be substantial bipartisan political bias in the data, with Democrats far more concerned than Republicans, the rise in this metric from 2.6% in November suggests this is something to keep a close eye on.

US stock markets declined for a fourth consecutive week, falling 2.2% (-3.9% YTD). Growth stocks underperformed value shares, and large caps lagged small caps. Tech-heavy indices were broadly inline with the wider market.  

The United Kingdom

The UK economy has had a disappointing start to 2025, with monthly real GDP contracting by 0.1% in January largely due to a 0.9% fall in production output. This worse than expected figure follows what had been a surprise 0.4% uptick in growth in December 2024, driven by strength in the services sector. Propped up by the stronger number at the end of last year, real GDP is estimated to have grown by 0.2% in the three months to January 2025.

On a monthly basis, economic growth can appear to be quite choppy, but the bigger picture shows a stagnant economy. Talks of trade wars are now consistently making headlines, and this is likely to be unhelpful as far as UK consumer confidence is concerned.

The Spring Statement is fast approaching and it is becoming increasingly clear that Chancellor Rachel Reeves finds herself in a very difficult position. The Bank of England recently halved its forecast for economic growth from 1.5% to 0.75% in 2025. Given fiscal headroom is highly sensitive to changes in growth expectations, the previous £9.9bn of headroom will almost certainly no longer be available.

UK stocks declined 0.5% last week (6.6% YTD) but are still firmly higher for 2025. The pound ended the week little changed at US$1.29.  

Europe (excluding the United Kingdom)

European stocks extended their run of relative outperformance against the US, with the MSCI Europe ex UK falling 1.4% on the week (9.1% YTD). Uncertainty on tariffs and the Ukraine-Russia ceasefire are driving markets of late. German stocks were flat for the week (15.5% YTD), French stocks fell 1.1% (8.9% YTD) and Italian equites managed to eke out a small positive return, rising 0.2% (13.5% YTD).

Comments from European Central Bank policymakers cast doubt on another rate cut in April after they ECB lowered rates for a sixth time in less than a year earlier this month. The prosect of fiscal stimulus has boosted the Euro lately, rising to US$1.09 — its highest weekly close since October.