The first half of the year has been a geopolitical hot mess. US President Donald Trump’s chaotic approach to tariffs, escalating military conflict in the Middle East, the continuing war in Ukraine and the existential threat posed to the North Atlantic Treaty Organization (Nato) have left financial markets… largely unscathed? Global equities are in rude health, government bond yields are becalmed and oil is trading in line with its five-year average. The US dollar is the only casualty, losing ground against all of its peers in the past six months.
So the remainder of 2025 will follow the same pattern, right? Well. The Taco – Trump Always Chickens Out – trade in equities will be re-examined early this month when the tariff pauses end. The independence of the Federal Reserve looks set to be sorely tested. The fiscal implications of Nato’s 32 members belatedly agreeing to increase defence spending to 5 per cent of gross domestic product will reverberate around bond markets, particularly in Europe.
“The interplay of politics, economics and markets will make assaying the paths of stocks, bonds, commodities and currencies this year even harder than usual,” we wrote at the start of the year. The capriciousness of the world’s most important person means that staying nimble and being willing to scuttle to the sidelines will remain the safest strategy. In short: Be careful out there.
It’s your currency – and it’s becoming your problem
The greenback has lost more than 10 per cent against its major peers this year, sending the dollar index to a three-year low. While that’s broadly good news for a world that’s suffered in recent years from the home of the world’s reserve currency sucking in much of the available investment flows, it should start to worry US officials if it illustrates mounting concern about a burgeoning budget deficit. There’s a reason gold is near a record high.
In the same way as average government bond yields have returned to levels seen between 2005 and 2014 (more on that later), the greenback may weaken to historical norms. Its average for the past 20 years against the euro, for example, is around US$1.22 compared with about US$1.17 currently, while, versus the pound, the level is US$1.50 on average over the last two decades versus US$1.37 now. Though talk in Frankfurt of the euro playing a more global role sounds like wishful thinking, the dollar’s crown as king of the currency world is definitely slipping.
Higher for longer is the new mantra for US rates
At the end of 2023, the futures market was anticipating a Fed funds rate of around 3.5 per cent by December 2024; instead, it got 4.5 per cent. At the end of last year, it was expected that the rate would decline to 4 per cent by now, but it’s still stuck at 4.5 per cent. With the US economy – and the consumer – confounding the gloomy prognosis of economists, the US central bank has resisted increasingly strident calls from the White House (Fed chair Jerome Powell is a “very stupid person,” according to Trump’s latest broadside) to cut borrowing costs.
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Powell’s tenure ends in May 2026. With his replacement likely to be more craven/flexible (select according to taste) in acceding to Trump’s demands – and potential successors lining up in recent weeks to affirm their dovish credentials – the Fed’s independence in setting monetary policy looks worryingly compromised even before Powell’s exit.
For bonds, 3% remains the new 1.5%
The average 10-year government yield for the members of the Group of Seven has been basically treading water all year – but that means the 1.5 per cent borrowing cost that prevailed for the past decade is a distant memory, with the 3 per cent level of the decade before becoming the new normal. Treasury yields are down a bit this year, while bund yields are up a touch – the latter a surprisingly modest gain given the enormous surge in borrowing planned by the German government to fund increased defence spending. Switzerland remains an outlier with sub-zero rates at short maturities (more on that later).
The subtext for bonds is a little more complicated than usual. Rather than central bank action steering the market – the European Central Bank has been twice as aggressive as the Fed in easing policy – rising deficits and stubborn inflation are now the main bugbears for the bond vigilantes. So expect the focus to remain on what happens with the longer end of the yield curve; if investors fall further out of love with 30-year debt, fiscal alarm bells should start to ring.
Negativity is back, baby
Negative yields were supposed to have been banished, never to be seen again. At least that was the fervent hope of those who rightly fear deflation. However, 2025 has served up another unwanted surprise, with the Swiss National Bank cutting its policy rate to zero in June. In anticipation that the strength of the franc and the inflation rate slowing to minus 0.1 per cent may prompt a further cut to below zero in September, Swiss government bonds out to three years now have negative yields.
The universe of negative-yielding bonds peaked at an astonishing US$18.4 trillion at the end of 2020. While we’re unlikely to revisit that scenario, what’s happening in Switzerland is a reminder that sub-zero interest rates will forever be part of the central bank toolkit.
Stock market’s animal spirits prove impossible to extinguish
Resistance is futile: The 20 per cent-plus recovery staged by the S&P 500 index in the aftermath of Trump’s initial introduction of tariffs in April tells all. Too many investors went underweight and are being dragged back in. And, this year, stock indexes in Europe and Asia are outpacing their US peers, broadening the gains and driving the world’s stock-market value to a record US$133 trillion.
What happens next with tariffs is anyone’s guess, so the outlook for corporate earnings remains shrouded in doubt. But betting against investor appetite for stocks, no matter how overvalued they might seem to be, hasn’t been a winning strategy.
“The world is swimming in oil”
Global oil demand is rising gradually, but ever more of the black stuff is being pumped. Saudi Arabian supply is set to reach a two-year high of 10 million barrels a day as it chafes at its partners in Opec+ (Organization of the Petroleum Exporting Countries and other oil-producing nations) exceeding their mandated quotas. “The world is swimming in oil,” as our colleague Javier Blas wrote last week.
Even the conflict between Israel and Iran produced just a short-lived spike in Brent crude that quickly faded, leaving it trading below US$70 a barrel. With the Opec+ cartel agreeing to increase production quotas and prices high enough for US shale producers to have locked in their output, oil prices are headed only one way – down. BLOOMBERG
