Double whammy of bad news for markets

Anyone looking for a quiet week will be sorely disappointed. There has been another surge in the VIX index at the start of this week, and Wall Street’s fear gauge is now at its highest level since December. Stocks are a sea of red in Europe and US futures are expected to open lower later on Monday. The mild recovery in US stocks on Friday has been short lived, and there could be more asset price damage to come.

Trump abandons US markets in favour of political goals

The markets are digesting a double whammy of bad news for equity market bulls. Firstly, President Trump seems to have abandoned the US stock market and is willing to put his political vision above the near-term outlook for the US economy. Secondly, there are signs that the German coalition currently being put together by the Conservative Friedrich Merz is fraying, and the Green party have rejected Merz’s spending plans on defense and infrastructure.

Trump puts economic pain on the agenda

Donald Trump said in an interview over the weekend that the US economy is facing a ‘period of transition’. The interview with Fox News could have been used by President Trump to calm financial markets, after US stocks fell more than 3% last week, their largest decline for 6 months. Instead, Trump refused to rule out a recession for the US economy, which has reinvigorated animal spirits once more, but this time on the downside.

Trump takes a page out of the Putin and Xi play book

This suggests a few things, firstly, Trump is putting his political goals ahead of the strength of the US economy and the stock market. This is the playbook of President Xi in China and President Putin in Russia, who have both put politics in front of economic growth in recent years. This has had major repercussions for their economies. Trump may think that he is steering the US economy in a healthy direction, but this is worrying the broader financial markets. Trump’s flip flopping on tariffs, and his old-fashioned views of America first, is weighing on consumption and knocking confidence.

This means that this week’s University of Michigan Confidence measure and the inflation expectations are as important for overall market sentiment as the CPI report is on Wednesday. The market is looking for a small pullback in the inflation rate last month, however, a larger than expected moderation in price growth for February could help to calm markets, especially if it gives the Fed a little bit more wiggle room when it comes to future rate cuts.

US bond yields drop as growth fears increase

US bonds are outperforming Europe yet again, and 10-year and 2-year yields are down approx. 7 basis points ahead of the US market open. Trump’s refusal to rule out a recession in the US economy is weighing on bond yields, as growth fears boost US bonds and weigh heavily on equities. We expect this to continue until we see 1, a change in Trump’s economic strategy (unlikely), and 2, weaker inflation, which is also not a given. The consumer confidence data later this week will be worth watching, and any pickup in inflation expectations could be read as a sign that consumers are already pricing in the inflationary impact from Trump’s tariffs.

S&P 500 could breach key technical level if tech stops drop as expected

From a technical perspective, the S&P 500 is approaching a key level, the 200-day sma at 5733. If we get a definitive daily close below this level, it would be a bearish development for the S&P 500. Trump’s comments on the US economy are leading to a crisis in confidence in US economic strength. If the President is talking down the economy’s near-term prospects, then it is tough for investors to have faith in the next ‘industrial revolution’, and AI stocks could be on the chopping block at the start of this week, as Broadcom’s strong results become a distant memory.

German chancellor could face opposition to spending plans

The second driver of markets on Monday is news that the German Chancellor in waiting, Friedrich Merz, could face opposition to his plan to break Germany’s debt rules and dramatically increase government borrowing to fund defense and infrastructure spending. This caused the largest daily increase in German bond yields since reunification, and the euro had its best weekly performance since 2009 last week.

Why the European defense theme has further to go

The news that Germany’s soon to be chancellor might not have free reign over Berlin’s purse strings has limited euro upside for now, although we expect the euro to get its mojo back in the near term, and $1.10 in EUR/USD remains on the cards. It has also helped weigh down European stocks, and the Dax is the weakest performer in the European equity space today and is lower by 1.5%.  German mid cap indices are under even more pressure on Monday. However, Rheinmetall, the German defense company,  is still the top performer on the Dax today, although the pace of gains has slowed sharply. This suggests that the market believes a deal will be struck to allow Germany to boost spending. Overall, we continue to favour European stocks over US stocks in the current environment, and the European defense sector could have further to go, even if it runs into roadblocks on its upward journey.