Direct From Dowding: April 2025

Okay. Hello to everyone joining good to be catching up on what is Liberation Day, isn't it? In the United States? So no shortage to talk about. I'll be doing my best to look in the crystal ball and tell you what we think is going to be happening in the next 24 h. But obviously more importantly, in terms of market implications over the course of the weeks and months to come.

Obviously tackling matters at hand. Obviously a lot of discussion, a lot of narrative at the moment in terms of what's going on in terms of the economy, what's happening in terms of the policy agenda in the United States. And when it comes to tariffs, if we take a bit of a step back, I think we've been articulating for some time that we've thought that there's a big part of the US policy agenda that effectively it is motivated by the idea of making changes to the tax system, reducing direct taxes on income and also on corporation tax, at the same time raising indirect taxes on consumption.

And in this regard, when we look at the idea of tariffs. These are seen as a pseudo consumption tax, albeit a tax that is exempting domestic production. And through the eyes of the administration they'll obviously highlight in the US that they have no Federal sales tax.

So here and now today, as US companies are producing their exports and sending these to jurisdictions like Europe, these exports are being taxed with VAT at a rate of like 20%. So we're taxing their exports. they're now going to tax our exports. And they're just happening to do so through the lens of a tariff.

And so, from that point of view, I think that that is part of the way in which the administration has been thinking all along. And there's been this desire to level the playing field which they feel has skewed the system against production in the United States.

You see that in the offshoring of jobs, not just in manufacturing, but even take Ireland as another example. Ireland, of course, has been a booming economy over the course of the past 10 years, but a lot of that boom has been on the back of US corporations in tech, in pharma. Setting up their corporate headquarters in Ireland, very much to take advantage of what is obviously a very successful tax arbitrage. And there is this desire now to bring those jobs, bring that investment, bring that money back home to the United States.

So I think that's quite a motivating factor. But with that being the line of thinking we've always thought that that means that you probably want to end up in a landing point where you're going to end up embedding tariffs into the US federal budget, and you kind of need to put things in budget in order to utilize the revenues that are raised from tariffs as part of the budget process.

But the whole journey to actually legislate tariffs is going to be a bit of a protracted one through a series of reconciliation bills in the context of the 2024. Sorry 2025, I should say, budget. And in that respect I think that we may well end up seeing sort of tariffs running around 10% come the end of the year. So this may be where we get to, but we won't actually see that legislation move through congress, we don't think, until sort of Q4 time.

And so in the interim, we have this window in which Trump is applying tariffs via executive order, setting these at a higher level today, both as a negotiating tactic and also as a way of actually advancing other elements of the US policy agenda around immigration drug control and all of the rest of it. And the thinking here is, maybe you end up with tariffs at 25 today. So that if you eventually end up with tariffs back down at 10% as legislated tariffs later in the year, at that point everyone calms down, everyone gets their anger out of the way.

You go through a turbulent period at this particular moment, but by the time you get into next year everything is looking calmer and more settled, and things are on a better trajectory again.

And in this regard I think it's certainly worth reflecting on the way in which Elon Musk has worked in many occasions in the past. Obviously, recently at Twitter he's not scared of blowing things up in the short term. Creating a bit of chaos subscribing to, if you like, the Austrian economic school of creative destructivism in terms of a journey to actually remodel things. The way in which he wants to see them sort of enacted.

I remember when he sort of took on Twitter for a while it looked like the whole thing was being blown to pieces. But then, 6 or 9 months later, you look, and you actually observe that he's ended up modeling X very much in the image in the way in which he wanted to achieve all along in the 1st place.

So there may be some method in the madness, but there certainly isn't any particular fear of taking some short-term pain to get the longer-term gain. But the imposition of tariffs here, particularly in the short term we see this as a factor that is going to be depressing growth. It's going to be depressing consumption, but at the same time it's going to be rising prices in that respect very much acting as something of a negative supply shock.

In addition, we've also got the DOGE spending cuts taking place. This is leading to a loss of federal jobs and jobs in other associated agencies, which we do think also could have a negative sort of impact on consumption in the near-term.

Now longer term, there's this question as to whether these spending cuts are actually going to be used to actually help reduce the deficit. I'm a bit sceptical on that. I'm more inclined to think that many of the spending cuts that get sort of delivered today may well end up being used in terms of delivering tax cuts, but those tax cuts, the benefit of tax cuts may be felt more in 2026.

So the near-term pain could be felt today with the better news thereafter. But it does mean a bit more of a growth negative is going to be felt, I think, in the course of the next 6 months as some of these impacts wash through.

And then, thirdly, when it comes to immigration, the fact that we're getting many fewer immigrants into the United States. That in itself also means that you end up with less consumption growth. Again, a 3rd thing, which is a bit of a growth negative here, albeit this particular facet is actually one which, in as much as you're sort of reducing immigration, reducing, capping, even reversing the growth in the supply of labour in the United States.

This is effectively something that could lead to some tightening of the labour market. It could push up wages. It could also create sort of issues, as we've been highlighting in certain sectors like agriculture and dairy, where you have a very high dependency on immigrant workers in that part of the economy.

So putting all of these things together and looking at the US economy, where does that leave us? Well, the 1st thing I need to say here with a caveat is just, don't bother looking at GDP data. GDP data for the time being are going to be nonsense largely because of very substantial gold imports that's going to completely throw out the Q1 GDP print. Remember, the GDP equation is C, plus I plus G plus X minus M, and where you've got that sort of very large M on the imports of gold that's throwing out the data.

But that point aside, I think if you look at the underlying trend in the US economy, if the US administration were doing nothing at the moment, I think you actually are looking at an economy that's growing 2 and a half to 3%. We're growing at trend, or, if anything, slightly above trend, the labour market continues to be pretty healthy.

We've just had some ADP job numbers today. Weekly claims are also supportive of the fact that the labour market is tracking along just about fine. The current data all looks pretty reasonable in the here and now. The fears are more about what's happening in terms of growth in the future. But if you take that 2 and a half 3 as a bit of a baseline of where growth was. I think that the impacts on tariffs on the DOGE on immigration. All of this probably, is reducing the trajectory of the economy more to a level of one to one and a half in terms of growth over the course of the next six months, which is obviously a below-trend situation.

That should see unemployment rise, but I think that the rise in unemployment will be muted, partly because we've actually got this sort of labour market tightness coming through the immigration side. So I think any move up in the unemployment rate may be a bit muted, but nevertheless, it is going to feel like a slowdown, I think, over the course of the summer.

But at the same time, if we've got growth slowing, we'd actually have sort of inflation going the other way. So core PCE is 2.6, I think that's going to somewhere between 3 and 3 and a half that ties in with core CPI going pretty much up to 4%. And so when you put this to the Federal Reserve, as we have over the course of recent weeks. What will you be doing? How would you be thinking against these economic variables if the reaction function plays out in this particular manner. And the thing that comes back very clearly to us from the Fed is, look, if we've got a negative supply shock, if we've got growth slowing down, but inflation speeding up. as far as we're concerned monetary policy can't do very much about this monetary policy interest rates. It's not a very effective tool. We saw this in Covid.

If you end up sort of cutting rates into a slowing economy, but inflation is going up. Guess what you can end up with a bigger inflation overshoot. So, although I think the Fed will be very reluctant to hike rates if the economy is slowing, given that rates are already at a level that is above where the Fed would see neutral, I think that near-term rate cuts are certainly very unlikely against this more inflationary backdrop.

And so from that point of view, we would be saying that if markets are taking yields too low in the near-term, that's an opportunity to fade those moves and actually go to a short duration stance.

It's kind of interesting to me that when I speak to a lot of market participants, they're very focused on what's happening on growth, much less focused on inflation and actually, central bankers, it's the other way around. They're more preoccupied by the inflationary hit.

When asking central bankers like the Fed, “So where is the Fed put on the economy if things start to go a bit bad?”, they say, look, there isn't a Fed put on the stock market, although I think that would probably change if S&P went below 5,000. That would probably be enough of a tightening of financial conditions that could get the Fed more interested at that particular point.

But the more relevant Fed put is probably on credit markets, if you see a big seizing up in credit markets and also, more importantly, on unemployment. I think if you saw 5% handles on the unemployment rate again. and that may be enough to actually encourage the Fed to get off its hands and actually act.

Otherwise, I think that you could well see rates going sideways for some time. And against that backdrop I think that what we could be paid to do here, as mentioned, is, look to take the opposite side of the market's view and look to go short duration if yields go too low.

And so we've been saying thematically, yields below 4.2 on the 10 year to us look too rich, and we want to be slightly short duration. Yields at 4 and a half would be fair. Yields up at 4.7 start looking cheap to us.

At the moment we've only got a small short-duration stance on US 10s. We are aware that if anything in the near-term that the news on trade could actually become more problematic, because I think the one other thing that we'd say moving to Europe, is that meeting with European policymakers what I'm really struck by at the moment is the level of anger, the level of rage against the US administration which is unlike anything that I've really ever seen during the course of my career.

I've just been in Frankfurt for the last couple of days, and I was kind of joking there that post the Brexit vote in 2016 I remember copping a load of grief from policymakers wanting to single me out for being British, blaming me for Brexit, wanting to vent and unload. But the hostility, the anger at everything that the US is doing at the moment, I think is on a completely different level. It really is like the red mist has come down.

And you see, sort of this anger of what's happening in terms of US aid, what's happening in terms of Gaza, what's happening in terms of Ukraine, what's happening in terms of the environment. Pretty much any part of the agenda how the US is treating its allies in Europe. All of this has really got the European policymakers pretty mad, and the one thing that policymakers in Europe are observing is that actually, they're kind of aware that monetary policy doesn't really work as an effective tool if you have a bit of a trade war.

What you really need to be able to do is you need to deploy fiscal policy and fiscal easing. And in this regard, of course, Europe is in the midst of actually easing fiscal policy. The move in Germany, away from the constitutional debt, break to actually spend a lot more on defense and infrastructure effectively is going to be mirrored across the eurozone, we believe.

And in that context the sort of fiscal shift that we're seeing certainly in Germany is as significant as anything that we've seen since the fall of the Berlin wall and the reunification of the country. But given you've got that cover from fiscal policy, it actually means that Europe is in a better position to actually withstand a bit of the trade dislocation that we are going to be seeing ahead of us, and it puts Europe in a position where it feels emboldened to try and hit back hard.

We are hearing from European policymakers, “We want to give it to Trump”, “We want to test Trump's pain threshold here”. So in the short term I would look for more confrontation. I do think that this can be problematic for risk assets, I think, on the whole, markets have wanted to say with Trump his bark is worse than his bite. People have been skeptical that things can actually evolve in the trajectory that Trump has been saying all along. And so I do think that there is still a moment where investors in risk assets will need to appreciate that more fully.

But in as much as what we're looking at in terms of European growth. I would have said that European growth at 0 point 8 probably was revised up to 1.5 on the back of the German and other anticipated European fiscal easing. Now it may be somewhere between one and 1.5 if we end up into a bit more of a trade war, but that does pretty much put US growth and European growth for the time being, at a pretty similar level.

From that point of view I think that the period of big dollar strength, the period of US exceptionalism is now effectively behind us. We've moved into a new regime. We could be moving into a landscape which is more of a weaker dollar move, particularly if we end up seeing changes in consumption and investment patterns.

Already we're seeing investors boycotting the US, boycotting, not just Tesla, but Amazon, other US companies. We're seeing Canadian flight bookings to go to the US over the summer down 70%. It feels as if there is this sort of rising anti-US sentiment that is being expressed in terms of consumer preference.

We also see it in portfolio shifts as well, not just the Norwegians looking to divert their sovereign wealth fund away from US stocks towards the European Defence Sector, but also more holistically, a bit of a sense that we're seeing a rotation away from US tech towards European stocks. And for a very long time, of course, it's been sort of flows from jurisdictions like Europe that have gone into US stocks, almost there is no alternative.

The TINA strategy for driving stock market valuations higher in the US has been something that's been responsible for elevating multiples and actually helping sustain US growth, and actually making a lot of wealth creation in terms of the US economy and wealthy individuals who then come back to Italy on holiday, for example.

But if you cut off that engine of money going into the US in the first place, I'm not saying that all those market shifts will unravel, but certainly that impetus that was driving us stocks before is one that may well have dissipated. So when we step back from this it'll be interesting to survey whether we've seen a bit of an inflection point here for the dollar, a bit of an inflection point in terms of moves and relative shifts in terms of risk assets and global equity markets.

But otherwise in terms of fixed income we think that the outlook for European yields is quite similar to the US I would say that I think that with inflation being a bit higher in Europe on the back of tariffs, with fiscal easing likely to be relatively dramatic, I don't really see room for the ECB to really cut rates. I know markets are really discounting that we'll see another 50 basis points or more of rate cuts this year. But I'm skeptical that the ECB will even cut rates in April. This is an against consensus call, but in our dialogue with the ECB I am struck by the fact that they're expressing uncertainty at the moment, and uncertainty in terms of the impact on prices. And given that fiscal policy is being eased, I'd question why the ECB needs to rush to deliver further rate cuts just in the here and now, so that will be relatively interesting.

Bund yields meanwhile, around 2.75, we think, are kind of fair value. So I like the idea of being short, the Euribor contract, ERZ5. At current levels we like the idea of being short. US 10s, below 4 20. These are where we're running positions in rates.

Otherwise, in terms of the UK we're not really running any risk. But I remain very bearish. Growth remains very weak. Inflation remains problematic. We've got 5% service inflation, 5% wage inflation, an economy with no productivity inflation looks embedded around 4% through my eyes. And I think we're going to see some ugly inflation prints in Q2. I know the Bank of England would still like to cut rates. They may do so at the next meeting. I think that's probably a mistake. If they do, it will probably end up pushing gilt yields higher.

If the government wanted to bring gilt yields down what they should be doing is telling the Bank of England to stop doing QT gilt sales, creating losses, driving up yields, and also creating losses for the UK government that are eliminating any fiscal space for them.

They should also be tweaking the leverage ratio to make it more attractive to own gilts rather than own interest rate swaps, which is a conversation which has been had with policymakers globally in the US and in Europe as well at a time when there's a lot of government debt.

So plenty going on there, but we don't run any active positions for the time being on gilts. I would continue to express a largely negative view on the gilt market and also on the pound.

Otherwise in Japan, I mentioned on the last call that we took profits on a long-held position. A short position that we'd held in JGBs ever since 10-year yields were at 25 basis points. That's worked out very well for us, and here and now the one position that we favour in Japanese rates is being long of 30-year bonds versus 10-year bonds. That part of the yield curve is too steep in my eyes, and I think with Japanese investors likely to buy more domestic assets in the coming fiscal year, I think long dated JGBs, if anything, are looking a little bit cheap at this particular point in time.

At the same time the Japanese economy continues to do well. I'm impressed by the productivity growth in Japan. The aging of society is actually forcing companies to become more efficient in their use of labour. So we're seeing corporate restructuring. We're seeing increased use of technology. 1% productivity growth with risks of the upside in Japan compared to no productivity growth.

Here in Europe also, Japan is the society that continues to work hard. Where I continue to do five or six meetings if I go there on a Friday, they work you darn hard in Japan. I can tell you that much.

But it does feel like an economy, a society that is doing better at this particular point in time, and this also sort of goes back to the theme that we've been highlighting on previous calls, that we think that the yen is probably the currency to favour in the FX space at the moment.

You've got extremely, extremely cheap valuations for the Japanese currency. You've also got a closing of rate and growth differentials. You've also got a situation where Japanese investors are going to be investing more at home in the coming fiscal year, and also policymakers on both sides of the Pacific would both like to see a stronger yen. So it does feel like the stars are becoming aligned. We're looking for a 10% appreciation in the value of the yen in the course of the coming year.

Otherwise just quickly to finish in terms of credit markets in credit, we continue to see credit spreads as tight. There's nothing too exciting to talk about here. But I would say, on the whole, credit will continue to perform ok as long as we avoid recession.

And sometimes people have asked me, “Okay, you've downgraded growth for the next six months in the US to 1, 1 and a half. What do you think about possible recession risks?” And here I'd say that you've probably taken your recession probability from around about 5% up to like a 20% level. But remember the US economy going into this sort of tariff shock and into this DOGE shock, is going into this shock with strong consumer balance sheets if anything.

We look at credit card data showing signs of underlying credit improvement in terms of the consumer. So consumer balance sheets are decent. We've got unemployment at low levels, we've got wage growth, so the underlying consumer is largely looking ok.

Corporate balance sheets are okay. You don't have too much leverage in the economy. Housing is actually looking a little bit better on the back of lower mortgage rates. And you've got ongoing investment in the economy in the AI space, which is also a positive growth driver.

So with all of that going on, and with not very much leverage in the US economy, I think it's kind of difficult to take the economy all the way towards, like a recessionary outcome at this particular point in time. But we will have to look at the data carefully. I know some of the forward-looking data sentiment indices have been sort of flashing red. But here we are mindful of the fact that you take a data series like consumer sentiment. Of course, if you're a Democrat voter, you're going to be saying that the future looks bloody, awful at the moment.

You're that much in despair at what you're seeing in terms of the policy agenda. So politics are actually having a bit of an impact in terms of some of those sentiment indices, but the hard data for the time being all looks relatively robust. I think if we do get surprised more by unemployment that may start to change. But in here and now we think that we avoid recession, it's still a low probability.

Credit probably hangs in there, albeit it's made sense for us, and we've articulated this on previous calls to be somewhat cautious in terms of the investment stance, because credit isn't very cheap and there'll be many assets out there that you'll probably get an opportunity to buy at a cheaper price if there is a bit of a moment of volatility over the course of the weeks and months to come.

So this is how we've been tending to think and how we've been set up. We continue to like European financials, We continue to like other areas that offer safe carry.

But with that I'm mindful of time. I've spoken for 25 min. I said I would allow some time for questions.

And the first question I have is, “Are there any historical analogues that you would compare to the current market environment to?”

Well, I think that's an interesting question. I mean, I guess I often like looking back at history. Sometimes we can be prone to saying we're living in unprecedented times, can't we? And I think that sometimes we can almost be caught up with the hyperbole of what we're currently seeing. That said, I do think what we're seeing in terms of the US policy agenda here, certainly, in its relation to many of its allies, is very different to anything that I have witnessed, and I have seen through 30 years in the market myself.

In many respects it feels like some of the norms that have held sway since the Second World War are being sort of shredded in front of our eyes, albeit when I do speak to the US what they're saying is, what matters in foreign policy is China.  China, that's all they care about. They need to pull Russia away from China. They need to isolate China.

As it comes to Ukraine, they don't care about it. It's a European problem for Europeans to sort. So, this is the mindset the Americans have. But the way that they're going about it, the rage that they are creating in some of their traditional allies and partners is unlike anything that I've seen.

That said I would say that what we're looking at here is a negative supply shock. We have seen other examples of negative supply shocks, haven't we? Covid, if you like, was the mother of all negative supply shocks. And so there are echoes in terms of the economic impacts and the market impacts that we might expect to learn from and draw from in terms of historical experience.

I'd also highlight that when it comes to tariffs it's not just prices going higher. This is going to be about supply chain disruptions as well. All of those dislocations could be quite messy and quite difficult, we think, in the course of the coming weeks, and so something to keep an eye on. But we'll continue to try and draw on past experience.

The second question is, “With credit spreads rising, albeit not that much, is the behaviour of the market acting in a similar fashion to what we see at the end of a cycle like in ‘98 or 2007?”

Well, yes and no. I think the one thing that I would observe in those other couple of moments was there was a lot of leverage, particularly in 2007. We had ended up with huge amounts of leverage.

I remember the age of CDOs, and even as you got into 2007 CDOs weren't giving investors enough spread. So what did we end up inventing not me personally, I'd like to add. But what did the market end up innovating? CDOs-squared. So it felt like you were putting leverage on leverage.

And so from that perspective, I feel that you're not seeing the same sort of risk taking behaviour today away from the one obvious exception which is in private markets. I think private markets are not in great shape at all. I think they're very exposed to higher funding costs effectively. Rates which are higher for longer are toxic for anything with too much leverage has kind of been my mantra, and so I do have concerns around some of what I'm seeing in terms of some of the SRT transactions and some of the other financial innovation around NAV lending and leverage within private markets to try and juice returns. This is something to keep an eye on, but otherwise in terms of IG credit in terms of high yield credit. Actually, credit quality balance sheets are pretty strong, fundamentals are more robust than we've seen in those moments.

The one thing that I would say has got more of an echo to other sort of past episodes has maybe been the overvaluation that we've seen in certain parts of the US stock market, and the fact that we've ended up with very narrow leadership, which, of course, is now being called into question.

And lastly, current views on France. I'm so sorry I didn't get to mention France. Of course I so should have done. Look, I think the French should have learned the mistake that the US made. If you try and bar someone from office using the courts, you'll probably add to their popularity and not detract from their popularity.

It also gives Le Pen cover to actually bring down the prevailing government in the summer calling new elections, which I actually think that the National Rally will end up winning. So I think that you could end up with political turmoil in France.

 I don't think that this is good for OATs and OAT spreads and so one of the views that we've embedded in portfolios is a long position in Italy relative to French Government bonds. I think that spread there through the course of the year could end up hitting a flat spread at some point in time.

But with that I'm going to stop. Thank you for joining, good luck in the markets. Good luck tomorrow on Liberation Day announcements. I hope this call has been interesting and useful to you. I look forward to speaking again in a month's time. Thanks for now. Bye.