Muzinich Weekly Market Comment: Three is the magic number

February 10, 2025

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In our latest roundup of the key developments in financial markets and economies, we looked at how investors were able to shrug off more tariff news and whether the US administration can achieve its 3-3-3 economic plan.

Positive momentum in financial markets has continued into February, with government bond yield curves flattening — long yields leading the decline. Corporate credit prices continue to rise, with investment-grade bonds outperforming in line with falling government yields.

The US dollar is broadly weaker, with the Japanese yen emerging as the strongest G10 currency, perhaps the result of recent hawkish comments by Bank of Japan officials to prepare investors for further policy tightening.^[1] Meanwhile, in emerging markets, the Chilean peso is benefiting from rising copper prices.

Most commodity prices are trending higher, except for oil, with the US administration’s plans to increase domestic production^[2] weighing on sentiment. Equities also maintained their positive momentum, with the Hang Seng Index standing out as last week's top performer, aided by China’s cautious response to US tariffs after the country returned from the Chinese New Year holidays.^[3]

Easy does it

The Bank of England (BoE) cut its policy rate by 25 basis points (bps) to 4.5%, as expected.^[4] The surprise was that two members of its Monetary Policy Committee voted for a more aggressive 50bps cut. Initially, investors interpreted this as a dovish signal, but BoE Governor Andrew Bailey later clarified in a press conference that the committee remained committed to a "gradual and careful approach" to monetary policy adjustments.

The BoE’s updated economic forecasts project that headline inflation will rise sharply in the near term, peaking at 3.7% in Q3. Meanwhile, the central bank has grown more pessimistic over the UK’s short-term growth prospects, estimating that output contracted by 0.1% in Q4 2024, a downward revision from the 0.3% growth forecast in November. Q1 growth is also expected to be weaker, at just 0.1% (down from its previous estimate of 0.4%).^[5]

Fears of UK stagflation have returned, with investors more focused on the UK’s growth prospects than the inflation spike driven by rising utility bills. Since the start of February, the overnight interest swaps market has priced in an additional 10bps of rate cuts, with policy rates expected to decline to 3.82% by year-end.^[6]

The key data release from the Eurozone was the European Central Bank’s (ECB) main gauge of wage growth. The wage tracker now predicts salaries will rise by 1.5% by the fourth quarter of 2025, slightly above the 1.4% projection from December but significantly lower than the 5.3% peak recorded a year earlier.^[7]

This is encouraging, as ECB President Christine Lagarde has recently emphasized that wage growth — particularly in the service sector — is a key driver of persistent inflation. If slower wage growth materializes, the ECB is unlikely to hesitate in easing policy back to neutral or even shifting to an accommodative stance in the event of a tariff-driven slowdown.

Tariffs (again)

In the US, the new administration’s policy agenda continued to grab the headlines. The market initially reacted negatively to the expected implementation of a 25% additional tariff on imports from Canada and Mexico and an additional 10% tariff on all Chinese imports. This reaction was unsurprising, given that these three countries collectively account for around 40% of US imports.^[8]

In response, Canada and Mexico swiftly announced new border measures, before the US formally postponed the tariffs until March 4.^[9] Meanwhile, China’s retaliation was measured, imposing tariffs totalling just $14 billion on American products, with expectations increasing that the two nations will reach an agreement before Chinese tariffs take effect on February 10.^[10]

Investors seem to be of the view that events could have turned out worse if the price appreciation seen across most financial assets is anything to go by.

The rule of three

Tariffs are a powerful negotiation tool for the US administration, resembling the classic game of chicken, with the US confident its opponent will be the first to yield. If one side backs down, the outcome is positive. However, investors should be mindful of what could happen in financial markets if neither party yields in time.

The tariff drama overshadowed a revealing interview with new US Treasury Secretary, Scott Bessent, on Fox Business Network, where he gave more details on the administration’s economic plan, dubbed ‘3-3-3’:^[11]

• Boost US petroleum production by 3 million barrels per day, by developing Alaska’s natural resources, which would help address inflation issues in the economy.
• Achieve real GDP growth of 3% by extending the Tax Cuts and Jobs Act and deregulating the banking sector to encourage more lending.
• Reduce the fiscal deficit to around 3% (from the current 6.9%) by reducing government spending, such as the dramatic cuts to the US Agency for International Development by the Elon Musk-led Department of Government Efficiency.

Bessent also explained the administration's focus on lowering borrowing costs, specifically by reducing 10-year Treasury yields rather than the Federal Reserve’s short-term interest rate. Bessent said the decline would be driven by falling oil prices and a shrinking fiscal deficit.

It is easy to be a cynic, but there may be holes in all 3 parts of the plan.

First, convincing private oil companies to ramp up production as prices and profits decline may prove a tough sell. And inflationary pressures in the US remain closely tied to its tight labour market and are unlikely to ease if growth is at 3%.

Second, excluding the rebound from COVID-19 in 2021, the US economy has grown 3% or more just once in the past 20 years. Cuts to government spending — one of the key drivers of recent growth — would make achieving the target even more of a stretch.

And finally, the goal of halving the fiscal deficit seems at odds with implementing tax cuts. That’s before factoring in the impact of a global tariff war.

Past performance is not a reliable indicator of current or future results.

References

[1] Bank of Japan, ‘Speech: Japan's Economy and Monetary Policy,’ January 14, 2025
[2] Crude Oil Prices Today, ‘Can Trump Really Boost U.S. Oil Production?’ February 1, 2025
[3] BBC, ‘China calls Trump tariffs 'discriminatory' in WTO complaint,’ February 5, 2025
[4] Bank of England, ‘Monetary Policy Summary,’ February 6, 2025
[5] Bank of England, ‘Monetary Policy Report,’ February 6, 2025
[6] Bloomberg, ‘Market implied policy rates,’ as of February 7, 2025
[7] Bloomberg, ‘ECB’s Wage Tracker Points to Steep Slowdown This Year,’ February 5, 2025
[8] Deutsche Bank, ‘Early Morning Reid,’ February 3, 2025
[9] Bloomberg, ‘It’s Almost Like They Knew Trump Was Bluffing,’ February 4, 2025
[10] Bloomberg, ‘CLP leads gain on China’s cautious tariff response,’ February 2, 2025
[11] Fox Business Network, ‘Scott Bessent addresses Musk’s influence on US Treasury amid Dem ‘squawking’’, February 5, 2025

 

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