And into the second half…

Slowing 

Global growth is slowing. Taking historical GDP data and forecasts from the International Monetary Fund’s World Economic Outlook, of the 18 largest economies in the world, only India and Spain will have a 2025 growth rate above their 45-year annual average. The aggregate measure of growth relative to the long-term trend suggests global growth slipped below trend in 2024 and will be even more so this year. This does not suggest there’s a recession coming just yet. But it indicates a growing risk of one. Historically, the US National Bureau of Economic Research has dated American recessions to periods when there has been a sharp deceleration, to below average in world growth. We are potentially at one of those inflection points and that clearly has asset allocation implications and for how investors should be positioned in fixed income markets. Slower growth should extend the monetary easing cycle and the scope for additional rate cuts is clearly more pronounced in the US and UK than it is in Europe.

Tariff tedium 

However, markets are not priced for a recession and much of the analysis suggests the world economy is resilient and can withstand the imposition of a modest level of US tariffs. But we don’t know what the eventual level of tariffs will be. One piece of investment bank research I read this week suggests the most likely outcome on 9 July is a 10% baseline tariff, and the US will endeavour to reach deals with other countries and retain a “negotiating stance” that threatens additional tariffs if no deal is reached. At the end of this week, market sentiment appeared to reflect a sense that there was progress between the US and China on a trade deal. It’s all a bit tedious really. Why not just have free trade? Never has so much potential economic damage been done for so little clear gain.

On hold 

There also appears to be optimism that the Federal Reserve (Fed) is closer to a rate cut. Market pricing suggests an increased possibility of a rate cut on 30 July - and a decent chance we could get three cuts by the end of the year. I’m not sure about that. Given the constant pressure on the Fed to cut rates from the White House, there needs to be real evidence from the hard economic data to justify such a move. These are not normal times, and although a rate cut based on lower growth forecasts might be justified, the credibility of the Fed is at risk. It may be too late, as President Donald Trump has already indicated that he has four potential candidates in mind to replace Fed Chair Jerome Powell. However, right now, rate volatility is modest and bond markets are doing their ‘safe-haven’ thing. 

Slower (growth) but higher (tech stocks)

What about the data? Final US first quarter (Q1) GDP growth data came out this week and showed a 0.5% contraction. Not too much should be read into this given the frontloading of imports and some easing of consumer spending after a very strong Q4 in 2024. But the trend is softer growth across most of the GDP components – in year-on-year terms the economy expanded by 2.0% compared to 2.9% in the same quarter last year. The quarter just ended will be interesting given the volatility around trade, the decline in business and consumer spending - and the real impact of tariffs on consumer incomes and business margins. Slower growth clearly raises the risk of the economy slipping into recession. The question is whether that is enough to derail the optimism of a stock market that is again being fuelled by rising prices for technology shares? As everyone ramps up their artificial intelligence spending, Nvidia’s share price could keep making new highs, as it did again this week.

Early signs

The Institute for Supply Management’s monthly surveys are always closely watched by markets. In the manufacturing survey there has been a clear drop in the imports index and a clear increase in the prices paid index – as one would expect from a tax on imported goods. Weekly jobless claims data has also been trending higher with the four-week average at 245,000 in the week ending 20 June compared to 223,000 at the end of Q1. Nothing dramatic, but enough to suggest the US is on a lower growth trajectory. Not enough for the Fed though. Not yet anyway.

Credit is rock solid 

Slower growth but no recession is generally supportive for a broad fixed income allocation. The bias is to lower interest rates – that remains my expectation. Even in Europe, where euro strength has resumed, the European Central Bank may find that inflation falls to too low a level and may be forced to follow the Swiss National Bank’s return to close to zero rates eventually. Even without such an extreme move, the interest rate environment should be supportive for corporates and for investors that want to maximise the bond portfolio income. In discussions with bond portfolio managers this week, the expectation is that demand for credit remains very strong and that corporate credit problems and defaults in the high yield market remain rare. Spreads are tight, but yields are attractive (5% in US investment grade and more than 7% in high yield).

Take the win?

Market returns in the first half have been much better than anyone would have thought given the trade war and the US getting directly involved in military action against Iran. Some equity returns are spectacular. Korea’s main stock index has delivered a total return of 29%, according to Bloomberg. Bond returns are modest but consistent with yield levels at the beginning of the year. The US high yield market has delivered a total return of 4.3% in US dollar terms; its total return index keeps making all-time highs. A full year return of 7% to 8% looks likely.

The starting point for the second half of the year is expensive markets and continued risks. If the choice was to lock in gains or chase higher returns, I think I know what I would choose. It’s not as if the Administration in Washington is suddenly going to become more predictable and orthodox, or that geopolitical risks have disappeared. The VIX index is at 16 and the one-to-five-year ICE Corporate Bond index is yielding 4.5% - both look good value!

Happy summer!

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 26 June 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.