United States: Inflation, Labor Market Resilience, and Policy Uncertainty

The US economy remains at the centre of investor focus as inflationary dynamics evolve amid an increasingly restrictive trade policy stance. The February Consumer Price Index (CPI) eased to 2.8% year-over-year, below expectations, and the core inflation print softened to 3.1%, the lowest since 2021. Producer prices stagnated, offering further evidence that inflation pressures may be receding, strengthening the case for Federal Reserve rate cuts in the latter half of the year.

While actual inflation metrics have moderated, inflation expectations have surged as the University of Michigan Consumer Survey’s year-ahead inflation expectations rose sharply to 4.9%, the highest since 2022, while the five-year inflation outlook jumped to 3.9% marking the steepest month-over-month increase since 1993. This divergence presents a challenge for the Federal Reserve, as softening inflation data suggests room for policy easing, but deteriorating consumer sentiment and rising long-term inflation expectations introduce an element of caution.

However, the labour market remains unexpectedly resilient. Job openings rose by 232,000 in January, surpassing expectations and suggesting that while hiring has slowed in some sectors, the overall employment landscape remains tight. The University of Michigan’s consumer sentiment index, however, plunged to 57.9, its lowest since November 2022, signalling growing unease over economic uncertainty and the administration’s aggressive tariff policies. The trade landscape remains turbulent, with Trump’s escalating tariffs targeting key trading partners such as Canada, Mexico, and the EU. The administration’s imposition of a 25% levy on steel and aluminium imports, followed by retaliatory measures from the EU and Canada, has rattled markets. Investors are concerned that corporate investment and consumer confidence could further erode, despite the resilience of the labour market.

United Kingdom: Fiscal Strains and Market Volatility

The UK economy contracted by 0.1% in January, an unexpected decline that adds pressure on Chancellor Rachel Reeves ahead of the Spring Statement on March 26. Weakness in the manufacturing and construction sectors was particularly pronounced, with output falling by 1.1% and 0.2%, respectively. Retail sales growth slowed sharply to 0.9% year-over-year, reflecting the continued impact of the cost-of-living crisis. The bond market is flashing warning signals, with UK gilt yields climbing back above 4.7% amid concerns over increased government borrowing. Reeves faces the challenge of balancing spending cuts and market stability, particularly as bond investors demand fiscal discipline.

Meanwhile, the Bank of England held rates steady at 4.5% this past week, citing persistent inflation risks and labour market tightness. Wage growth remains elevated, and policymakers remain cautious about cutting rates prematurely. Sterling fell 0.25% against the dollar, while UK equities struggled amid rising bond yields.

Eurozone: ECB Policy Shift, Trade Retaliation, and Fiscal Expansion

The European Central Bank cut its benchmark rate by 25 basis points to 2.50%, marking a key pivot in its monetary policy stance. Eurozone inflation declined to 2.4% in February, with core inflation easing to 2.6%, supporting expectations of further easing in the months ahead. However, ECB policymakers remain divided, with Isabel Schnabel warning against excessive rate cuts given lingering inflation risks. Meanwhile, European equities outperformed US markets, with the DAX up 14.8% YTD versus a 3.9% decline in the S&P 500. Investor rotation into European assets is accelerating, driven by trade uncertainty and Germany’s fiscal expansion plans, which include a €500bn infrastructure fund and unlimited defence borrowing.

Trade tensions escalated further this week, with the EU retaliating against US steel and aluminium tariffs with levies on €26bn of American goods. The Trump administration responded by threatening a 200% tariff on European alcohol imports, exacerbating fears of a prolonged trade war. The euro strengthened 0.5% against the pound, benefiting from rising capital inflows and expectations of looser fiscal policy in Germany. However, corporate sentiment remains fragile, with German industrial giant Thyssenkrupp announcing 1,800 job cuts, and Volkswagen’s Cariad unit planning to lay off 1,600 employees.

Outlook

The past week has reinforced the complexity of macroeconomic forces shaping developed markets. Monetary policy is becoming increasingly accommodative, with the ECB leading the charge on rate cuts, and the Federal Reserve moving toward a similar path later this year. However, geopolitical risks and trade policy uncertainty continue to weigh heavily on global markets. With consumer sentiment weakening and inflation risks evolving, high-quality fixed income remains an attractive hedge, particularly in the US and UK, where central banks may be forced to cut rates sooner than expected. Defensive equity sectors, such as consumer staples and healthcare, are likely to outperform cyclicals in a slowing growth environment.

The dollar remains vulnerable to shifting rate expectations, while gold and inflation-protected securities could see increased demand as stagflation fears rise. Meanwhile, European assets are experiencing a resurgence in demand, fueled by a weaker dollar, trade uncertainty, and Germany’s fiscal expansion. At Regal Capital, we remain cautiously optimistic about high-quality fixed income as a defensive play, while selectively identifying opportunities in equities, particularly in sectors less exposed to trade disruptions.

The resilience of certain industries, including technology and real estate, provides avenues for strategic allocation, but risk management remains paramount as policy uncertainties persist.

Looking ahead, trade negotiations, central bank decisions, and corporate earnings will be critical catalysts. We remain agile and nimble in our approach, navigating these dynamics to uncover value in an increasingly intricate global landscape

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