United States: Growth Fears Collide with Stagflation Risks

The US economy is showing signs of losing momentum, with a series of lacklustre data releases shaking investor confidence. Equity markets sold off late in the week, with the S&P 500 falling 1.7% on Friday, its steepest decline since December. The market reaction was not tied to a singular catalyst but rather an accumulation of discouraging economic signals that suggest the hot US economy may be cooling faster than expected. PMI data revealed that business growth is teetering on stagnation. Services activity contracted for the first time in more than two years, offsetting a modest rise in manufacturing. But even the manufacturing sector is flashing warning signs, with export orders falling sharply. Housing data was equally discouraging, with new housing starts and existing home sales plunging. Mortgage applications softened, reinforcing concerns that higher borrowing costs continue to dampen consumer demand.

Consumer sentiment has taken a turn for the worse. The latest University of Michigan consumer confidence survey plunged 9%, its largest drop since last April. The deterioration was broad-based across all income and age groups, suggesting that elevated prices and policy uncertainty are weighing on household sentiment. The biggest hit was in buying conditions for durable goods, which fell 19% as consumers grew wary of the inflationary impact of tariffs. The evolving narrative around tariffs is starting to feed into inflation concerns. PMI survey respondents overwhelmingly blamed rising input costs on trade policies, as tariffs and supplier-driven price hikes began filtering through supply chains. Inflation expectations ticked higher, and fears of stagflation have surfaced. While cooling growth could theoretically help tame inflation, rising trade-related costs complicate the outlook, particularly as long-term inflation expectations diverge across political affiliations.

Chart: Conference Board Consumer Confidence Index

Inflation pressures remain a concern, particularly after Core PCE, the Federal Reserve’s preferred inflation gauge, rose 0.3% in January, up from 0.2% the previous month. While this was within the expected range of 0.4%, it reinforces concerns that inflation remains sticky despite slowing economic growth. With annualised inflation still above target, the Fed faces a challenging balance between preventing an economic slowdown and maintaining price stability.

The evolving narrative around tariffs is starting to feed into inflation concerns. PMI survey respondents overwhelmingly blamed rising input costs on trade policies, as tariffs and supplier-driven price hikes began filtering through supply chains. Inflation expectations ticked higher, and fears of stagflation have surfaced. While cooling growth could theoretically help tame inflation, rising trade-related costs complicate the outlook, particularly as long-term inflation expectations diverge across political affiliations.

Chart: Core PCE Percentage Change, US Bureau of Economic Analysis

Labour market dynamics remain in flux. Initial jobless claims jumped to 242,000, up from 220,000 previously, exceeding the forecast of 225,000. The rising trend suggests that labour market conditions may be softening. The full impact of federal job cuts has yet to materialise in economic data. However, analysts estimate that corporate restructuring efforts, including those at Musk-backed federal projects, could add as many as one million workers to the job market. Such a shift would represent a 15% increase in unemployment, potentially disrupting wage growth trends and influencing Fed policy expectations.

Despite these macroeconomic headwinds, the Fed remains on the sidelines at the moment, with monetary policy taking a backseat to fiscal policy uncertainties. Market participants are closely monitoring whether a worsening economic backdrop and financial market volatility could exert pressure on the administration to adjust its tariff strategy. If growth continues to slow while inflation remains sticky, the risk of stagflation could drive renewed volatility across equities, credit markets, and interest rate expectations.

United Kingdom: Inflation Risks Rise Amidst Policy and Trade Crosswinds

The UK economy is facing a complex inflexion point. Inflation risks have resurfaced, driven by stronger-than-expected pay growth, placing the Bank of England in a precarious position. Deputy Governor Dave Ramsden has acknowledged that risks to the inflation outlook are now “two-sided,” as wage growth has consistently outpaced expectations. The latest data revealed that private sector earnings climbed 6.2% annually in Q4 2024, exceeding forecasts and potentially complicating the BoE’s rate-cutting path. Markets have responded by scaling back rate-cut expectations, lending support to sterling, which posted its best month since September, rising 1.7% against the dollar in February.

Sterling’s strength has also been fueled by optimism surrounding US-UK trade relations. During his visit to Washington, Prime Minister Keir Starmer discussed a new trade framework with President Trump, raising hopes that Britain could sidestep the looming wave of US tariffs. Trump’s comments about a “real trade deal” have buoyed market sentiment, reinforcing the perception that the UK may emerge as a relative winner in a protectionist global trade environment. Foreign inflows into gilts, which yielded more than US Treasuries, further bolstered sterling’s rally, but its durability will hinge on sustained macroeconomic momentum and monetary policy clarity.

However, consumer demand remains fragile. The CBI Distributive Trades survey registered a retail sales balance of -23 in February, marginally better than January’s -24 but still underscoring subdued spending. Despite wages rising faster than inflation, persistently weak sentiment has led to the steepest deterioration in investment intentions in nearly six years. Yet, the housing market continues to defy broader economic sluggishness. UK house prices climbed 0.4% in February, outpacing expectations, with annual growth at 3.9%. Buyers have accelerated transactions ahead of the April stamp duty threshold rollback, contributing to short-term price resilience.

Chart: Annual Percentage Change in UK House Prices (Nationwide Building Society)

Europe

The eurozone’s economic trajectory remains fragile, with weak activity data reinforcing concerns that growth will struggle to accelerate meaningfully. The flash PMI for February stalled at 50.2, just above the expansion threshold but below expectations. Inflationary pressures have proven more persistent than anticipated, complicating the European Central Bank’s anticipated rate-cutting cycle. Markets are fully pricing in a 25bp cut in March, but ECB officials remain divided over the pace of further easing, particularly as energy-driven inflation risks linger.

Chart: HCOB Flash Eurozone PMI, S&P Global

Germany, Europe’s largest economy, continues to battle stagnation. The Ifo Business Climate Index was unchanged at 85.2 in February, undershooting forecasts, as firms grew more pessimistic about current conditions. Retail sales, however, provided a rare bright spot, rising 2.9% YoY, driven by online spending. Still, persistent weakness in manufacturing and construction raises concerns that growth will remain elusive.

Asia-Pacific: Diverging Trajectories in Growth and Policy

In Japan, retail sales advanced 3.9% in January, marking 34 consecutive months of growth. However, housing starts contracted 4.6% YoY, highlighting the sector’s structural changes. Meanwhile, Australia’s manufacturing PMI edged up to 50.6, reflecting cautious optimism.

Chart: Japan Retail Sales, Ministry of Economy, Trade, and Industry (METI) - Japan

However, demographic concerns persist in Japan, with the country recording its lowest number of births in 125 years. The ongoing population decline remains a long-term structural headwind for Japan’s growth amid ongoing structural and policy reform.

Outlook

The past week has reinforced a complex macroeconomic environment in developed markets, where inflation risks, trade policy uncertainty, and shifting monetary policy expectations continue to drive investor sentiment. With consumer confidence weakening and inflation risks persisting, high-quality fixed income remains an attractive hedge. Defensive equity sectors, such as consumer staples and healthcare, may 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.

At Regal Capital, we remain cautiously optimistic about high-quality fixed income as a defensive play, while selectively identifying opportunities in equities, particularly in areas that are less exposed to trade disruptions. The resilience of certain sectors, 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 in our approach, navigating these dynamics to uncover value in an increasingly intricate global landscape.

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