May 12th, 2025 - The "S" beast could be around the corner.

The term "stagflation" comes from merging the words stagnation and inflation. It is perhaps the worst case scenario for any economy and eventually for its financial markets, as the central bank cannot react to stagnating economic activity and higher unemployment by lowering interest rates, because inflation is high and potentially rising. And as the FED has a dual mandate, which is "inflation at around 2% and full employment", it means that it will have to pick first the fight it can win between the two. The rational view would be that they will opt to allow for a recession to happen if inflation shoots up beyond 3-4% again, as this is one of the most effective deflationary medicines. Which means that they would have to raise rates, and this is a scenario than neither bonds nor equities are prepared for it, right now.

Speaking of the FED, it left interest rates unchanged but showcased its big concern about stagflation. Without, of course, mentioning the dreadful "s" word, there was abundant reference to the rising risks to inflation and increasing downside risks to growth, first in the statement and then in Powell's replies during the press conference. More important, in his prepared remarks, he used the words "respond in a timely fashion" and in the Q&A session, he said "when things develop, of course, we have a record of we can move quickly when that's appropriate". All of that shows that the FED will be re-active and not pro-active, which means that markets would have to go through pain and data to worsen significantly before we see some action by the central bank. On the positive side, they are not going to raise rates in anticipation of higher inflation, but only as a response to it.

The deals that President Trump announces are helping market sentiment, but reality stays the same. Taking first the UK-US example, which was marketed as a "huge deal", we see that the 10% universal tariff remained and the only achievement was the UK's intention to buy more beef, ethanol and planes. Progress on negotiations with China was also announced last night and it remains to be seen how low the 145% tariff can drop, but will probably remain in very high double digits. Overall, tariffs are in place at the highest level in decades and will affect inflation. Ford, for example, already announced an increase in prices of specific models, while Amazon hinted that it will start posting the actual tariff impact on the retail price of its products. Inflation is destined to move higher if tariffs do not completely go away.

Equities were under minor profit taking, after the relentless rally of late. The US indices fell marginally, by 0.3% on average, but some European markets showed resilience. German equities rose to a new record high, ending the week with a 1.8% gain and helping the Euro Stoxx 50 rise by 0.5%, as the new Chancellor, Mr. Merz, was finally voted after some drama that kept markets nervous for a few hours. Energy was the best performing sector, as speculation about BP being a takeover target boosted sentiment, while Healthcare was the worst as there is still uncertainty about Trump's intentions for tariffs. Last night he announced that he plans to reduce drug prices by 80%, which could lead to more selling pressure and uncertainty in the coming days.

The Bank of England cut rates by 25bps to 4.25%, as widely expected. However, the outcome of the vote was split with five MPC members supporting the 25bp reduction, two voting for a 50bp reduction and another two for keeping rates on hold. In terms of forward guidance, the Committee stuck to its previous message of “gradual and careful” easing and a meeting-by-meeting approach. Overall, this outcome reinforces market expectations of a gradual quarterly pace of cuts, implying now a pause on June 19, with the next cut on August 7.

China's exports surged 8.1% year-over-year in April. This rise comes after a 13% jump in March, ahead of the April 2nd "liberation day". But looking into the details we see that exports to the US fell 21% and the trade surplus with the US narrowed to 20.5bn from 27.5bn in the previous month. On the other hand, Chinese exports to South East Asian nations surged by 21% and to the European Union were up by 8%, which shows that China is finding alternative ways to ship its products. There is of course speculation that the surge in exports to South East Asian countries will eventually find themselves to the US.

Swiss inflation fell by 0.3pp to 0.0% in April , the lowest level in four years, sparking the debate for negative rates again. Inflation at zero undershot consensus expectations for 0.2% and it is also running below the SNB forecast for Q2 of 0.3%. The details were weak and the disinflationary impact of the recent CHF appreciation is not even in the numbers yet. Core inflation declined by 0.3pp to 0.7% y/y. The share of the CPI items which are exhibiting year-over-year deflation (i.e. negative inflation) is now at 55%, an all-time high. While the SNB has stressed that temporary deviations from its 0-2% inflation target range would be tolerated, current conditions as well as the prospect of weaker growth, point to another 25bp rate cut in June to 0%, but the risks are tilted towards a renewed move into negative rates.

Bonds retreated as the FED showed concern both for growth and inflation. The US 10yr Treasury traded closer to 4.40% again, up almost 25bp from the recent lows and the German equivalent rose close to 2.60%. This move higher confirms again our view that the recent low yields should have been avoided for purchasing more bonds, but now we are getting again closer to buying levels, in the high quality space, especially in EUR.

Chart of the Week : Gold has been a better investment than the S&P500 for the last 10 years ...

The above chart shows the performance in USD of Gold (blue line) and the S&P500 (in green) for the last 10 years. It is really amazing that in that time frame and thanks to the recent rally of Gold prices and the slump of US equities, Gold's return to investors has been larger ! We have to note that the S&P500 has also provided dividend payments which are not calculated in the above performance, to the tune of about 2.5% per year on average, and hence if we add all that up, US equities would still be a better performing asset class , albeit with a smaller margin than people would have thought. We should also note that this outperformance has come only in the last three months or so. For most part of the last ten years investing in Gold would have not produced superior results compared to owning the S&P500. Still, a fun chart to watch purely for recreational purposes.

Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

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• Sources: Chart of the Week : FactSet