Market Update - 28 May 2025

As we approach the midpoint of 2025, investors find themselves grappling with a complex and shifting market landscape. The past few months have seen a remarkable V-shaped recovery, with markets rebounding from recent lows to return to their starting points. However, beneath this seemingly robust rally, there are indications that the current market strength may be more tenuous than it appears.  

One key factor contributing to the market's fragility is the pervasive illiquidity that has gripped markets, particularly in the fixed income sector. Capital flows have been largely paralysed, exacerbating price movements and making it challenging for investors to execute trades efficiently. This lack of liquidity has amplified the impact of even minor market shifts, leading to exaggerated price swings.

Compounding the uncertainty is the recent u-turn in U.S. fiscal and monetary policy. The administration has rolled back tariffs and abandoned its efforts to close the current account deficit, effectively reverting to the status quo of the previous year. While this policy reversal has provided some short-term relief to markets, it has also raised questions about the long-term sustainability of the U.S. economic trajectory.

Looking ahead, the critical juncture for investors will likely come in July or August when the U.S. debt ceiling is raised, and the Treasury resumes bond issuance. The extent of foreign participation in these auctions will be a key indicator of global confidence in the U.S. economy and the potential for future market stability. If foreign investors prove reluctant to engage, the U.S. may face a stark choice between allowing real yields to rise, potentially jeopardising growth and financial stability, or implementing yield curve control, which could fuel inflationary pressures in the longer term.

In the face of these challenges, we are being quite cautious in our positioning in the near term, which entails being moderately defensive but by the same token not deviating too much from benchmark positions. We need to be on our toes though as a potential end to so-called ‘U.S. exceptionalism’ could lead longer term disruption in markets as well as opportunities in other markets, particularly in emerging economies that may decouple from U.S.-centric trends.

In the medium term though, the spectre of stagflation still looms large. If the Federal Reserve is forced to implement yield curve control, the U.S. could find itself mired in a prolonged period of low growth and elevated inflation, akin to the economic malaise of the 1970s. In this scenario, investors may need to seek out alternative strategies, such as inflation hedges and exposure to markets with more favourable growth prospects.

Ultimately, we think the key to navigating the current market landscape will be adaptability and a keen eye for emerging trends.

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