Fantasia

This week I witnessed a Pink Wig Parade, and a Cornish themed carnival procession. Entertaining the crowds were a Venezuelan salsa troupe; a Fleetwood Mac tribute band; and a Red Arrows aeronautical display over one of the deepest natural harbours in the world, where a huge cruise ship was anchored. But still, the weirdest thing I saw, was US President Donald Trump’s press conference where he announced the deployment of the National Guard to Washington, D.C. Such is the backdrop to life in 2025 where fiction and truth dance the fandango. Beyond the memes it is hard, albeit still possible, to decipher what investment strategies could work, and what might ultimately fall victim to the ephemeral risks. Thankfully, the market-based system is robust, and thankfully bonds sit at its centre. If you want income, you got it.

• I still like: Short duration credit, inflation linked bonds and high yield.
• I’m worried about: US equities, the US dollar and potentially wider credit spreads

Coastal microcosm 

I tend to spend a lot of the summer in Falmouth, Cornwall, in Britain’s far south-west. In this epoch of climate change, it’s more comfortable than the Med. The scenery is amazing, the water alluring and the local food is delicious. I still look at markets – my Bloomberg screens are always on – but not quite as much as when I am in the office. It’s more of a time to think more broadly about economics and markets, as well as how many times a week is it acceptable to have fresh mackerel for dinner!

Being outside the metropolis you notice how evident income disparities are and how tough a time the UK economy is enduring. The local high street has more than the usual number of shuttered retail units this year. The town is very busy with tourists, some of whom I am sure are put off going to Europe because of the cost and extreme heat. But tourists on holiday are not your core shoppers at low-end retail stores, and they seem to be the ones struggling. Gossip has it that the property market peaked some time ago. Yet, the local boatyard, famed for manufacturing and maintaining luxury yachts, is booming and is set to expand operations in the coming years. The local scene is a microcosm of the national economy - little growth, under-employment masked by the proliferation of low-paid jobs, but quite visible evidence of wealth.

Meme life 

The details of economic life don’t always fit with the bigger picture macroeconomic view. There are so many different narratives - some positive, some negative. That has always been the case. Today, a new narrative is taking hold: the meme economy, where political bias, market manipulation and fake news hold sway and stories develop a life of their own, often in total detachment from reality. Much of the narrative is nonsense, and only gets aired on social media, but some of it is at the centre of economic policy and geopolitical relations. Over the past week, Trump has called for the resignation of a leading US technology firm’s CEO; threatened to impose an export tax (are import taxes not enough?) on semiconductor sales to China; and criticised the management and economic research team of a bulge-bracket investment bank for - in his view - getting it wrong on the economy. These are not normal events and thus make it difficult to perform normal analysis of where the economy and markets are going.

Trump’s team claim there is no evidence of tariffs leading to higher inflation, even though core inflation rose from 2.9% to 3.1% in July and the inflation report shows sizeable increases in inflation rates for certain consumer goods. In the wake of the data, Treasury Secretary Scott Bessent called on the Federal Reserve (Fed) to cut interest rates by 150 basis points. The Administration hopes to have its own economist, Stephen Miran, on the Federal Open Market Committee by the time the next interest rate decision is made on 17 September. The news of a 0.9% increase in producer prices in July (and 3.3% compared to a year earlier), again evidence of the tariff effect, means that there is going to be an interesting policy discussion at the Fed. And then there are reports of a new wave of retail-driven rallies in meme stocks which have helped, alongside everything else, to drive the S&P 500 index to a new all-time high (the usual references to massive overvaluation apply). And this weekend, Trump is to meet Russia’s President, Vladimir Putin, so that the US and Russia can decide which parts of Ukraine’s invaded territory it can keep. Oh, for simpler days.

Good news 

The Trump administration sure spins a good story. The government is doing deals. Billions of tariff revenue is flowing into the Treasury’s coffers. Inflation is low (it’s certainly lower than the average during Joe Biden’s administration) and the labour market is strong, despite what those spurious non-farm payroll numbers told us a couple of weeks ago. The “experts” have been wrong – there is no economic catastrophe. With corporate earnings growing at a double-digit pace, why shouldn’t the stock market be reaching for the stars? It is generally only people that have been trained to understand lagged effects in complex economic networks that are arguing that the worst is yet to come, while the anxiety about rising prices and slowing job growth is dismissed by the meme narrative.

Where is the money coming from? 

The latest US Treasury daily statement (11 August) shows customs revenue (tariffs) standing at just under $155bn in the current fiscal year to date. Someone is paying money to import goods into the US, and it is not foreign firms or governments. Foreign exporters might be cutting their export prices to offset the tariff impact, at their own economic loss (and at a push, their governments’ if it results in lower corporate taxes), but estimates of the tariff impact fall mostly on US importing companies and consumers. There is a tax transfer from the private to the public sector, while there is also evidence of an income loss for consumers because of higher prices. But the negatives don’t fit the meme. And they may never do, because the most important trading partner of them all, China, keeps getting 90-day postponements to any additional tariffs.

Trust 

Why am I bothered with all this? I guess I can’t get away from the feeling that policies that are appropriating income from the private sector, which are interfering with federal institutions’ independence, play an important role in the US economy management, and that may – because of political pressure - be driving corporate leaders to make suboptimal decisions, that will ultimately have some negative macro and market implications. Trust is important in investing – ask any corporate analyst weighing up whether a firm’s management will make a dividend payment next quarter; or dilute the equity; or be able to sustain the current credit rating. If trust is compromised, then investors should receive higher returns in the form of risk premiums. For the US to remain exceptional, the trust is that the policy meme will continue to stay convincing, and the artificial intelligence bubble will continue to generate enough earnings to monetise the increasingly stratospheric valuations. All will be revealed in time, but there is enough to think about when investors have US dollar exposure. Last year’s exceptionalism has transformed into this year’s fantasia.

No bond catastrophe 

Meanwhile, in bond land there is stability. US Treasury yield volatility has been even more contained this summer than is typically the case, despite the concerns about the Fed, inflation, and the long-term budget situation. Yet one doesn’t have to trawl social media for very long to find doomsday predictions about the global government bond market. Luckily, these come from remarkably uninformed people who don’t understand the role of government bonds in the financial system and don’t understand the income flows that are represented by interest payments on government debt.

Around one quarter of US Treasury debt is held by foreign institutions, which is a function of the long-term funding of the structural US trade deficit and the need for foreign central banks to hold reserves to support their own international liquidity. There is not really anything necessarily nefarious about this, although the concentration of these foreign holdings in just a few countries does give Americans some cause for concern. There has been little evidence of foreign investors selling Treasuries. They are a required core component of global finance. The fact that 10-year yields are hovering around 4.25% show demand is strong – this must really annoy the debt Cassandras.

The rest of the debt is held by federal agencies such as the Federal Reserve and the Social Security Trust Funds (guess why? Yes, to pay social security checks); by pension funds and insurance companies; by mutual funds, banks and individual savers through their brokerage accounts, or in the form of tax-efficient savings bonds. When the Treasury makes coupon payments the money benefits, by and large, American bond holders. It’s income for savers and pensioners that supports living standards or is reinvested as capital, benefitting the US economy. And it’s the same in other countries. One article I read on X (formerly Twitter) suggested the high level of US interest payments on Treasury debt is just going to foreign governments and bankers. I suspect bankers have more lucrative ways of making money than holding a 4% coupon Treasury note.

Fiscal concerns 

This is not to belittle concerns about debt stability. The more tax revenue is devoted to just paying interest, the less there is for governments to fund welfare and investment. And there will come a point when increased demand from government for borrowing will start to crowd out private borrowers. But I don’t think we are anywhere near a crisis yet. In the US, federal debt interest payments represent about 14% of total outlays. That is high, and back to levels seen in the 1980s and 1990s. Since then, relatively low rates have reduced the pressure on governments to restrict spending – and lower rates allowed them to respond aggressively to the economic shocks of the global financial crisis and the pandemic. Higher rates – which mean higher interest payments – should increase pressure on governments to get borrowing under control. In the UK, net interest payments represent around 8% of current government expenditure and this has been remarkably stable for the last two decades. Nevertheless, elements within the UK media are screaming about it and pushing the Labour government into more tax increases this autumn – just what a low growth economy does not need. It should also be kept in mind that Treasuries can adjust their borrowing, with the general level of bond yields lower than their 2023 peak, and short-term yields being considerably lower.

Risks but steady returns 

There are reasons to be concerned about the fiscal position in the US and the UK. The US, because the current Administration has just loaded additional debt onto the medium-term budget outlook and, currently, prefers a regressive tax system. The average coupon on Treasury debt maturing in the next five years is around 2.75%, so the cost of borrowing is going to keep rising as old debt is replaced. Under the current Administration that will mean seeking more funding at the short end of the curve as well as pursuing further attempts to restrict spending on entitlement programmes and other areas of federal spending that don’t align with the Trumpian agenda. For bond investors it means more supply of Treasuries with higher coupons than the bonds that they currently own, so higher levels of income. We should not discount what that income goes to finance!

Concerns about the UK stem from the weak growth profile (the 1.2% growth rate in the second quarter was mostly driven by government spending) and it is difficult to see government borrowing coming down without further tax increases. But the central and embedded role that government bonds play in our economies means that it will take a lot to really disrupt those markets. In the meantime, I remain positive on fixed income. Evidence from recent years suggests volatility and yields pick up in the second half of the year, but not by enough to warrant aggressive shorting of the bond market. The income available is too precious, alongside the low level of volatility of fixed income relative to equities. To the end of July, the income component of total return performance was 1.9% for US Treasuries and gilts; 2.8% from high grade US dollar and sterling-denominated corporate bonds, and from euro high yield; and 3.9% from US high yield bonds. Income from bonds is beating inflation. Income from credit will increasingly beat cash returns as rates fall in the US and UK.

Reality works, more or less 

In any society, the distribution of savings is not equal. There are disparities in income reflecting differences in ability, opportunity, education and luck. Higher income earnings tend to save more and require less debt. Lower income earners can’t afford enough debt to provide a sustainable minimum standard of living, hence governments issue debt to provide that through welfare, health and education spending. The rich buy the bonds and benefit from the interest income (which of course they partly finance through taxes). It’s the financial plumbing of the social democratic/capitalist system which has proved to be resilient since the middle of last century. And it has allowed acquirers of financial assets to increase their income and wealth. Thus, we should retain confidence in the system whatever the current memes are and whatever the ‘crypto nerds’ tell us. But the system needs to be allowed to work with acceptable levels of transparency and with relatively unencumbered market forces. That is at risk in the US at the minute, but for now, the bond meme is more attractive than the stock meme.

Here we go 

I tend not to discuss football so much these days. But the sun is still shining and it’s the opening weekend of the Premier League – what is there not to be excited about? I see that the sports results forecaster Opta predicts that Manchester United will finish outside of the top 10. I would take that bet. United have spent wisely and should be much more competitive than last time out. I think it will be a close title run, with several clubs in contention. Check with me in November to see how long the optimism lasted…Man United and gilt 61s, it’s the hope that kills you.

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, AXA IM, as of 14 August 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.