What’s the price of uncertainty?

The three things investors need to know this week

1. Economic uncertainty is at pandemic levels.

2. As markets try to price in this kind of uncertainty, we are beginning to see significant volatility across assets, bonds outperforming equities and equities rotating into safer harbours.

3. The price of uncertainty is not too high - yet. Continued, however, constant decision-making gyrations could have a significant effect on the economy.

Summary

This is a time of extreme uncertainty, at least in peacetime. The world is as uncertain as it was in the depths of the pandemic.  The new US administration has applied a shock to the global economic and diplomatic system, far beyond anything we had seen. Making things worse is fluidity. Investors see not a clear change in direction, however painful, but rather what Gianis Varoufakis called “Creative Ambiguity”. So how is uncertainty priced in? 

A basic tenet of investment and economics is “markets hate uncertainty”. This is as true for Wall Street as it is Main Street. Investors need to have some sort of confident view on interest rates, economic growth and inflation to assess the profitability of firms. For businesses, it is exactly the same. Hiring decisions, expansion plans and capital structures all depend on some sort of visibility. Additionally, businesses need to have a predictable inflow of goods, i.e. a stable supply chain. 

The new US administration has applied a shock to the global economic and diplomatic landscape. And although it was not entirely unexpected (we had often said that Trump 2.0 would not be like Trump 1.0) the shock is still very real. 

Making things worse is fluidity. Investors see not a clear change in direction, however painful, but rather what Gianis Varoufakis called “Creative Ambiguity”. Within one week the US administration announced the execution of tariffs on Canada and Mexico which it had previously temporarily rescinded, then rescinded some of these temporarily again. “Reciprocal Tariffs” in essence, mean the creation of a very complicated system of individual tariffs on thousands of goods that may be under constant revision. That ambiguity extends internally. The Department Of Government Efficiency initially an all-powerful cost-cutting uber-ministry and the cornerstone of US economic strategy is now an “advisory” function, but still without clearing the actual mandate and its limits. 

Other countries, which initially held back in hopes that tariffs were all rhetoric, are now beginning to respond. Canada and China responded in kind. Europe, considering the long game, has opted for a significant expansion of its defence and infrastructure spending which may help Germany out of a recession. Germany opting out of a mercantilist model and opting for debt-fuelled growth gave an opening to France to extend its nuclear shield for other nations. In one short week, Europe moved forward in a way it hadn’t for years.  

The world in 2025 is as fluid and unpredictable as it has ever been in peacetime, bar maybe the Great Lockdown and the onset of the Global Financial Crisis. To quote Robert Armstrong and the FT’s “Unhedged” column: No! One! Knows! Anything!

So how is uncertainty priced in? What does it actually mean for businesses and portfolios? Certainly, the past few days Trump and Bessent warned of economic and investment volatility, what do portfolio managers actually translate this to? 

For one, uncertainty translates into asset volatility and diverging views between equity and bond markets. 

Bond yields in the US dropped and rose in the EU, as America sees a challenge to its growth, whereas the EU sees Germany potentially out of recession. 

Meanwhile, equity investors took to opposite route, rotating from US to Rest-of-the-World equities, from growth to value, from cyclical to defensives and from Developed to Emerging Markets. 

Adding to worries about US assets are two additional factors – boiling down to one: a weaker US Dollar. Dollar weakness and Yen strength are reversing the “carry trade” (investors borrowing in low-yielding Japanese Yen and investing in higher-yielding US assets) which fuels US assets. 

But the fact that equities didn’t correct but merely rotated suggests that the equity market is not yet wholeheartedly buying into the slower US growth argument (bar the cyclicals-into-defensives rotation), and certainly not pricing in a US recession. And whereas we in the investment profession usually look to the bond and not the equity market for macroeconomic forecasts, to quote Atlanta Fed’s Raphael Bostic “The direction of the economy is… very much up in the air”. So, equities rotating into sectors they have higher confidence in (like European Defence) is possibly the better reflection of uncertainty than betting on a US recession and sharp rate cuts. 

But we digress. The second fact worrying markets and bringing down the USD is rumours of a “Mar-A-Lago” accord. This refers to a possible 1985 Plazza Accord-style deal to devalue the US Dollar and allow America to re-industrialise. The dynamics of course are very different between now and then (China 2025 is not Japan 1985 and transatlantic relations are at a nadir), but a possible Dollar devaluation is now giving equity investors at the very least to look at attractively valued non-USD assets.   

Adding to risks on a more systemic basis is deregulation. While this was expected, the US government jumped the legislative gun and began weakening regulators.  Defanging agencies wholesale increases the probability of risks conflating, creating market Black Swans. 

And here we arrive at the dangers for businesses. First, there is the obvious, that businesses will become more risk averse. What does this mean?

• Less hiring.
• Less expansion and capital spending decisions.
• Less borrowing.

However, the impact of such uncertainty is bigger than a fluctuation in profits. Continued, it may define an economic cycle. 
You see, whilst financial markets may rely on central banks for a “put”, no such put exists for the Main Street economy, save for fiscal policy, usually backed by debt. At 325% global-debt-to-GDP this becomes more difficult. 

The price of uncertainty is not too high - yet. Some market volatility, rotation and portfolio managers becoming more wary of risk. The macroeconomy is experiencing a slowdown to be sure, but nothing too pronounced. If clarity is restored, even if the direction of travel is a perilous one, then businesses and markets will adapt. 

Continued, however, constant decision-making gyrations could have a significant effect on the economy. Equities have got it right that we are not there yet. Bonds are right that, the US at least, is heading in that direction. And Main Street is wondering how long it can keep its breath.

George Lagarias – Chief Economist

Market update

Last week saw significant moves in all asset classes - equities, fixed income and commodities. In GBP terms, global equities decreased by -4.2%, led by a -5.9% decrease in US equities, which was in part due to the weakening of the US dollar throughout the week (The pound rose by +2.7% versus the dollar). The US President's previously declared tariffs on Canada and Mexico of 25% and China of 10% saw delays and exemptions as the deadline of implementation approached. The uncertainty around tariff policy took a toll on investment sentiment and had an impact not only on US equities, with the major US indexes having the worst week since September 2024, but also the rest of the world. European equities were down by -0.8% in Euro terms, but increased by +1.0% in GBP terms thanks to a strengthening Euro, while UK equities decreased by -1.2%.

Germany’s potential next chancellor, Friedrich Merz, alongside the most likely coalition with the SDP, agreed to amend the constitution, exempting defence and security spending from the debt brake (0.35% of GDP) and proposing an off-balance sheet €500 billion special fund for infrastructure over a decade. German 10-year Bund yields jumped +45 basis points over the week. US and UK 10-year bond yields saw increases of +10 and +17 basis points respectively after a volatile week, reacting to tariff news and macroeconomic data releases (bond prices and bond yields move in opposite directions).

The price of oil saw a significant drop of -6.1%, following US tariff news, as well as a surprising (first since 2022) production hike from OPEC+ (alliance of crude producers) announced on Monday.

Macro news

The agreement of Germany's likely next chancellor, Friedrich Merz, and the coalition partners to exempt defence and security spending from the debt break and the proposed infrastructure funds contributed to a sharp German 10-year Bund yields. They jumped 24 basis points to 2.72% on March 5, the largest one-day rise since October 1998. The 30-year Bund yield also soared 24 bps, marking its biggest daily increase since October 1998.

The three key interest rates - deposit facility, main refinancing operations and marginal lending facility - were cut by -0.25% by the European Central Bank (ECB). This was announced at the ECB press conference, where the ECB President, Christine Lagarde, highlighted that the disinflation process is progressing well, with headline inflation expected to average 2.3% in 2025, 1.9% in 2026, and 2.0% in 2027, as well as other forecasts such as growth of 0.9% for 2025 due to lower exports and ongoing investment weakness stemming from high trade policy uncertainty. Lagarde emphasised a data-dependent and meeting-by-meeting approach to monetary policy, with no pre-commitment to a specific rate path, with decisions being aimed to ensure inflation stabilises sustainably at the ECB's medium-term target of 2%.

On 4 March, new US tariffs targeting Mexico, Canada, and China (including a 10% additional tariff on Chinese goods linked to fentanyl) took effect. A one-month exemption for US automakers was granted on 5 March, but markets still felt the heat. US stocks dropped for two days, with banks like Bank of America and Citigroup falling over 6%. Uncertainty over trade policy and potential growth slowdowns dominated sentiment.

On Wednesday, the Federal Reserve's Beige Book reported a slight increase in overall economic activity since mid-January. However, consumer spending declined, price sensitivity increased, and prices rose moderately in most regions. The report mentioned tariffs 49 times, further highlighting ongoing uncertainty about the effects of the US President Donald Trump administration's new policies.

China set a 2025 growth target of ~5%, launching a "special action plan" to boost consumer spending rather than industrial output, reacting to US tariffs. Beijing raised its fiscal deficit by one percentage point to 4% of GDP, the highest level in decades. It also announced plans to create more than 12 million jobs in cities, setting a target for urban unemployment at around 5.5% for 2025. The figure stood at 5.1% last year. The government also pledged to provide more support to high-tech industries, restore stability in the property market, and expand elderly care programmes for its ageing population.

Week ahead

Next week is probably less about macros and more about politics. The US and Ukraine will try to reset their relationship, whereas China and other countries begin to respond to US tariffs. We should also hear from Germany and Friedrich Merz’s attempt for a ruling coalition.