The activities of Trump, the European Central Bank and the Bank of England make up the market big picture over the past three months:
Trump tariffs trigger trade volatility: Q2 2025 started volatile as US President, Donald Trump introduced “Liberation Day”, with uncertainty surrounding tariffs. Designed to usher in a golden era of US manufacturing and economic growth, a new baseline 10% tariff on all imported goods plus some eye-watering additional 'reciprocal' tariffs on various countries was imposed, whether justified or not. By May, however, a US trade court ruled that Trump overstepped his authority in using the International Emergency Economic Powers Act for reciprocal tariffs of at least 10% on goods from most US trading partners and for the separate 25% levies on goods from Canada, Mexico and China related to fentanyl. As it stands, Trump's tariffs are to remain in effect for the time being after an appeals court granted a stay.
UK-US trade deal reached: May saw the UK and US strike a trade deal, despite uncertainty surrounding global trade policy. As a result, the US would scrap 25% tariffs on imports of British steel and lower tariffs on domestically manufactured cars from 27.5% to 10%, the rate which will remain for most other goods imports. Trump did, however, pour cold water on any ideas of seeing the UK deal as a template for other negotiations, saying that Britain ‘made a good deal’ and that many other trading partners may end up with much higher final tariffs because of their large US trade surpluses.
European Central Bank cuts rates twice: In terms of central bank movements, the ECB made the largest impression, lowering borrowing costs twice during the quarter, by 0.25% in both April and June. With inflation now just below 2%, ECB President, Christine Lagarde, said the central bank was in a ‘good position’ with the current rate path.
The Bank of England split on modest cut rate: The BoE cuts rates only once during the period, a 0.25% move during May. Although fully priced in by markets, the headline news came in the form of the BoE’s rate setting committee, which narrowly voted 5-4 in favour of cutting borrowing costs. Two Monetary Committee members, Swati Dhingra and Alan Taylor, voted for a bigger 0.5% cut, while the BoE’s Huw Pill and Catherine Mann wanted to keep rates on hold.
Middle East strikes spike oil prices: Over June, hostilities in the Middle East increased sharply. This began with Israel targeting Iran’s nuclear and oil facilities with the biggest wave of air strikes in years. The situation escalated when the US struck Iran’s three nuclear enrichment sites with 14 bunker busting bombs. As a result, Brent crude oil prices soared from $63 at the end of May to more than $78 on 19 June. An orchestrated ‘face saving’ attack by the Iranians on the US air force base in Qatar, which was communicated to the US in advance, was seen as a sign of de-escalation, which saw the oil full back to $67 at month end.
Asset allocation highlights
Tariff delays calm equity volatility: Trump’s “Liberation Day” tariffs caused volatility across most mainstream equity markets, with benchmarks whipsawing in the immediate aftermath of the announcement, only to snap back a few days later, erasing previous losses, as news broke that he would delay most of his proposals for 90 days to leave more time for countries to negotiate.
Europe leads: Similar to early 2025, for a sterling investor, European equity markets were the standout performer over Q2. Investors were drawn to the region’s attractive relative valuations, more unified political system, both coupled with an accommodative central bank. It was the influential German Benchmark that did most of the heavy lifting for the broader European index, hitting several record highs throughout Q2.
US tech rebounds: The volatility endured at the start of Q2 seem like a distant memory as the US benchmark staged a remarkable recovery from mid-April, delivering returns in excess of 5% to sterling-based investors by quarter-end. America’s largest company, Nvidia, is arguably the poster child. It announced during April that it would take a $5.5bn financial hit after Washington placed fresh restrictions on the export of its H2O AI chips to China, in the latest escalation of a growing battle for AI dominance. April’s losses made way to strong gains in May and June, and patient investors were rewarded with quarterly returns approaching 36% in sterling terms.
UK small caps outperform: Domestic small cap markets also enjoyed a very strong quarter, outperforming their blue-chip counterparts in the UK. Having previously struggled in the wake of the UK Chancellor’s October Budget, with its introduction of potentially inflationary measures such as increased NIC contributions from businesses and increased minimum wage levels, small cap stocks bounced back strongly. Spurred on by stronger than expected domestic economic data, an accommodative central bank and a trade deal signed with the US, Q2 proved to be a fertile period for UK markets in general.
Weaker US data hits dollar: The lower growth outlook and weakening confidence data in the US had a detrimental impact on the US dollar. The trade-weighted US dollar index declined by 7% during the quarter. The dollar weakened a further 6.3% versus the British pound over Q2, extending its depreciation since the start of the year to 9.7%. This foreign exchange translation effect will have proved a notable headwind for sterling investors that hold US assets.
Bond yield volatility: US Government bond yields proved to be exceptionally volatile over Q2. This was largely driven by fluctuations in macroeconomic inputs, which fluctuated between slowing growth and concerns about inflation, geopolitical tensions, along with credit rating agency Moody’s downgrading US Treasuries. Overall returns for the period did drag themselves into positive territory but it was at the margin. The UK and Europe Government bond yields fell over Q2 as core inflation moderated, with the expectation that the US tariff situation was likely to prove deflationary outside of the US.
Market outlook
Central banks remain cautious: Uncertainty concerning inflationary pressures are likely to keep the US Fed and BoE in a cautious mindset in terms of cutting rates. The full impact of Trump’s economic policies is likely to be inflationary in the US, although the precise impact of his tariffs is yet to be fully realised. However, both central banks are cutting twice by 0.25% increments by the end of the year.
Germany’s fiscal shift: Germany's ‘whatever it takes’ fiscal policy cannot be understated. After years of economic stagnation, the new German government wants to deliver a huge shift in fiscal policy, entailing a significant increase in defence spending and infrastructure investment. With the market focusing on geopolitical tensions, this shift in thinking has been largely overlooked by markets. While the ECB has cut eight times during the previous year, we still expect one more 0.25% rate cut to come before this year is out.
Earnings and valuations support equities: Despite the volatility experienced in stock markets over Q2, the performance of US companies should be supported by strong earnings growth. Despite the recent pullback in US equities, the US market should still be supported by strong earnings. While investors in European stocks will find a comfort in reasonable valuations and the likely pickup in growth supported through more accommodative fiscal policy.
Infrastructure taps into global megatrends: Infrastructure should provide exposure to major global megatrends going forward. Exposure to changing demographics, decarbonisation and digitalisation, all represent opportunities. Although there are risks from geopolitics and valuations, we believe that these are far outweighed by the positives.
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