Markets in Uncertainty: Policies, Geopolitics, and Investor Behavior

Oliver Bennett

Welcome to The After Market Party. I’m Oliver Bennett, your host for this evening. Tonight, we will delve into significant issues affecting the Federal Reserve and the European Central Bank. We will also review recent market trends and discuss the outlook for stock markets, bonds, and currencies.

Oliver Bennett

So, let’s kick things off by diving into how markets have been responding to political uncertainty—a powerful variable that, honestly, keeps many investors awake at night.

Oliver Bennett

Now, if we look back to the early days of Donald Trump’s presidency, you’d think markets would’ve been all over the place, right? And and in some ways, they were. Initially, his inauguration speech, which some dubbed 'responsible populism,' eased bond yields and oil prices. Market fears of irresponsible fiscal policy were dampened - at least for the time being.

Oliver Bennett

But the string of policy moves that followed unsettled investors. For instance, last week’s example of tariffs on steel and aluminum. They made a noise, no doubt. But what caught my attention was the broader fatigue setting into the market. You know, it’s like this constant stream of policy updates—some concerning, others just, well, drowned out by the sheer volume of it all. Investors are human, after all, and even the most rigorous minds can get exhausted by nonstop upheaval.

Oliver Bennett

Now, if we shift to market specifics, take the VIX index, often referred to as the fear gauge. It saw a spike early in the week, jumping above 17 on the back of poor inflation data and tariff chatter. But soon after, it dipped back to 15. It’s sort of like a roller coaster—peaks of anxiety followed by stretches of calm as markets either digest or dismiss the chaos of the moment.

Oliver Bennett

And speaking of roller coasters, bond yields followed suit. The US 10-year yield climbed significantly after the inflation report but eventually settled back, virtually unchanged. It's a testament to just how fickle sentiment can be when markets are processing what feels like an information overload.

Oliver Bennett

As for equities, European markets had their own brighter moment. Defence stocks hit remarkable highs, buoyed by speculation over increased military spending. Rheinmetall, BAE Systems, and Thales were the stars there. But there’s a bigger theme brewing—European leaders are strategizing not just for defence but for the broader economic implications of a Ukraine peace deal, which, if materialized, could ignite considerable spending and shift focus away from weaker growth elsewhere on the continent.

Oliver Bennett

What we’re really witnessing is a hard reset in how markets react to political headwinds. Investor perspectives are catching onto the pattern—a sort of Pavlovian response, if you will, where the assumption is: 'Well, this new tariff? It probably won’t stick.' You can see why that kind of mindset builds. The question, of course, is whether markets are too optimistic. Perhaps, in in this case, they may be underpricing some longer-term moves, especially as fatigue clouds judgment.

Oliver Bennett

So, all this begs the question, how does policy uncertainty, like potential tariffs, feed into deeper inflationary trends and central bank responses?

Oliver Bennett

Now, turning to central banks, the Federal Reserve is in a waiting game right now. Last week's CPI data came in a bit too hot for comfort—though that's not the whole story. Core PCE inflation, you know, the Fed's preferred measure, is expected to dip this year, but it’s still floating above target. And with tariffs lingering on the horizon, there's this tsunami-like inflation risk no one can fully ignore.

Oliver Bennett

What’s the Fed's take on this? Well, Fed Governor Chris Waller talked about holding rates steady—watching and waiting, basically. Philadelphia Fed President Patrick Harker echoed that sentiment, pointing out the balancing act between inflation risks and weak employment trends. It’s clear they’re sticking to this cautious on-hold stance for now. But markets seem to think we might see some 40 basis points trimmed off the rate this year. As it stands, the effective Fed funds rate could slip from 4.33% to somewhere around 3.95% later this year according to the forward pricing. This seems optimistic considering tariff-related inflation risks.

Oliver Bennett

Now, on the other side of the Atlantic, the ECB is moving decisively but cautiously in its own right. A 25-basis-point cut next month seems all but inevitable, which would bring the deposit facility rate to 2.50%. What’s interesting here is that even at 2.50%, the ECB still considers policy restrictive. The data isn't quite where it needs to be for them to confidently cut below that so-called neutral rate range of 1.75 to 2% just yet. Inflation’s easing in the coming months, but it’s gonna take more evidence before we see them venture into stimulative territory.

Oliver Bennett

Now, let’s talk perspective. Governing Council members Olli Rehn and Mario Centeno feel the ECB shouldn't shy away from dipping below neutral if growth remains weak and disinflation continues successfully. On the flip side, you've got hawkish voices like Robert Holtzmann and Joachim Nagel urging caution. Holtzmann even remarked that the closer we get to 'neutral,' the harder it should be to justify further cuts.

Oliver Bennett

And then there’s the markets—forward pricing reflects the general consensus, discounting a total of around 40 basis points of cuts through March and April. What happens beyond that? Well, it’s likely we’ll see a continued slow pace of 25 basis points cuts as the ECB assesses inflation’s trajectory and especially service inflation. For now, caution is the dominant theme. It’s tricky because lower growth forecasts make aggressive easing tempting, but the ECB has the purest form of inflation target as the policy objective.

Oliver Bennett

What this really underscores is how central banks are walking a policy tightrope; their credibility is tied to sticking to data-driven decisions.

Oliver Bennett

So, when we look at bond markets right now, one of the biggest stories is how US yields are behaving in this sort of choppy and frankly unpredictable environment. The US 10-year yield—well, it’s hovering in this ‘wait and see’ phase, right? It spiked briefly after that hot inflation report, but then circled back. What’s fascinating is how firmly it’s still tied to expectations about Fed policy. If markets were to completely remove all rate cut pricing, we could see the 10-year yield push up to around 4.80%.

Oliver Bennett

Now, the thing about US bonds is, they’re not just... you know, influenced by domestic inflation or Fed decisions alone. Tariffs, geopolitics, market sentiment—they’re all in the mix, and it creates this feedback loop of noise and reaction. It’s, well, exhausting to track but crucial to understand, especially as markets keep reevaluating inflation risk timelines and the odds of further easing.

Oliver Bennett

Now let’s switch gears to the German 10-year Bund. It’s kind of caught in its own balancing act, likely trading in that 2.30 to 2.60% range for months to come. The ECB’s cautious approach means markets aren't rushing to price in deeper rate cuts just yet. But here’s the kicker—if they do, and we see softer expectations steadily take root, the German 10-year Bund yield might get a dip to 2.30%, but it’s likely to be, well, temporary. The ECB’s hesitancy, you know, that gradualist mindset, might limit how fast or how far yields drop.

Oliver Bennett

And it’s not just about the ECB today. Longer-term factors are lurking, like the Eurosystem’s shrinking securities holdings. If bond yields were hoping for sustained downward pressure from rate cuts alone, well, this reduction in holdings could act as a counterweight. It’s like these opposing forces creating just enough tension to keep Bund yields tethered closer to that higher band. Softer ECB expectations will need time to build—markets, like the policymakers guiding them, aren’t exactly in a hurry here.

Oliver Bennett

But stepping back, this cautious dance between cuts and market reaction highlights how interconnected all these moving pieces are.

Oliver Bennett

Alright, shifting gears a bit to stock markets—Europe’s equities have certainly been making some noise lately, haven’t they? The STOXX 50 index just hit a new all-time high, breaking records we haven’t seen since 2000. And what’s fueling this surge? Well, the optimism surrounding a potential Ukraine peace deal is a major driver. It’s just fascinating how even the hint of geopolitical resolution can move the needle so significantly.

Oliver Bennett

But it’s not just a peace deal sparking movement. The defense sector is seeing an undeniable boom. Companies like Rheinmetall in Frankfurt posted a 14% rise, while BAE Systems in London and Thales in Paris weren’t far behind, climbing 9% and almost 8% respectively. The defense and aerospace index as a whole is at levels not seen since, well, the early 90s. And it makes sense—European leaders meeting in Paris to map out military spending strategies has investors betting big on a long-term uplift in defense expenditure.

Oliver Bennett

What’s intriguing, though, is how the policy environment is subtly shifting to accommodate these trends. Behind the scenes, Brussels sources—those so-called deepthroats—are reportedly referring to discussions ways to provide flexibility around the EU fiscal rules. Specifically, we’re hearing whispers about using a national escape clause to boost defense budgets beyond the usual borrowing limits. Letting countries sidestep fiscal rules is gaining traction among member states like Italy, Spain, and Greece. Even the Baltic countries are whispered to be on board.

Oliver Bennett

Von der Leyen, President of the European Commission, hinted at maximum flexibility just recently, though what that means in practice remains to be seen. Would allowances extend beyond defense hardware to include staffing, training, and maintenance? And would exemptions apply broadly across Europe, or only to countries directly pushing for defense expansions? These are, frankly, big questions policymakers will need to answer sooner rather than later.

Oliver Bennett

Meanwhile, the potential economic ripple effects of a peace deal in Ukraine really can’t be overstated. If the EU takes charge of reconstruction efforts, we’re looking at a mammoth EUR 500 to 1000 billion in spending over the next decade. In parallel, a significant decline in natural gas prices could further stimulate economic activity. Investor sentiment is already responding positively; last week saw the first net inflows into European equities in months, contrasting with plateauing U.S. fund flows.

Oliver Bennett

Now, it’s tempting to view all of this as a turning point for European equities. But let’s not lose sight of the uncertainties still looming large: the German elections on Sunday, potential U.S. tariff escalations, and a macro landscape that’s barely showing green shoots of the Eurozone growth. Even so, these rumor-driven tactical rallies suggest markets are, at the very least, open to optimism—cautious though it may be.

Oliver Bennett

Now, let’s wrap things up by taking a closer look at the currency markets—specifically, the euro-dollar exchange rate. It’s a fascinating story, really, with several moving parts converging to shape where the euro might stand against the dollar in the coming months.

Oliver Bennett

First, we’ve got tariffs. And and here’s the sticking point—tariffs are more than just taxes; they serve as geopolitical tools. For Europe, there’s this lingering tension around how the U.S. might target its exports, particularly with Trump's April 1 trade investigation deadline just around the corner. If harsher tariffs are imposed, the euro could face added downward pressure, especially if markets perceive these moves as sustained rather than symbolic. On the flip side, softer tariff outcomes or a negotiated deal could provide some breathing room for the euro.

Oliver Bennett

Energy and geopolitics are the second piece of the puzzle. The potential peace deal in Ukraine is a wildcard. If negotiations advance and Europe plays a central role, we might see an economic boost tied to rebuilding efforts and maybe, just maybe, some relief in natural gas prices. These shifts could solidify confidence in the euro, though, as with all geopolitical matters, the path is far from linear.

Oliver Bennett

Then there’s the idiosyncratic local stories, which are always, well, a bit of a mixed bag. On one hand, the Federal Reserve seems to be nearing the end of its rate cut journey, which caps upward momentum for the dollar. On the other hand, the European Central Bank looks poised for more cuts, possibly even dipping below the so-called neutral rate. This divergence in rate paths hints at a subtle leaning toward dollar strength in the near term.

Oliver Bennett

And, finally, we come to market technicals. The U.S. dollar is undeniably strong right now, with historic long positions built up—positions that tend to carry their own risks of abrupt reversals. For the euro, any surprise developments, like progress in Ukraine talks or a dovish shift at the Fed, could trigger just such a correction, creating a window for some euro resilience amidst broader dollar dominance.

Oliver Bennett

So, what’s the big takeaway? It seems likely that the euro-dollar exchange rate will remain under pressure, trading lower through the end of the first and second quarters. Tariff risks alone favor dollar strength, with Europe’s own challenges around inflation and growth adding weight. That said, this is hardly a one-way street. Positive surprises—whether in the form of geopolitical breakthroughs or easing tariff rhetoric—could set the stage for a euro recovery down the line.

Oliver Bennett

And that, my friends, is a wrap on today’s episode. From the swirling maelstrom of political policies to the tug-of-war in currency dynamics, volatility may reign supreme for now, but there’s always clarity to be found if you know where to look. Keep sifting through the noise, and with any luck, we’ll navigate these uncertain tides together. On that note, we’ll see you next time. Take care!