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.

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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 have 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?

For one, uncertainty. 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 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. 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.

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 at forming a ruling coalition.

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.

However, 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. 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,y 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 to 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 Messrs 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.

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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

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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.