Markets moved sideways over the course of February, as investors attempted to digest the rapid change in policy from the Trump administration in several areas. A resurgence in inflation also led to concerns that interest rates would need to remain higher for longer. With the economy robust in the US, the Federal Reserve in particular is now reluctant continue easing monetary policy. Towards the end of the month, a German general election received significant attention given the rise of the right wind AFD and changing dynamic between the US and Europe.
Donald Trump remained in the headlines, with characteristic rhetoric designed to shock and disrupt. Key areas of focus were tariffs, Gaza and Ukraine. A range of tariff threats were made in the month, directed at the majority of major US trading partners. While only some have been implemented, corporates and investors were left scrambling to adjust to the changes. The ongoing ceasefire in the Middle East was interspersed by periodic suggestions from the US President. While little has changed, the ceasefire holds and hostage exchanges are continuing.
However, it was the US interventions in the Ukraine conflict that was the largest geopolitical shock (for Europe at least). The about turn in US policy, from steadfastly supporting Ukraine to appearing to back Russia, surprised European partners who have been rapidly looking to establish alternatives to the US defense umbrella. While the Ukraine war may or may not be resolved in the near future, the lasting impact of the US actions will be increased military autonomy and defense spending by European countries.
Inflation, which has been easing now for some time has begun to increase, driven by higher food and energy prices, as well as latent services inflation caused by wage rises. This trend is not isolated to specific countries and is widespread throughout the developed world. Indeed, Japanese inflation is now 4%, having been consistently above 2% since 2022. As a country that has battled deflation for decades, this is a notable development. Higher than desired inflation, albeit not at the extreme levels of 2022/23, will lead to caution among central bankers, who may choose to ease more slowly.
The German elections came hot on the heels the changing US policy towards Europe, which was a significant point of discussion running into and following the election. The new Centre Right coalition leader has voiced a strong desire to increase defense spending, potentially unlocking greater deficit spending through constitutional reforms. While German debt to GDP is low, governments have been constrained by deficit limits. Given the size of the German economy, the relatively low absolute level of debt and current low defense expenditure, this could lead to significant military spending increases, the largest in Europe. European defense stocks have unsurprisingly seen strong rallies.
