Market Recap & Outlook

First, Europe. Historians sometimes refer to the long 19th century as ending in 1914. Similarly, the long 20th century arguably ended in February at the Munich Security Conference. The US may not have actually changed sides in the Ukraine war yet, but governments in Berlin, Paris, London, and Kiev all seem to think so. US economic, military and intelligence assistance to Ukraine has been unilaterally and abruptly suspended. This is effectively an ultimatum to Ukraine, as battlefield conditions for Ukrainian forces are likely to deteriorate quickly.

To summarize a recent briefing from the Royal United Services Institute, the UK military think tank, stated that Ukraine was invaded by Russia in 2022 in a decapitation strike on four axes. Ukraine responded with extraordinary efforts and held their position against Russia. However, Russia manages setbacks by doubling down, and those troops have been replaced by 400,000 new conscripts and contract soldiers. Ukraine’s manpower problems are even more severe. Battlefield conditions have swung back and forth, in large part due to irregular supplies of munitions from Ukraine’s allies, but currently favor Russia. Europe is simply incapable of supplying the missing US support, particularly in areas of air defense, satellite ISR (intelligence, surveillance, reconnaissance) and electronic warfare.

European confidence in US NATO guarantees has fallen. Germany’s PM Merz has proposed the elimination of the constitutional debt brake and massive rearmament. This will be vastly expensive and complex, as Europe simply does not have some of the US capabilities. While the evolution of German and more broadly, European fiscal policy has question marks, including whether the European Green Fiscal Policy will support the proposal, markets have moved to price it as the new reality. German bund yields jumped 30bp in a week, from 2.5% to 2.8%. Other Eurozone markets moved in tandem. One study estimated that replacing US military support in Europe will cost 300bn EUR for ten years, or about 3 trillion EUR. The implied fiscal boost for Europe is growth bullish, equity bullish, EUR bullish and bond bearish.

In the United States, the reduction of federal employment is material. Some 100,000 employees have been let go or will take retirement later this year. The federal contractor and supplier ecosystem is expected to lose another 200,000 jobs as well, using a 2x1 multiplier. We expect education and university research grants to fall. Second, the focus on tariffs has implications both economically and politically in US global relations. The Canadian and Mexican tariffs have been announced, delayed, re-announced, and delayed once again. Tariffs on Chinese goods have increased by 20% as have product tariffs on steel and aluminum. Reciprocal tariffs are supposed to go into effect in April of this year. For the current US tariff policy, more rather than less has become the prevailing view. The potential ramifications of a supply shock could increase import prices and challenge supply chain logistics, in our view. Together these fiscal and tariff policy measures could pose a threat to near term US growth exceptionalism. We believe the potential outcome is growth bearish, equity bearish, oil bearish, bond bullish and USD bearish.

Our Strategy

If US rates fall or US growth slows enough, we expect the strong demand for yields to wane. This could trigger potential outflows from credit funds putting upward pressure on spreads, in our view.

Source: Bloomberg, and Royal United Services Institute as of March 2025.