Macro Moments Weekly: In a game of dare, when will bond markets lose patience?

Key takeaways:

• Emerging markets show resilience and growth leadership: Despite global shocks, many emerging economies—especially Taiwan and South Korea—remain central to global growth, though rising oil prices pose risks for energy-importing nations like India.
• Developed markets face mounting inflation pressure: Persistent inflation (notably in US shelter costs and rising European CPI) is unsettling bond markets and likely to force central banks to tighten policy sooner.
• Geopolitics and trade dynamics favour China: Ongoing inflation in developed markets is boosting China’s export competitiveness, while stalled or uncertain global trade and political negotiations add further market instability.

During our emerging markets webinar last week, there was an air of calm optimism. The resilience of emerging markets to the series of shocks that have happened in this decade and the astonishing performances of Taiwan and South Korea helped emphasise the point that these economies are at the centre of world growth. The main worry is, of course, the rise in oil prices due to the Iran war, which has been driving inflation. Clearly, energy-poor nations such as India are most at risk at this point, but their energy stockpiles are proving effective, although they are falling fast.

The same cannot be said about the developed markets. The latest Consumer Price Index (CPI) print in the United States was notable not for rising energy prices, but for elevated shelter costs.¹ Forecasters had been anticipating lower shelter costs would be the offset that enables the Federal Reserve (Fed) to keep interest rates on hold. Elsewhere, German CPI accelerated to 2.9%, driven by energy,² while wholesale price inflation is now running at 6.3%.³ In France, the CPI jumped 1.2% in a month and is now 2.5% year-on-year (y/y).⁴

These inflation numbers are on the cusp of getting out of control and will likely require action sooner rather than later. It is no surprise that bond markets are now unsettled. The argument that the markets are doing the central banks work for them may, in part, be true. But this is a staring contest—a game of dare. The central banks will have to blink, and it would be better if they did so sooner rather than later.

The game of dare becomes more complex here in the UK, as the inability of the political classes to find a prime minister has now stretched back to 2016. Seemingly no one can break this impasse, although Labour is going to try once more. To put into context how far the United Kingdom has fallen in the market’s eyes, look at the spread of UK 10-year bond yields to comparable Italian yields. In 2018, Italian bonds yielded 2% more than the United Kingdom; today, Italian yields are 1.25% less. With the rising cost of money and falling confidence, corporate capital expenditures (capex) could fall, so it is no surprise to see year-over-year business investment turn negative for the first time since 2021.⁵ 

Will inflation in the developed markets provide a problem for emerging economies? Sure, there will be some slowing of demand (mainly from Europe rather than from the United States). But exporters, in particular China, seem to be both willing and able to absorb rising energy costs in a way others cannot. That means every time there is an inflationary event in the developed markets, Chinese competitiveness improves. It should be no surprise that China continues to enjoy strong export growth, and why would the current conditions not accelerate that?

That is why US President Trump’s visit to China could have been so important. Seemingly there was an opportunity for a reset and perhaps, after the 2025 tariffs, to show some elements of improving trade relations. In 2017, his state visit was associated with the headline of US$250 billion-plus in deals, involving everything from Boeing jets to liquefied natural gas. This time there is no similar headline. That is not to say that there will be no deals at all, given that the list of CEOs on the plane was beyond impressive, but maybe deals will take more time to complete. Maybe one side or the other thinks they can get a better deal later.

This applies to potential agreements surrounding many of the current geopolitical conflicts and tensions and political instabilities around the world. Markets—in particular, bond markets—may not have such patience.

Parting shot

At an initial public offering (IPO) conference this week, it was fascinating to listen to the stories that companies had about how difficult in terms of time, energy, stress, and how extremely expensive it is to go public. As an investor, you have to wonder why is it that hard? We need regulation, we need a process and we need rules to protect investors, but surely this is an area that artificial intelligence could rapidly transform?