Macro & Markets: For the birds

Macro

Switzerland has a problem; actually, it has several problems! First, it has made absolutely no progress with the United States over its penal 39% tariffs. While this may be good for the Swiss watch shops in Toronto, it’s very tough for the pharma industry that runs a US$35.4 billion (bn) surplus with the US (Source: Trading Economics, Swiss Exports of Pharmaceutical products to the US). Second, to stem the demand for the Swiss franc after “Liberation Day” (US President Trump’s announcement of tariffs on 2 April 2025), the Swiss National Bank (SNB) intervened in the foreign exchange markets and bought 5.1 bn (francs) in the second quarter, intervening for the first time in five quarters. Such purchases could easily lead to calls of currency manipulation again.

But the real problem looks to be at home. Swiss inflation has been trending to zero and is now there; the Swiss CPI fell by 0.2% in September. Services are leading the drive to deflation, and it’s worse when you look at restaurants and hotels. If service sector inflation turns negative in any country, then deflation is really setting in and bedding down. Deflation needs action, and this will likely force the SNB to cut rates, which are currently at zero. Market yields for two-year and five-year paper are already negative. It’s also a shout-out to the European Central Bank: Service sector inflation is what is holding up the numbers in Germany; it’s the last shoe to drop. Is Switzerland a lead indicator? It has been in the past.

In the United Kingdom, it has been a challenging week for the government; the Labour party held its annual conference knowing that commentators would pull apart every word for its possible effect on the make-or-break budget in two months’ time. The stage management went well, with flag-waving and cheers in the right places, but what about the numbers? Estimates are settling on a £30 bn fiscal hole in 2029/2030 that the government needs to address, with an additional £10 bn headroom. When you have promised not to touch 70% of the tax take, and businesses have spent the week telling you the negative impacts of the higher employee tax, your options are limited. Up steps Morgan Stanley as the conference ends, with an extraordinarily detailed report on how to find £45 bn from a variety of means, such as freezing tax thresholds, gambling taxes, income tax for pensioners, etc., etc., etc. Morgan Stanley’s recommendations would cut the government deficit from -4.4% this year to -2.3% in 2028/2029.¹ That downward trend is the opposite of what we see in and around Europe. If this is the case, then why wait for 26 November to get involved?

Equities

European equities commenced the pivotal third quarter following stronger-than-anticipated earnings performance in the second quarter, and third-quarter market performance turned out to be one for the record books. However, the expectations from analysts for 2025 are unchanged from the second quarter, at +6% growth in earnings-per-share for 2025. While the strength of the euro has not gone away, it should already be in estimates. That there are no changes in estimates for the third quarter, even though the second was better, feels mean IMHO. The economies have stumbled along well enough, and I think there is scope for some optimism.

Like last week, the focus in the United Kingdom (UK) has been the consumer stocks: Tesco beat expectations and, after complaining about a £235 million tax increase on employees and another £90 million in the newly introduced packing tax, raised midpoint guidance by 5%.² Shares rallied accordingly. Driving sales are fresh food (we are all cooking more at home), and luxury own brands. Elsewhere in food, Greggs, the adopted home of the sausage roll, also confounded the shorts, beating lowered expectations. This is more grist for the mill that retail in the UK is doing fine.³

Bonds

For fixed income, the feature of the week was the UK 10-year auction. It was poorly subscribed, placing at a yield of 4.769%. See the discussion above for why no one is interested, but we are almost at the magic five-handle, which is enough.

French government debt remains under pressure as the new Prime Minister Lecornu searches for political friends. He must present a budget by 13 October, and no one thinks he will succeed. A stalemate and Lecornu’s exit would mean you simply roll last year’s budget to next year, and that would produce little or no spending cuts. When a nation is running a deficit of over 5%, this outcome would likely not be good enough for markets.

Parting shot

In a report this week, the Bank for International Settlements released its triennial survey into the foreign exchange (FX) market. Picking April as its comparative month was always going to produce fireworks, thanks to Liberation Day. The key statistic is that 89% of all FX transactions have the US dollar on one side of the trade. That’s up from 88% three years ago. The euro is down from 31% to 29% with the Japanese yen in third place, unchanged at 17%.⁴ If anyone thinks the US dollar is not the world’s reserve currency, or that in some way the US dollar is “losing it,” just quote these numbers.

My thoughts? De-dollarisation is for the birds.