Is Goldilocks afoot?

A consensus definition of Goldilocks is a scenario in which an economy is just about right – not too hot, not too cold. In economic terms, this would amount to moderate growth, low inflation, low unemployment and conducive monetary policy. This list is not definitive and is certainly open to interpretation but these factors are widely adopted taking a top-down approach. Applying this rationale, how do things look?

Tariffs Deals secured so far include Japan (15%, covers cars, pharma and machine parts) and inward investment to the US of $550bn; China (10% on a broad range of goods as part of a 90-day truce); UK (0% to 10%, exemptions on the first 100K of cars exported to the US, Steel & Aluminium tariffs have been lifted), EU is still under a 90-day agreed suspension; Canada (still at 25% but critical goods exempted); Mexico (still pending as formal response has been delayed); South Korea (still 25% but negotiations still believed to be ongoing) and ASEAN (25% to 40%, no deals yet). As it stands, the overall, weighted-average tariff rate is a little over 15%.

Geopolitics No imminent flare-ups on the horizon at this stage. Iran has gone quiet and is unlikely to flare-up any time soon – it will not want to jeopardise its weapons-grade enrichment plans; Russia-Ukraine seems confined within its borders. Any “flare-up” would need to result in oil prices being driven up and / or a squeeze on shipping/transit routes. Nothing in sight for now.

Labour markets have softened but still lean to tightness. For example, in the US lead indicators like the weekly jobless numbers remain tight. They have to hit or exceed 300,000 per week to suggest weakness – we’re currently only at 217,000, its lowest since April; wage growth is around 3.7% y/y. In the UK, unemployment is at 4.7%, its highest in 4 years; wage growth is around 5% y/y (down from 5.3% y/y) but still ahead of inflation. In the EU, unemployment continues to fall and stands at around 6.2% while real wage growth averaged +2.5% y/y in Q1 this year. In Japan, the labour market is tight (unemployment at 2% to 3%) while wages continue to rise – and inflation with it! In China, youth unemployment is high but the wider market is stable although this masks the way numbers are reported.

Rates Trump’s annoyance with Powell that he won’t cut rates is well-reported! How much room is there to cut? Some – but not huge:

The Fed’s own “Dot-Plot” indicates two more cuts (0.25% each). Trump would naturally like more as this would help corporates and consumers by offsetting some of the tariff impact – but it comes with a price, inflation! The Euro-Area paused rate cuts after eight successive cuts. Like the Fed, their natural leaning is not towards cutting rates – if they do, it comes down to tariff negotiations. Japan raised rates in January this year but has paused since – largely due to tariff-induced volatility. There has been no change in China – fiscal measures are clearly preferred over monetary tools.

How far does Trump want the Fed to cut rates and when? The “when” is easy – ever since he took up his office. He needs to offset the effects of tariffs which, based on latest indications, suggest around 80% are being passed on to US consumers. The rest is being absorbed by importers and exporters. The offset comes from measures in the OBBB (One Big Beautiful Bill)….but he needs more than that. There are only two, effective ways – lower interest-servicing costs (e.g. mortgages) and lower energy costs. How much does he want to cut? There’s a real danger here – if a President forces/pressures the Fed (which is supposed to be independent) to raise/cut rates based on inflation and employment, this is called fiscal dominance and leads to currency risk, inflation and loss of market confidence. This is exactly what happened in Turkey! That’s why Trump needs a new face at the helm to head up the Fed. Otherwise, there will be all-out carnage in markets. Here’s a quick comparison of the two styles so far:

Trump might see lowering rates, quickly, as a as a way of reducing Debt-to-GDP. How? Be warned, this is something of an illusion! When Turkey (under President Erdogan) was hitting inflation of 80%+ while also running huge fiscal deficits and watching its currency lose value very quickly, its Debt-to-GDP ratio plummeted – all because with inflation running at over 80%, its GDP naturally increased by a similar amount on the back of price rises (remember, GDP is the sum of all the output in the economy and output is volume X price). Nothing fundamental was improving (volume stayed the same, arguably it even fell back) but prices went up comparatively more. So as long as your debt doesn’t grow by the same amount, the ratio naturally improves – this is highly misleading: your Debt-to-GDP can look better even as your economy is melting – as long as inflation is high enough. Could the US deploy a “soft version” of this approach? Theoretically yes – but very difficult and risky in practice. It’s like trying to lose weight by skipping meals – great first but, if not controlled, becomes risky! All it would do is inflate away debt, fundamentally weaken the US$ (à carnage) and hide underlying financial risks (funding costs would soar as bond yields spike).

What was the final outcome in Turkey? The Turkish Lira collapsed, Inflation went even higher and while Debt-to-GDP fell (see above), currency credibility, savings and purchasing power collapsed as well. I don’t think Trump would ever risk it!

MARKET SUMMARY…

Global yields tracked sideways – risk-on prevailed again boosted by the announcement that a tariff deal had been struck with Japan and it seems the US got a lot more than it bargained for – including a huge $550bn investment fund. So far – and Europe is next in the firing line and I have no doubt have been going through the details with a microscope – the US has been securing good terms for itself while “minimising” tariff damage (circa 15%). It will be interesting to see where it all settles – Europe will be the decider. In the meantime, it’s looking like the US will be paying a lot less (low single-digits) on its own tariff exports.