Gloom on complex moving US policy parts

The week was characterised by a complex interplay of US fiscal and trade policies, varied central bank responses to evolving inflation and growth dynamics, and significant corporate sector vulnerabilities.

Markets initially faced downward pressure following Moody's downgrade of the US credit rating. While stocks attempted a recovery, significant selling pressure emerged mid-week - with the Dow dropping by more than 800 points on Wednesday. This downturn was primarily linked to rising US Treasury bond yields and mounting concerns about the US fiscal deficit, particularly the advancing Trump tax bill. Towards the end of the week, markets showed signs of stabilisation, though underlying anxieties persisted.

The FTSE 100 was +1.0% over the week by mid-session on Friday, with the more UK-focused FTSE 250 trading down 0.6%.

• VE Day: Remembering the individual's experience of war
• How many ISA accounts can I have?
• US stock market review: what are the prospects for investors?

Global trade

Attention shifted dramatically to domestic fiscal policy as the Republican-controlled House of Representatives passed President Trump's tax cut bill, reportedly by a slim margin. The legislation, now headed to the Senate, includes provisions to extend the 2017 corporate and individual tax cuts, cancel many Biden-era green energy incentives, tighten eligibility for certain social programs, boost military and border enforcement spending, and loosen regulations on firearm silencers. It also reportedly includes tax breaks on US Treasury Inflation-Protected Securities and car loans and an expansion of the State and Local Tax (SALT) deduction cap to $40,000.

Crucially, the nonpartisan Congressional Budget Office (CBO) estimated that the bill would add approximately $3.8 trillion to the existing $36.2 trillion U.S. national debt over the next decade. The Tax Foundation provided a similar estimate, projecting that making the expiring 2017 Tax Cuts and Jobs Act (TCJA) provisions permanent would reduce federal revenue by $4.5 trillion between 2025 and 2034. Paradoxically, the bill also includes a provision to raise the federal government's debt ceiling by $4 trillion, thereby averting the immediate prospect of a default.

The market reaction to the tax bill's passage was predominantly negative. The passage of this U.S. tax bill, which promises significant fiscal expansion and a larger deficit while the Federal Reserve maintains a cautious stance on inflation (partly due to existing tariff impacts), creates a scenario where fiscal policy is actively expansionary and potentially inflationary, while monetary policy aims to remain neutral or slightly restrictive. This policy divergence could lead to a higher baseline for both inflation and interest rates than would otherwise be the case, and it introduces increased market volatility as investors struggle to price in these conflicting signals albeit tentative, as an indicator of this potential structural shift.

Economics

Central bank activity was a pivotal theme, with divergent policy paths emerging globally, heavily influenced by domestic inflation trends and the pervasive uncertainty of U.S. trade and fiscal policies.

Flash PMI data for May showed an improvement in US business activity following a slump in April. The S&P Global Flash US Manufacturing PMI rose to a three-month high of 52.3 from 50.2, beating forecasts, while the Services PMI increased to 52.3 from 50.8. The Composite PMI stood at 52.1, up from 50.6. This suggested a rebound, with manufacturing production returning to expansion and new order growth hitting a 15-month high. However, a significant driver for the manufacturing strength was the largest accumulation of input inventories on record. This stockpiling was linked to business concerns over potential tariff-related supply shortages and price increases. This inventory build-up, while boosting current PMI figures, signals a potential "bullwhip effect." Businesses are front-loading purchases as a rational short-term response to policy uncertainty. However, once these inventories are deemed sufficient, or if tariff threats lessen, new orders are likely to drop significantly as companies destock, potentially leading to a sharp contraction in manufacturing activity and increased volatility for supply chains. US Treasury yields remained elevated in the wake of this data, and while the US dollar was initially little moved, it found some support.

The US housing market, however, presented a weaker picture. April's Existing Home Sales, also released on 22 May, unexpectedly fell by 0.5% to a seasonally-adjusted annual rate of 4.00 million, short of the 4.10 million expected and marking the slowest April since 2009.

The divergence between the somewhat resilient PMI data and the weak consumer-centric housing data suggests that underlying consumer financial health and confidence may be more fragile than headline business activity surveys imply. While businesses might be adapting to new trade realities, for instance by building inventories, the end consumer appears to be feeling the pressure from persistent inflation, higher interest rates, and general economic uncertainty, leading to caution in significant expenditures. If this consumer demand falters more broadly, the improvements seen in business activity surveys may prove unsustainable.

The final April CPI figures for the Eurozone to March, released on May 19. However, core CPI, which excludes volatile items like energy and food, rose to 2.7% year-over-year from 2.4% in March, with services inflation accelerating to 3.9% from 3.5%. While headline inflation remained close to the ECB's target, the uptick in core and services inflation was a point of concern, complicating the central bank's policy trajectory amidst ongoing tariff uncertainties. The Euro strengthened sharply on this news.

Conversely, Flash PMI data for May was disappointing. The Eurozone Composite PMI fell to a six-month low of 49.5, slipping back into contractionary territory from 50.4 in April and missing expectations of 50.8. Germany's Composite PMI also fell to a five-month low of 48.6, and France's Composite PMI registered 48.0. This pointed to renewed weakness in the Eurozone economy. The euro fell after the German PMI data, and the German 10-year Bund yield dipped slightly, suggesting a flight to safety or increased expectations of ECB accommodation due to the weaker growth outlook.

The UK's April CPI data delivered a significant upside surprise, with the headline rate surging to 3.5% year-over-year from 2.6% in March, exceeding forecasts of 3.3%. Core CPI also rose to 3.8% from 3.4%. The Office for National Statistics (ONS) indicated that the largest upward contributions came from housing and household services (notably the energy price cap adjustment), transport, and recreation and culture. This development complicated the Bank of England's policy outlook, particularly as it had recently initiated a rate cut. The unexpected surge in UK April CPI, largely driven by regulated price increases and energy costs, highlights the "last mile" difficulty in taming inflation. It also underscores the vulnerability of inflation paths to administrative decisions and volatile energy markets, making central bank forecasting and policy calibration exceptionally challenging. Sterling initially rose on the inflation news before paring gains, while UK Gilt yields moved higher across the curve, with the 10-year yield increasing by 5 basis points to 4.75% as markets scaled back expectations for further BoE rate cuts.

The UK's Flash PMI for May showed the Composite PMI rising to 49.4 from 48.5 in April. While still indicating a contraction, the downturn moderated. Manufacturing remained a drag, but price pressures eased from April's spike. Business confidence rebounded, partly attributed to reduced concerns over trade and tariffs following the US pause and a UK-US trade announcement. However, job losses continued for the eighth consecutive month. Sterling pared gains against the US dollar following this weaker-than-expected PMI, as moderating price pressures and signs of faltering growth kept the door open for potential further BoE rate cuts.

Economic data presented a mixed view of China's economy. Industrial Production grew by 6.1% year-on-year, with some sources indicating this “exceeded expectations”, while others suggested it fell short of a 5.5% consensus against a previous 7.7%. Retail Sales rose 5.1% year-on-year, below the 5.5% consensus and down from 5.9% previously, highlighting ongoing challenges in boosting domestic consumption amidst a property crisis, deflationary pressures, and trade uncertainties. The mixed data, coupled with Moody's U.S. downgrade, contributed to headwinds for Asian stocks early in the week.

Geopolitics

G7 finance chiefs condemned what they called Russia’s “continued brutal war” against Ukraine and said that if efforts to achieve a ceasefire failed, they would explore all possible options, including “further ramping up sanctions.”

More than 90 lorry loads of humanitarian aid have been collected by UN teams inside the Gaza Strip, three days after Israel eased an 11-week-long blockade.

Companies

Shares in utility companies Severn Trent and SSE made marginal gains in morning trading as investors turned to defensive stocks amid global trade tariffs concern. Both companies also reported their results for the year ending 31 March. Severn Trent reported a 15.3% rise in pre-tax profit to £590.2 million and said it had been a “record year” with a new era of growth”. The UK water company gave an upbeat earnings outlook forecasting adjusted earnings per share (EPS) doubling between 2025 and 2028 and guided operational outperformance of £300m across five years.

Intermediate Capital Group shares topped the FTSE 100 leaderboard on Wednesday morning as the alternative asset manager reported a "milestone" financial year, with strong growth in assets under management and cash flow.

Great Portland Estates raised its estimates for rental growth this year after a solid performance over the 12 months to 31 March, with profits and valuations coming in ahead of expectations. The West End office-focused real estate group said it expects estimated rental value (ERV) across its portfolio to rise by 4-7% over the current year.

BT Group raised its target for rolling out full-fibre broadband as it posted full-year results that were in line with City expectations. The former phone monopoly, which is facing increased competition from 'alt net' rivals, said it is investing in its Openreach arm to build up to 5 million additional fibre premises in its new financial year, targeting 25 million by the end of 2026 and as many as 30 million by 2030.

Property giant British Land has said that mid-week occupancy in central London offices has returned to its pre-pandemic level, more than five years after the start of the work-from-home mandate. Management expects three-to-five-percent annual rental growth across its portfolio, which includes commercial property, retail parks and university campuses.

Short-haul carrier easyJet is on track for a record year as travellers shrugged off economic anxieties. Management said bookings for the peak summer season were “supportive” of it achieving pre-tax profits of £703m in the 12 months to the end of September, in line with market expectations. That result would beat its previous record of £686mn in 2015.

Guinness to Smirnoff drinks giant Diageo is in consolidation mode. Growth has stalled, margins have slipped, and debt is running higher than comfortable. But what followed Tuesday’s strategy update was not an apology. It was a reset. Investors hoping for a rapid turnaround may need to be patient, but the drinks group is now pushing harder on the levers within its control. Diageo expects just 1.9% organic revenue growth next year, with US spirits, its most profitable market, forecast to decline by 1%.

Sales at Greggs have picked up after the UK’s biggest bakery chain branched out into iced drinks, pizza boxes and a macaroni cheese that has gone viral on social media. The bakery, which is headquartered in Newcastle upon Tyne, reported a 2.9% rise in comparable sales in the first 20 weeks of the year, with an improving trend in the last 11 weeks helped by warm, sunny weather. New beverages and food on the shelves also helped step up sales growth, including a peach iced tea and a mint lemonade. Greggs said that a newly launched mac and cheese “went viral on TikTok”, with a video of the snack played more than 3 million times.