Hello, I'm Eric Robertson, Global Head of Research and Chief Strategist at Standard Chartered. And I'm Madhur Jha, Global Economist and Head of Thematic Research also here at Standard Chartered. Welcome to Macro Freestyle, our monthly podcast series where Madhur and I will identify and explore topics that are likely to be most impactful and relevant for financial markets and the global economy.
Welcome back everyone to another edition of our podcast, Macro Freestyle. We're recording this on the 23rd of July and we will discuss in detail fiscal policy and its macro and market implications. Eric, let me begin by asking you if you think that the passage of the One Big Beautiful Bill significantly lowers recession risks in the US, despite all the uncertainty around trade.
And do you also see similar fiscal stimulus in other major emerging markets helping to limit the downside risks to global growth? Look, fiscal is a really fascinating topic for this year because we have so many of the major economies of the world either passing or contemplating new fiscal stimulus packages. For the US, I guess the first point that I should make is that even without considering fiscal stimulus, I am not of the opinion that the US is going into a recession.
So as a team, we think the US economy is softening a bit from last year's levels. But I think the real question is whether or not this new fiscal stimulus package is going to generate incremental growth and at what cost. Now, I think there were significant sources of uncertainty with regards to the growth impact earlier in the year.
So much so that I think even the Federal Reserve has incorporated the possibility of an uplift to growth and inflation because of fiscal into their forecasts. I think where we come out today is that the growth impact may, while still positive, may be less emphatic than we thought before. But also the other challenge that I see is that the cost of this fiscal package, especially in terms of accumulated debt and interest expense, is actually worse than I had previously thought.
The way I think about the US impact of fiscal at the moment is that it's probably a net negative for long-term interest rates. In other words, long-term bond yields higher because we do expect to see more supply. But in terms of the growth impact for the US, I would describe it as marginally positive.
And Eric, do you think that markets are being too complacent in terms of the bond yield move so far on US fiscal concerns, but also what's happening in other parts of the developed world, including euro area Japan? What's interesting is you have seen, for the most part, a divergence between DM and EM rates this year. We've seen on a country-by-country basis these fits and starts of fiscal fear.
We have long-term interest rates going higher in the UK. We're seeing long-term interest rates in Japan go higher for a combination of inflation fears, fiscal fears, etc. We have seen various episodes of yield curve steepening in Korea, for example.
And then coming back to the US, there have been periods of fiscal uncertainty or fiscal concern that have led long-term interest rates higher. What we have yet to see, although I'm very much on the lookout for it, is a sort of correlated move higher in long-term interest rates across global markets. And I think that would potentially be a real headwind, not only to risk appetite and risk sentiment, but even to the global economy.
Now, I should make one final point, which is that when we think about long-term interest rates going higher, it can usually happen for a couple of different reasons. One is growth expectations improve, and maybe even with a little bit of inflation. So you get this increase in nominal growth.
That doesn't have to be bad news. In fact, I would argue it's probably pretty good news. But if the increase in rates is driven by a deterioration in the budget deficit, increased fiscal concerns, an increase in term premium, that's where you get these gap risks.
And I think that gap risk is something that we've been faced with in 2025, and I think that's going to continue. Madhuri, you've spent a lot of time looking at the spillover impact, if you will, from DM to EM. And I wondered if you could talk a little bit about how you see the spillover to EM growth this year from a lot of these fiscal packages that we're seeing.
I think you've hit the nail on the head when you were talking about what is driving some of the financial market moves, the higher bond yields. Is it growth expectations being higher, or is it fears of the risk premium being higher? If you look at what's happening for emerging markets in particular, in terms of the spillover effect, there might be limited trade impact.
Because most of these fiscal stimulus packages in the West are largely oriented around defense spending, which tends to have a very low import content, especially from emerging markets. Even for the U.S., we're not really expecting the big fiscal bill that's been passed to have a very big impact on the growth of the U.S. itself. So again, the export demand for emerging markets is going to be limited.
But on the other hand, the risk is that the Fed keeps rates higher or does not do as much easing because they're worried about the inflation impact of this fiscal stimulus. And also that the yield curve continues to steepen because of this rise in risk premium and fiscal concerns, which makes it much more difficult for emerging markets to finance themselves in the external market. So this financial channel of higher yields, higher rates, plus also exchange rate appreciation of their currencies is making them more uncompetitive and actually could be a drag on their growth outlook.
So I think it would be a little bit of a stretch to say that the fiscal stimulus will have positive spillover. There will be some spillover from trade channel, but there could be a bigger offset from the financial channel. And that's why we have to look more carefully at domestic stories.
And sticking with the theme of fiscal stimulus, Eric, markets have been hoping for some big stimulus announcements from China. Do you think that this is likely and can growth hold up without such a big package in China? The China economic narrative at the moment, I think, has surprised people.
And I say that because due to the 90 day pause in tariffs that we saw in Q2, we saw a very interesting pattern, which was that China's exports to the U.S. collapsed in the second quarter. Right. But China's exports to the rest of the world, especially EM, increased.
And so China's overall export momentum stayed relatively unchanged at a very lofty level. Now, that was great news for China in H1. They've delivered, frankly, better growth than the consensus expected for the first half of the year.
And I think there was quite a bit of front loading. The challenge for China is whether that's sustainable. And the secondary question to that is, is there enough demand from EM to absorb all of China's excess capacity?
And for me, the answer is there may have been over a short period, but I don't think there is on a more sustainable basis. I think that China's export machine is probably due to lose some momentum in the second half of the year. Now, that gets to the question of will they announce a fiscal stimulus package?
The short answer is I think they may. The secondary answer is that I think it may come later than many people had originally expected. And part of that's because H1 was better than expected.
But I also think that they're still trying to figure out ways to make sure that the fiscal stimulus packages and programs that were previously announced are being fully utilized. And I don't think we've seen the maximum impact of that yet. And so China's policymakers are probably going to say, let's hold off on a big fiscal stimulus package as long as possible until we see further evidence of a material deterioration.
I think the big downside risk for China is that export momentum slows more than expected, combined with the fact that domestic demand in China still remains very, very soft. And some of that's due to real estate, some of that's due to deflation, some of that's due to the lack of demand for credit, etc. I think the downside risk is still material, and that could be the trigger which pushes China's policymakers into being more aggressive with fiscal.
But I do think we have to accept that it may come later than many people had hoped. Madhur, I wonder if you could talk a little bit about how you see the different scenarios playing out between China's growth trajectory, its policy trajectory, and what that means for EM growth and EM policymakers. I think as long as you have slightly stable growth around 5% in China, that will provide, again, some support for emerging markets in that region.
But if you look at the fiscal stimulus that has already been announced by China, most of it is still very much infrastructure heavy, very domestically determined. There will be some increase in demand for commodities, imports, but overall that's going to be fairly limited on an annual basis. The big news has so far been about the consumer trade-in program from China, which is slightly new, which has been encouraging retail sales growth to be a little bit better than what we had seen previously, especially for those goods that are targeted by the consumer trade-in program.
Now, do we expect that this would really benefit other economies? Again, the answer is it's most likely to be limited because this consumer trade-in program is more to support domestic industries and domestic consumption. Also, this trade-in program is now almost coming to an end unless it is further expanded in scope.
So, again, China's fiscal stimulus will have very limited spillover effects to the rest of the region or even to the wider world. But clearly, having growth around 4.8 to 5%, even though we are seeing a slowdown in the second half of the year, having still stable growth will obviously be a positive and will allow other countries to look at their own domestic stories, try and get some wins on the export front through diverted trade, through grabbing more market share in the US, etc. And that's where we see more of the impact coming through.
It's going to be more about trying to get more market share from China into these economies and not so much from China's own domestic policies. I guess that leads to a follow-up question that I have. Has fiscal space fallen off the radar in EM because other factors have become more dominant?
And therefore, is it a risk that we need to really start to focus in on again? Or have fiscal concerns justifiably reduced because there are better growth stories? Maybe EM central banks have more policy flexibility so that they can ease rates, which supports growth.
So maybe there's less need for fiscal. Yes, actually, I think there's been a lot of focus on the US and the developed world fiscal space story. But frankly, markets are a lot less forgiving of higher deficits and higher debt for emerging markets than they are for the developed world because of a number of factors.
The lack of depth in the domestic markets. Some EM countries have a history of defaulting or repayment challenges. And also, there is greater dependence of emerging markets on external funding of their debt.
So a lot of these factors make markets a lot less tolerant of higher debt levels. And I don't think that these concerns have really gone away. Right now, people are focused on the central bank's abilities to provide support for growth through rate cutting cycles.
Because also the currencies have appreciated and inflation is falling, gives them some space on the monetary policy side. But when you're looking more medium term, clearly, there will also be focus on the fiscal. Looking at post-pandemic trends, there has been a rise in spending from emerging markets, but the revenue side is not picking up quite as rapidly.
So there is a widening revenue expenditure gap in some emerging markets, and this will leave them a lot more reliant on external funding to meet their fiscal needs. And this increases their vulnerability to higher yields and a steepening of the yield curve, which means higher funding costs for these economies. So that's where I think people will start to focus a lot more on which countries have domestic fiscal space, which countries have the ability to continue to fund themselves externally and access external markets at relatively cheaper costs.
Most countries, I would say, in the emerging market space do have some fiscal space to raise spending in case this heightened uncertainty continues and starts to really drag on their growth stories. But there are a few who do not really have too much space. For example, those countries that are already in IMF programs like Egypt, Pakistan, clearly, they have to do a lot more belt tightening.
And for other emerging markets as well, I think the focus will be on do you use your fiscal policy to support productive investment, or are you doing more populist measures? And I think markets will be less forgiving of measures that are not seen to be productivity or growth enhancing. So I think the fiscal space issue will become a lot more important as we continue to see yield curve steepening and the possibility that the Fed doesn't lower rates that much, which will also constrain how much central banks can then do in terms of their own monetary policy.
And maybe sticking with the Fed, Eric, recently, President Trump has really upped his criticism of Fed Chair Powell. Do you see a real threat that the Fed chair could be asked to leave? And is this a creep towards less Fed independence?
I think we have to highlight that legally, it is very difficult for President Trump to forcibly remove Powell just because he disagrees with his policymaking stance, which is why you've seen some of these other unrelated issues come up in terms of the cost of the renovation of the Fed building and that sort of thing. So I still believe that the odds of Powell being forced out prematurely are very low. But I also think this raises a couple more interesting questions.
Let's say, for example, that actually they were able to either remove Powell or that Powell just became so disillusioned that he resigned before his term ended, and you were to see a much more dovish Fed chair come into the role. And market expectations around Fed cuts would obviously go up significantly. But I think that would have a very counterproductive impact on the overall rates market.
I think long-term interest rates would go much, much higher. And interestingly, that is really what President Trump and Treasury Secretary Besant care about. They care about long-term financing costs.
If you think about the weighted average maturity of the Treasury liabilities, it's around five and change years. So cutting the Fed funds rate isn't really what they should be thinking about. What they should be thinking about is getting long-term interest rates down and obviously forcing out the Fed chair is not going to do that.
There's also quite a bit of discussion about how they manage their issuance program. There were concerns when Trump was elected that his fiscal program would lead to a significant increase in long-term debt issuance. There's a growing discussion about whether they may start to shift their issuance plans away from the long end and into the front end.
In other words, focus on Treasury bills and very short-dated coupon maturities. Now, that obviously has the advantage of a lower interest rate cost because of a steep yield curve. That has the advantage of shortening the weighted average maturity of the overall portfolio.
And that's the short-term benefit. The problem is that all of those Treasury bills that they issue have to be refinanced in six months, one year time. And if it's two-year Treasuries, then in two years time.
And we know there's a wall of Treasury maturities over the next couple of years. So the question is, do they want to quote-unquote gamble with doubling down on that short-end issuance and that refinancing profile? I think there's a reasonable and balanced argument that says they probably could increase Treasury bill issuance.
There's certainly a lot of demand at the front end for money market funds. There's trillions sitting in money market funds that would be happy to deploy into Treasuries, giving them three and a half or four percent. But I think there's a limit to how much they can do that.
And I think Scott Besson as Treasury Secretary knows that. So we still expect the yield curve to steepen in the second half of the year. We still expect that fiscal is ultimately going to be the driver here.
There is some wiggle room with managing the maturity profile of their issuance. But I do think that ultimately the deterioration of the budget deficit is going to be the big driver for long-end rates. And Eric, staying with this theme of the issuance of shorter-dated bills, do you think that this is a sign of U.S. confidence in its abilities to be able to finance itself?
Or is this a risk towards some sort of fiscal dominance, that is, the Fed ultimately having to step in to support the Treasury market? And what probability would you attach or what would you say would be the greater kind of view in the market about how this plays out? The benign response to your question is that Scott Besson is a seasoned macro market participant.
He understands the interplay between government policy and bond markets extremely well. I think the positive response would be that he will make an assessment of where he thinks there's good demand for Treasuries. He will make an assessment about where on the curve is the most cost effective and balance that with the risks of refinancing later in the future.
It's a thoughtful decision based on all of those factors. And in some respects, maybe that does reflect confidence in their ability to refinance a well-distributed Treasury portfolio over time. lower policy rates over the balance of Trump's presidency. And perhaps the cynical view is that they are going to make a bet that by shifting issuance into the front end of the curve, they're going to have a much more cooperative Fed over the course of the next two or three years.
Now, there's no way to prove that that's what they're thinking. But I think if the market started to believe that that's what they were thinking and started to believe that it was all part of a bigger playbook, I think the market would take that very poorly. I think the market would lower short-term interest rates, but I think long-term interest rates could potentially go a lot higher.
I also think that that would risk putting another big leg down in the U.S. dollar. The dollar has declined 10% in the first half of the year, has stabilized in the first few weeks of July. But I think the FX markets are looking for an excuse to sell the dollar on this loss of Fed independence combined with some gamesmanship with Treasury issuance and fiscal policy.
Fiscal dominance, as you called it, and I think it's a really interesting use of language. I think it's a risk that we have to give a reasonable probability to. How do you see this interplay of trade and policy uncertainty and fiscal concerns impacting other asset classes?
And is there something that markets are not focusing on currently that they should be appreciating a little bit more? One of the things that we've been thinking about is this idea that in spite of all of the trade uncertainty, in spite of what I would describe as the market's fairly downbeat growth expectations, not just for the U.S., but EM and globally, equity markets are behaving very, very well. But there's this apparent disconnect between the equity markets growth and earnings expectations and what I sort of generally hear in terms of the economic consensus.
I think if trade deals get finalized over the next two months, that's going to probably support this risk appetite that we're seeing. And I think it goes along the lines of a mediocre trade deal that gets done and that is finalized and puts the tariff risk behind us is a lot better than another six months of the prospect of 50 percent or 60 percent tariff rates. And so I think rightly or wrongly, the market has started to buy into the idea that if we're near the end of these negotiations, we can move on and get back to our daily lives.
Where I think that's potentially risky is that in various parts of the world, when we go back to thinking about the status of domestic economies, we go back to some very simple economic truths, which is that there are some parts of the world that have some real economic challenges, China being one of them. There are some parts of the world where access to capital markets is still constrained, either because of the prohibitive interest expense along with that or investor demand. There are a number of economic cross currents that I think have been put on hold while people focus their attention on tariffs.
The final one is the U.S. dollar. I think the market has embraced the narrative over the last seven months that the deterioration in policy transparency, policy credibility in the U.S. is reason enough to reduce what had been an overweight U.S. dollar position. As we look forward, the question now becomes how do we judge the U.S. dollar?
Is it based on U.S. economic growth outperformance or earnings growth outperformance? Is it based on interest rate differentials? This one is interesting because I think the market collectively now says interest rate differentials don't matter.
Yes, U.S. dollar rates are higher than most of DM and even in parts of EM, but it's no longer a rate differential story. It's a diversification out of dollars story. What's interesting related to that is you're starting to see very good performance in other asset classes.
Gold, digital assets continue to perform well. We're starting to see very good performance in EM equities. We're starting to see very good performance in Asia equities in general.
I think the benign interpretation is that the market no longer feels like it has to be overweight dollars and dollar assets, which is where the market has been for the last nearly 10 years. The positive angle is that people can now build more diversified portfolios. That's good news.
The potentially troubling angle is that if the dollar were to experience another, say, 10% decline over the next 12 months, does that raise unintended consequences for global portfolios? I think people are saying there's a high enough possibility that that's the case, that they want to own things like gold and digital assets as some form of a hedge to that fiat currency risk. I think that's something that is still bubbling under the surface and is going to come back to the front and center for markets in the second half of the year.
Thank you so much, Eric. Those were some great discussion points. There's lots more to discuss in the upcoming episodes, but that's all we have time for today.
Thanks, Madhur. Look, it's been a great podcast. Macro Freestyle has been a lot of fun for me.
It's been a great way to reiterate our views on current hot topics. And I think the one thing that we can say with absolute certainty is that the second half of the year is going to provide us with a lot more to discuss on this podcast series. So look forward to sharing thoughts again with everybody.
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