Monthly Update – August 2025

Summary: The Fed's policy dilemma

• The ongoing global expansion in liquidity continues to support financial markets. Despite some dampening factors, the tailwinds for risk assets remain in place for the time being.
• The Fed is caught in a policy dilemma: tariffs are increasing inflationary pressure while the labour market is showing clear signs of cooling. The risk of a delayed rate cut is rising – the Fed should give priority to its employment mandate.
• We maintain a neutral to slightly overweight risk exposure and a neutral duration stance.

Overall economic situation

Equity and credit markets continue to benefit from an expansive liquidity environment, which is also propping up the global economic backdrop. Nevertheless, growth has slowed markedly in the first half of the year, and inflation remains moderately elevated. Economic uncertainty remains high, particularly due to US tariff policy, the full impact of which is yet to be felt. In the US, signs of an economic slowdown are mounting, especially in the labour market. The risk that the Federal Reserve delays its rate cuts for too long is increasing.

Recent developments: Tariff impacts largely unmitigated

• Following recent trade agreements, the US is heading towards an effective tariff rate of 18–20% – alarmingly close to the 22% observed during the "Liberation Day" period, representing a fundamental departure from a century of US-led free trade. The effects are unevenly distributed across the economy – smaller firms and sectors with high import shares (e.g. autos and textiles) are disproportionately affected. Labour market data show that firms in these sectors have created almost no new jobs in recent months. Job losses loom, potentially undermining consumer spending – the key growth engine of the US economy.
• The "Big Beautiful Bill" will provide only limited economic stimulus. Many of the touted tax cuts were already enacted during the first Trump administration and are now merely being extended. Meanwhile, government spending is set to rise further – adding approximately 0.5% of GDP to an already unsustainable 6.5-7% deficit. Ideally, this figure should be closer to 2-3%. Moreover, the fiscal impulse is insufficient to offset the impact of tariffs, which effectively act as a tax on businesses and consumers.

Overview & outlook: The Fed is in a policy dilemma

• The surge in liquidity since the start of the year has supported a sharp rebound in global equity markets since “Liberation Day” in early April. With the suspension of the US debt ceiling, one positive liquidity factor is disappearing as the US Treasury is expected to replenish its Treasury General Account at the Fed by around USD 500 billion by the end of September – directly draining reserves from the banking system and tightening liquidity conditions.
• Globally, however, positive factors still dominate: The People’s Bank of China has expanded the money supply by around USD 1.5 trillion over the past six months. In addition, the US Treasury is increasingly issuing short-dated T-bills, considered near-money instruments, thereby boosting liquidity. Around 60% of global central banks remain in easing cycles, which continue to support risk assets.
• The US labour market has clearly lost momentum. Job growth is concentrated in a few sectors such as healthcare and education. Future Fed rate decisions will hinge on the unemployment rate – which will depend on whether the decline in labour demand outweighs the shrinking labour supply (partly due to restrictive immigration policy). Leading indicators point to increasing difficulty in finding employment – a further rise in unemployment seems likely.
• US inflation is expected to pick up further in the coming months. Surveys show that firms are largely passing on higher import prices to consumers – reinforcing inflationary pressures. The Fed thus faces a policy dilemma, but it should prioritise its employment mandate: While labour market pressures are likely to prove structural – with businesses requiring years to adjust to the new tariff regime – the inflationary impact of tariffs should be transitory. Moreover, falling real incomes and weaker economic momentum should dampen price pressures. The cost of overly restrictive monetary policy is therefore rising swiftly – a rate cut in September would be warranted.

Chart: Job search becoming harder – unemployment rate under pressure

Positioning: Neutral to slightly overweight in risk exposure

• The strong expansion of liquidity since the beginning of the year has provided solid support for the global equity rally, particularly since “Liberation Day” in April. However, the Treasury’s replenishment of its Fed account by roughly USD 500 billion by the end of September will now act as a liquidity headwind. Nonetheless, the overall backdrop remains supportive: The Chinese central bank has massively increased money supply, the US Treasury is favouring money-like T-bills, and the majority of central banks remain in easing mode.
• Against this backdrop, we are maintaining our current stance: Neutral to slightly overweight in risk exposure (equity sensitivity in convertibles and credit exposure in corporate bonds), with a neutral duration positioning.
• At the same time, we are monitoring potential warning signs and stress indicators closely. Of particular importance is the US dollar. Further weakening against the Japanese yen should be a serious warning signal. A breach below the 140 yen per US dollar threshold could trigger substantial capital outflows from the US to Japan. Other key early indicators include 30- and 40-year Japanese government bond yields and US money market spreads (SOFR vs. Fed Funds).
• Should any of these stress indicators flash warning signs, we would begin to reduce risk exposure gradually. It will be essential to closely observe the actions of major central banks – particularly the Fed, BoJ, and PBoC. In a stress scenario, rapid and decisive policy responses can be expected, such as rate cuts, renewed QE, or direct liquidity injections, all of which should help stabilise markets in the short term.

On the radar: The US Treasury is acting short-sightedly

The latest “Quarterly Refunding Announcement” has revealed the Treasury’s plans to refinance the record budget deficit this quarter: around USD 1 trillion will be raised following the passage of the “Big Beautiful Bill”, which lifted the debt ceiling from USD 36.1 to 41.1 trillion. The chosen issuance mix is telling: approximately 53% of new debt will be short-dated T-bills.

US Treasury Secretary Bessent justifies this with high long-term yields and a desire to avoid further increases. Additionally, demand for T-bills has surged, not just from money market funds but increasingly from stablecoin issuers. Under the recently passed GENIUS Act, stablecoins must be backed 1:1 with cash or T-bills. Bessent foresees a demand boom – predicting market capitalisation to grow from USD 270 billion today to USD 2 trillion by 2028. Given the current limited real-world use of stablecoins, this is an overly optimistic and speculative outlook, which in no way justifies the T-bill flood.

This strategy entails considerable risks. Refinancing risk increases, and there is no guarantee of lower interest rates in the future – particularly as the flood of near-money T-bills is stimulating both markets and consumption, thereby fuelling inflation. Critics have referred to this as stealth quantitative easing (QE), likely pushing long-dated Treasury yields down by around 50 basis points. In doing so, the Treasury is effectively manipulating the yield curve and encroaching on the Fed’s territory.

That such measures seem necessary at all is a clear warning sign – not only for the US. Other developed economies have followed a similar shortsighted path, significantly increasing the share of short-term debt. Emerging markets, by contrast, have drawn lessons from past crises and have steadily reduced their reliance on short-dated borrowing since the Asian crisis.

Chart: Historically high US borrowing outside of crisis periods