Merlin Weekly Macro: Trump’s unpredictability upends global norms

What an extraordinary week. One in which preconceptions have been debunked, apple carts overturned, accepted norms upended and conversions made on the Road to Damascus.

At the heart of almost everything of course is one person: Donald Trump. If not everyone to his tune, with the exception of Putin he certainly has them all dancing.

‘Unpredictable’ is an understatement

Consider what has happened.

The Americans voted with the Russians, Belarus and North Korea in the UN over Ukraine (the UK abstained, despite being publicly behind Zelensky — a long way behind, it seems).

Firmly against the deal, Trump now seems ‘inclined’ to allow the UK to donate the Chagos Islands to Mauritius with a £9 billion index-linked bounty despite the obvious security implications from China for the joint UK/US base at Diego Garcia compromising military and intelligence operations covering the Indian Ocean, the Gulf region, Pakistan, India and Afghanistan.

Rachel Reeves is a late convert to military spending having previously flatly declared there is ‘no magic money tree for defence’.

Taking its lead from Trump’s mantra of ‘Drill, Baby, Drill’, BP is going to do exactly that: slash its renewables initiatives and pump oil and gas like billy-o.

Trump feigned selective amnesia as to whether he had ever called President Zelensky a dictator; with access to Ukrainian mineral reserves and no security obligations in return, Trump doesn’t much care what he called Zelensky, he has exactly what he wants.

And in a case of mutual favour dangling, Starmer waved a morsel Trump could not resist (a Royal invitation to a second State Visit produced as if by magic from Starmer’s inside pocket), while with strings attached, Trump waved the prospect of a potential trade deal with the UK knowing full well that it would a) really annoy the EU (“the EU was invented to screw us”, said Trump memorably in his first Cabinet address) and b) would draw Starmer into Trump’s clutches and away from those of Brussels. Note that this is not a full free-trade deal as envisaged after Brexit, but if it limits Trump’s willingness to apply tariffs to the UK, so be it. The UK would still be collateral damage from a broader trade war, however, as countries which are subject to tariffs either make provisions for the higher costs of trade, or find alternative markets for their products creating price pressures and fears of ‘dumping’.  

One not to do with Trump: Labour has suddenly developed runway mania. Previously implacably against runway expansion in Opposition, it now wants a second runway at Gatwick, following hot on the heels of the third at Heathrow. It is in diametric contradiction with the Climate Change Commission (set up by Ed Miliband’s brother David), before whom this government habitually genuflects, which this week demanded that air travel be significantly curbed, not expanded.

A discombobulating week indeed. Almost as though the script has been torn up, policy is on a random walk being formulated on the hoof.

In search of security: Starmer’s Washington Odyssey

Starmer’s defence spending gambit as a pretext for making himself relevant at the White House, after Macron stole his thunder earlier in the week, was welcome (the touchy-feely ‘bromance’ between Trump and Macron intended by Macron to show everyone else that of all the major western leaders, only he had endured long enough from Trump’s first term to see Trump 2.0). At least we are no longer on a meandering indeterminate path from 2.3% today to 2.5% of GDP at some non-specific time in the future, and instead the target to achieve it is explicitly 2027.

But it’s worth looking beyond the spin to the underlying financial commitments. As the Institute for Financial Studies, the centre-left think-tank pointed out, the defence numbers don’t add up. Putting nominal values on the percentages, Starmer indicated that the 0.2 of a percentage point of GDP cut from the Overseas Aid budget to fund the 0.2 of a percentage point of GDP increase in defence spending, leaves a gap of more than £6 billion between the two. Another way of looking at it, according to the IFS: the annual defence budget is supposed to be protected in real terms; Starmer’s numbers suggest that in nominal terms, the defence budget is effectively frozen until 2027. As things stand today, ahead of the publication of the long-awaited 2025 Strategic Defence Review, the British Armed Forces are still due to shrink even further from their already hollowed-out state: fewer personnel; many fewer combat aircraft; fewer warships; fewer tanks. The acid test of Starmer’s new-found enthusiasm for defence will be if immediate prospective cuts already in the pipeline are reversed, including the £550m of cost-savings announced only three months ago by Defence Secretary John Healey involving scrapping the Navy’s two amphibious assault ships, reducing fleet logistics capacity, and binning the older but serviceable Chinook heavy-lift helicopters.

Starmer produced another apparent ta-da moment with his defence announcement: the intention to see the percentage of GDP allocated to military spending rising to 3% in the next parliament (i.e. before 2034, but with the not-on-the-hook qualification of “only if economic conditions allow”). Also welcome, it is nevertheless another political sleight of hand: 3% has already been agreed in principle by NATO members including the UK, and Secretary General Mark Rutte expects the new minimum bar to be endorsed at NATO’s annual conference in June. Moving the fiscal deckchairs around to make the target easier to achieve, the budgets for the intelligence services (MIs 5 & 6 and GCHQ) held in the non-departmental Single Intelligence Account will be included in the annual defence spending returns made to NATO. Unlike George Osborne’s smoke-and-mirrors obfuscation with the defence accounts to improve our NATO compliance by including service pension costs, the cost of military housing etc which pushed us from 1.9% of GDP to just over 2%, in many ways given the nature of what those security services do, it is surprising that their costs have not always been included in the defence returns.

As Merlin Investment Director Alastair Irvine made clear in his recently published “Call to Arms; a Strategic Blueprint for National Security” (Jupiter Insights 21 February), defence spending is all about bang-for-buck. As important as how much money is spent on defence is how efficiently it is spent, where it is targeted and to what effect. The new budget targets set by Keir Starmer are undoubtedly a step in the right direction but the key challenge is to ensure that every marginal pound of expenditure produces a tangible marginal benefit to our defences. History points to precisely the opposite: shrinking operational resources however big the budget is. That must be reversed.

Beware the dangers in keeping the peace

While Trump refuses (so far) to participate in post-ceasefire peace keeping duties in Ukraine, either boots on the ground or air cover for others (for him it is a European problem), Keir Starmer is ‘prepared to commit our soldiers to Ukraine in harm’s way’. Macron would do the same, though he wants his people in safe lodgements. The sentiment of Starmer’s ambition is admirable.

However, jammed like cheese in a sandwich between simmering and mutually mistrustful parties, even with a ceasefire, peace keeping forces must be scrupulously impartial. That cannot be the case with the UK because for three years we have quite rightly been supporting Ukraine and vilifying Russia. We have been supplying copious quantities of very effective anti-tank missiles, plus those long-range Storm Shadow missiles for use against targets inside Russian territory. We’ve sent Challenger tanks and we have trained tens of thousands of Ukrainian conscripts who have gone back home and killed many thousands of Russians. Indeed, the UK has just this week introduced new sanctions against Russians entering the UK. It is absolutely no surprise the Russians have said the idea of NATO peace keeping forces is an unacceptable proposition.

Peacekeepers need very specific objectives and crystal-clear terms of deployment. They must be neutral and have an unqualified internationally agreed mandate. It seems impossible to demonstrate impartiality when as a neutral peacekeeper your country has active sanctions against one of the protagonists and supports the criminal indictment of its president on charges of war crimes and genocide. You can be either a peacekeeper or a partial participating proxy but you cannot be both.

Therein lies the problem: the only forum to grant peace keeping authority is the UN of which Russia is a permanent member of the Security Council with a right of veto. Given the voting/abstention records in UN resolutions on Ukraine over the past three years, it is going to be difficult to find credible countries to supply troops for peace keeping purposes who are a) willing, b) capable, c) acceptable to both sides, d) are not members of NATO and e) who are going to be able to command any kind of respect.

The Investment Perspective

There is much to distil in the investment calculation. Stagflation¹: exacerbated by rising gas and electricity prices, real wage increases and a service economy with costs rising above the headline rate, the inflationary pressure is trending upwards despite zero growth in the UK and most European economies (here, with inflation back up to 3%, the Bank of England sees it potentially hitting 3.75% in the autumn; nothing disastrous, but moving away from the 2% target). Trump’s tariffs, obviously, including the ending of the one month grace for Mexico and Canada and the imposition of 25% punitive duties against both countries keeping the prospect of a global trade war with all its frictional costs still front of mind. Recent economic data, including business and retail confidence surveys which point towards a slowing US economy, evidenced by growth decelerating from 3.1% in the third quarter of 2024 to 2.3% in the fourth, albeit most European economies would die for such a ‘slowing’ growth rate. And on the geopolitical front, trying to make sense of a rapidly changing, immensely dynamic situation where a very mercurial and unpredictable man can cause so much upheaval as he pontificates on policy from a chair by the fireside in the Oval Office in front of a battalion of live-reporting television crews.

Taking everything in the round, and putting pressure on the central banks that their current “we’re in no hurry to cut interest rates” stance is inappropriate, and for the moment investors are tending to favour safe-haven assets: principally government bonds (and US treasuries in particular, where the yield on the 10-year bond has fallen from 4.8% before Trump’s inauguration to 4.2% at the time of writing, with the price heading in the opposite direction) and gold. Even if the gold price is off the recent top approaching $3000/oz, it has still appreciated 10% so far this year. All the Jupiter Merlin Portfolios have an allocation to physical gold, and have done consistently since 2007.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

Footnotes

¹‘Stagflation’ is the term for when an economy is experiencing low or zero growth, i.e. its economy is stagnating, while inflation is relatively high. In more normal circumstances, low economic growth would typically be accompanied by low inflation.