Muzinich Weekly Market Comment: Can’t see the forest for the trees
Insight
June 30, 2025
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In our latest roundup of the key developments in financial markets and economies, we explain why investors need to keep the bigger picture in mind, despite a strong end to the second quarter.
Last week, diplomats, politicians and administrators dominated investors’ attention. After a tense period in which the US was drawn into the Iran-Israel conflict, sentiment improved on news that a US-brokered truce had taken hold following 12 days of fighting. Israel agreed to the ceasefire on condition Iran refrains from further attacks, and Tehran signalled its willingness to comply. Speaking at a press conference during the NATO summit in The Hague, President Trump announced the US will hold talks with Iran this week, in an effort to advance a diplomatic agreement on the country's nuclear programme.[1]
Trump’s attendance at the NATO summit served two key purposes. First, he aimed to persuade member states to endorse a new defence spending target of 5% of GDP by 2035. This proposal includes 3.5% allocated to core defence activities, a significant increase from the longstanding 2% benchmark, and an additional 1.5% for broader defence-related initiatives, such as infrastructure, civilian resilience, and support for the defence industrial base. The success of this proposal allowed Trump to reaffirm the US’s commitment to NATO’s Article 5 mutual defence clause, declaring he was “all the way” with the alliance.[2]
Despite a united front at the summit, disparities in defence spending among European member states continue to raise concerns. Eastern European countries, such as Poland and the Baltic states, have significantly increased their defence budgets since 2022 and are on track to meet or exceed the 3.5% core defence target. Germany and several Scandinavian nations have announced plans to follow suit, aiming to reach at least 3% of GDP in the coming years. Meanwhile, the UK and France, traditionally leaders in European defence, support the new target but face fiscal constraints, with current plans indicating a gradual rise toward 2.5%. At the other end of the spectrum, Southern European countries such as Spain and Italy, which face fewer immediate security threats from Russia, are only now approaching the previous 2% benchmark.[3]
German fiscal plan moves step closer
More positive news on the government spending front came from Germany, where the lower house of parliament approved a €46 billion tax relief package, paving the way for final ratification by the upper house on July 11.[4] In parallel, the government agreed on its 2025 draft budget and set fiscal benchmarks through 2029. The message is clear, Germany is accelerating public investment, particularly in defence and infrastructure. The plan includes over €200 billion in spending this year and fresh borrowing exceeding 3% of GDP - a sharp fiscal easing in the second half of 2025.[5]
This combined stimulus is larger than expected and likely to support a rebound in investment, tilting growth expectations to the upside. Early signs of this momentum are already visible in business sentiment, with June’s Ifo Business Climate Index rising to a one-year high of 88.4, surpassing consensus forecasts.[6]
However, this improved economic outlook will come at a cost. To fund its fiscal programme, German government bond issuance will rise significantly. Over the 2025–2029 period, cumulative net borrowing is projected to reach approximately €850 billion - roughly 20% of last year’s GDP.[7]
Treasuries vs Bunds
In June, two clear trends have emerged. The first is the outperformance of the US government bond market compared to its European counterpart. For 10-year bonds, US yields have fallen by 17 basis points, while German Bunds have risen by 5 basis points. The second trend is the continued depreciation of the US dollar. These developments have been largely driven by a shift in relative economic momentum, with the euro area showing stronger growth prospects than the US. This is reflected in economic surprise indexes, where European data continues to beat expectations while US data repeatedly falls short.[8] However, actions by the US administration last week helped reinforce both trends.
US government bonds received a boost after the Federal Reserve proposed easing capital requirements for the largest US banks, a move that would allow them to hold more Treasuries.[9] In a 5-2 vote, the Fed advanced changes to the enhanced supplementary leverage ratio, which applies to major institutions like JPMorgan Chase, Bank of America, and Goldman Sachs. The proposal would lower holding-company capital requirements from 5% to a range of 3.5%–4.5%, potentially freeing up US$210 billion in capital across global systemically important banks. A 60-day public comment period is now underway.
Separately, a technical overhang for US fixed income markets was lifted as the so-called “revenge tax” on foreign investors was removed from pending legislation.[10] The controversial provision, known as Section 899, targeted countries with tax policies deemed discriminatory toward US companies. Its withdrawal follows a deal between the Treasury Department and G7 allies, under which US firms will be exempt from certain foreign digital and corporate taxes in exchange for dropping the measure from President Trump’s tax bill.
It was then Fed Chair Jerome Powell’s turn to reinforce the bond market trend. Speaking before the House Financial Services Committee, Powell said current interest rates are modestly restrictive but stressed the need to wait for greater clarity on the economic impact of proposed US tariffs.[11] He added: “If inflation pressures remain contained, then we will get to a place where we cut rates—sooner rather than later.” The overnight interest rate swap market is now pricing in 63 basis points of cuts by year-end, with three full 25 basis point cuts expected by the January 2026 meeting of the Federal Open Market Committee.[12]
There are numerous factors that influence the value of a fiat currency: narrowing interest rate differentials, particularly in a weakening economic context, tend to weigh against it. Another key variable is the perceived independence and institutional strength of a country’s central bank.
In this context, the US dollar reacted negatively to a Wall Street Journal report that President Trump is considering replacing Fed Chair Jerome Powell, with an announcement on a potential successor expected by September or October.[13] According to the article, candidates under consideration include Fed Governor Kevin Warsh and National Economic Council Director Kevin Hassett. Powell’s current term as Fed Chair expires in May 2026.
Risk comes in waves
In the second quarter, investors were hit by a series of event-risk waves. It began with the tariff shock on "Liberation Day" in April, when the US administration announced reciprocal trade measures. This was followed by the usual seasonal and sentiment headwinds tied to the “sell in May” pattern. Just as it seemed the quarter could not be any more turbulent, June brought a sharp escalation in geopolitical risk, as Israel and Iran exchanged strikes.
Given all that noise, few could have foreseen that capital markets would close the quarter with the VIX - our preferred gauge of market sentiment - trading below 20 and back at its February lows, signalling a return to risk-seeking behaviour.[14]
Meanwhile, the US dollar, the global reserve currency and consensus FX long for 2025, continues to depreciate, falling to a three-year low, as measured by the DXY index.[15] In credit markets, US high-yield bonds are on track for their best Q2 total return since 2021, while European investment-grade credit has seen its strongest second quarter total return since 2020. Meanwhile, equity markets have surged, with the Bloomberg World Large & Mid Cap Index reaching a new all-time high, with the outperforming sectors including industrials (led by defence securities) and finance (banking).
From an investor perspective, perhaps the phrase that best captures the second quarter is “you can't see the forest for the trees”. While event risk dominated headlines for much of the quarter, diplomacy and common sense ultimately prevailed. But in the process, many investors may have lost sight of a more important and lasting trend, with fiscal and monetary policy being loosened aggressively across the world.
China is accelerating fiscal spending ahead of schedule, the UK and Germany are pushing forward with significant public investment, and in the US, Treasury Secretary Scott Bessent said the 2025 fiscal deficit would come in between 6.5% and 6.7%.[16] At the same time, central banks around the world have begun easing policy. Of the 31 central banks we track, only one (Brazil) raised interest rates, while 22 opted to cut rates during the quarter.[17]
Arguably the most overlooked development in Q2 was the broad-based loosening of global financial conditions, as illustrated by our Chart of the Week below.
Chart of the Week: Easing of global financial conditions
Source: Goldman Sachs, Financial Conditions Index, June 27, 2025. For illustrative purposes only.
References
[1] Reuters, ‘ Trump says US to hold nuclear talks with Iran next week,’ June 25, 2025
[2] The White House, ‘President Trump’s Leadership, Vision Drives NATO Breakthrough,’ June 26, 2025
[3] All data in 3rd paragraph: Deutsche Bank, ‘Defending Europe: NATO summit delivers on narrow aims with the difficult work ahead,’ June 25, 2025
[4] Bloomberg, ‘German Lawmakers Back Merz’s €46 Billion Tax-Breaks Package,’ June 26, 2025
[5] DW, ‘German Cabinet approves high-borrowing draft budget,’ June 26, 2025
[6] Ifo Institute, ‘ifo Business Climate Index Rises,’ June 24, 2025
[7] Deutsche Bank, ‘An ambitious budget,’ June 24, 2025
[8] Citi, Economic Surprise Index, as of June 27, 2025
[9] Federal Reserve, ‘Federal Reserve Board publishes agenda for its conference on July 22 on large bank capital requirements,’ June 26, 2025
[10] Bloomberg, ‘Treasury Deal Kills 'Revenge Tax' That Spooked Wall Street,’ June 26, 2025
[11] Federal Reserve, ‘Semiannual Monetary Policy Report to the Congress,’ June 24, 2025
[12] Bloomberg, World Interest Rate Probabilities,’ as of June 27, 2025
[13] The Wall Street Journal, ‘Trump Considers Naming Next Fed Chair Early in Bid to Undermine Powell,’ June 25, 2025
[14] CBOE, 'Chicago Board Options Exchange Volatility Index,' as of June 27, 2025
[15] Intercontinental Exchange, U.S. Dollar Index, as of June 27, 2025
[16] Bloomberg, ‘Bessent Says ‘Remains to Be Seen’ Whether Tax Bill Adds to Debt, ‘ June 11, 2025
[17] JP Morgan, ‘Global Central Bank Watch,’ June 20, 2025
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of June 30, 2025, and may change without notice. All data figures are from Bloomberg, as of June 27, 2025, unless otherwise stated.
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