The US economy has once again thumbed its nose at the prophets of doom, posting growth figures that have left the consensus in tatters. For those of us who have spent decades watching the ebb and flow of the Atlantic economic tides, this resilience is both impressive and deeply unsettling. The numbers are out, and they are robust. But for the sterling markets, this is not a moment for celebration. It is a moment to watch for the capital flows that could destabilise our own fragile recovery.
The immediate reaction in London was a sharp sell-off in gilts. Yields on the 10-year benchmark rose by 6 basis points as traders priced in a more aggressive Federal Reserve. The logic is simple: a stronger US economy means the Fed will keep rates higher for longer. That sucks capital out of London and into New York. The pound, which had been trading in a narrow range against the dollar, slid half a cent before finding some support. But the real action is in the bond market. The yield curve is flattening again, a classic sign that the market believes the Bank of England will have to follow the Fed's lead, even if our own economy is showing signs of cracking.
And let's be clear about what this means for the UK. We are still wrestling with inflation that is stickier than a Treasury committee hearing. The latest CPI print came in at 2.3%, still above the Bank's 2% target. Core inflation is even more stubborn. The Bank of England has been signalling that it wants to cut rates to stimulate growth, but the US data puts a dagger through that plan. If the Fed stays hawkish, the Bank cannot afford to ease. The result is a policy straitjacket: higher rates for longer, crushing domestic demand while export competitiveness improves only modestly given the dollar's strength.
The corporate sector is already feeling the pinch. I spoke to a fund manager this morning who described the mood in the City as 'defensive capitulation'. There is a distinct lack of conviction in any equity rally. The FTSE 100 is being propped up by commodity stocks, but the broader market is struggling. The dollar-denominated earnings of multinationals are a bright spot, but that is small comfort for the small and mid-cap firms that rely on domestic spending. They are facing higher input costs, a weaker consumer, and now the prospect of tighter financial conditions.
The government's fiscal position is another worry. With gilt yields rising, the cost of servicing our national debt is becoming more onerous. The Office for Budget Responsibility has already warned that a sustained rise in yields could wipe out the chancellor's fiscal headroom. That would force either tax increases or spending cuts, neither of which is politically palatable in an election year. The Treasury is likely to be scrambling behind the scenes to reassure the bond markets. But the market is not in a forgiving mood.
What happens next depends on whether this US strength is a temporary blip or a new trend. If the data continues to surprise on the upside, we could see capital flight accelerate. The pound could come under more pressure, and the Bank of England might have to raise rates again, which would be a disaster for the housing market and business investment. On the other hand, if the US economy stumbles in the coming months, the Fed will be forced to cut rates, and the pressure on the UK will ease. But for now, the market is betting on American exceptionalism.
For sterling investors, the message is clear: batten down the hatches. Diversify away from UK domestic assets. Look for dollar-denominated earnings or companies with pricing power. The old adage that 'when the US sneezes, the world catches a cold' is being updated. The US is not sneezing. It is sprinting. And the rest of us are trying to keep up. The ripple effects will be felt in every corner of the British economy. The only question is whether they will be tidal waves or merely choppy seas.
