The 2nd of April seemed to mark a turning point, with Donald Trump announcing that he would be imposing much higher tariffs on products entering the United States than had previously been anticipated.
He has plunged the world and the stock markets into the unknown. Whether this is a negotiating tactic or a dogmatic approach, it is still difficult to see clearly, but the negative repercussions on financial assets and the economy would appear to be very real.
From Liberation Day to Recession Year?
While Trump explains that the effects of his customs policy will be positive for the US economy, economists are more circumspect, if not downright worried. The United States will be the hardest-hit country in terms of growth and inflation among the major developed countries. This will raise inflation by a further 1 to 2 percentage points and cost the country more than one point in growth over the next twelve months. Furthermore, economists currently estimate the probability of a US recession in the next twelve months at over 40%, compared with 10% at the start of the year.
In addition, this pricing policy is creating a lasting supply shock by disrupting value chains and worsening financial conditions, as evidenced by the rise in long-term rates and credit spreads, and the fall in equity markets and the dollar.
While the 90-day pause in US tariffs may have allayed short-term fears of a trade and financial shock, the tariff structure remains complex and uncertain (25% on steel, aluminium and cars, 140% on Chinese products, etc.). This will continue to weigh on business investment decisions and consumer confidence.
What response could the Fed then provide?
The market is anticipating four rate cuts over the year, including one in June, with a high probability. However, this does not match the speech of the institution is currently saying. Changes in its policy will depend on developments in the labour market, which has not had yet to face the consequences of the tariffs hikes, and on US inflation, which is expected to rise this summer.
On the long end of the curve, a number of structural factors, including above-target inflation, concerns about the Fed’s independence, a term premium and a higher risk premium, argue in favour of structurally higher rates.
Bad timing for the eurozone
The outlook for growth remains uncertain at this stage, with two opposing forces at play: the positive impact of investment plans on the one hand, and the uncertainty linked to developments in US policy on the other.
Even if the recessionary effect of the increase in customs tariffs appears to be less marked in Europe than in the United States, with exports to the US accounting for just 3.5% of the eurozone’s GDP, certain sectors (automotive, transport, aviation, pharmaceuticals, wines and spirits, etc.) and certain countries, notably Germany, the EU’s leading exporter, will be particularly hardly hit. Similarly, the economic uncertainties and the deterioration in financial conditions, which will delay business decision-making and penalise investment and employment. Another factor: increased Chinese competition, with the European market being the main substitute for the American market, would weigh on activity.
This is why we are revising the Euro zone’s GDP growth downwards in 2025, to 0.7% (vs. 1%) and 1.5% in 2026.
This tariff war should reinforce the disinflation movement, even if the EU retaliates against certain US goods. The slowdown in foreign demand, global overcapacity, falling energy and commodity prices, and the euro’s appreciation against the dollar all point to lower inflation. This should give the ECB sufficient visibility to continue its monetary easing, with a target rate that we now estimate at 1.75%
What next?
A significant unknown remains: geopolitics. While the world is focused on tariffs and markets, it is no longer looking towards Russia, Israel, or Iran, which could be at the heart of Donald Trump’s future decisions, provided he has the means to implement his policies. Just as China has effectively managed to halt the mechanics of tariffs, Saudi Arabia is trying to temper American enthusiasm regarding the Iranian issue.
By David Belloc, Portfolio Manager and Strategist at Mirova
