Low Visibility Navigation around Known Reefs

Sketching out more scenarios is a somewhat vain exercise in the highly volatile policy environment in the US. We can however adjust our previous assessment of the shock to the latest news. The temporary concessions on 9 April have changed the distribution of the shock for the rest of the world (less tariffs on almost everyone, but a much bigger one on China), but even after factoring in the reprieve on Chinese electronic goods (also only temporary), the overall magnitude of the inflation spike and GDP loss for the US is essentially unchanged: we still think the US will experience a brush with recession in 2H 2025. The size of the US shock – at a time when consumer confidence is already nose-diving – is likely to trigger more inflections in the White House’s position in the months ahead and we suspect that the final tariffs will be smaller than those announced last week. Yet, sheer uncertainty alone, unless negotiations resolve very quickly, will take its toll on business capex, financial conditions and consumption. 

We try to take some distance from the current news flow to explore a narrative which is apparently becoming popular in Washington: as disruptive as the current administration may seem, “Reaganomics” in the early 1980s were equally challenging to the received wisdom of the day but proved so successful that even after a “transitory recession”, Ronald Reagan was comfortably re-elected in 1984. Republican lawmakers should thus “stay the course” today. Looking back to the 1980s though, “Reaganomics” were less divisive than often thought – the President passed his tax cuts with the help of a significant fraction of Democratic Representatives – and, crucially, the “misery index” – the sum of inflation and the unemployment rate – peaked before Reagan took office. 

For all the instability, all the news flow points to faster disinflation in Europe and continuing for now to cut at a steady pace – while making it plain that the ECB will do what it must to deal with the changes in the Euro area’s international environment – is probably the best course of action for the Governing Council given the uncertainty level.