Pain Ahead (for all)

Those who had been hoping for a low “transformation rate” of Donald Trump’s electoral platform into policies may have to revisit their opinion after this weekend’s announcement of tariff hikes on Canada, Mexico, and China. True, the move on Chinese products was limited to 10%, and Europe has so far been spared, but we think this is just a first salvo, and the shock on US import prices will already be substantial. The message sent to all trade partners is that the US is ready to take some pain – the impact on US inflation is likely to be visible – to assert its dominance, and that no one, irrespective the tightness of the relationship with the US is, can consider themselves “safe” from US unilateral trade action. This will add to the Fed’s reluctance to ease further, already obvious in Jay Powell’s press conference last week before the tariff announcements, with ramifications for the long end of the curve. We do not think that rate cuts cannot materialise again without “Trumpnomics” going full circle, i.e. without a slowdown in GDP growth following the current “sugar rush,” which would help absorb a re-acceleration in consumer prices which, after this weekend’s announcement, is looking even more likely.

The ECB was largely on autopilot last week. Christine Lagarde did not have to deploy much creativity: the rate cut was telegraphed, and the change in forward guidance in December gave them cover to continue to bring their policy rate towards neutral. It is quite striking however that the market is now finding it absolutely normal that the ECB continues to ease while the Fed is pausing (likely for long). This is completely justified by the data divergence, but it is still interesting that the ECB has managed to assert its independence from its US counterpart without much market grumbling. We remain confident the ECB will break through neutral: if the ECB is already willing to go to neutral despite still officially believing in a recovery, then logically the continuation of the current stagnation – which we think is more plausible – should provide a strong reason to cut further. Moreover, we think the ECB will be increasingly spooked by the tightening in credit standards and erosion in credit demand, resulting in a descent in fully accommodative territory.