Tuesday’s Grey and Wednesday Too

This Wednesday 2 April, the release of the US “reciprocal tariffs” will herald the generalisation of the trade war. Yet, we can already see the signs of a stagflationary scenario for the US economy emerging with, for the first time last week, “hard data” and not just sentiment being hit. The steep upward revision in consumers’ price expectations is making them effectively close their wallets. After the release of the personal spending figures for February, the Atlanta Fed’s Nowcast estimate for Q1 GDP stands at -0.5%. The 25% tariff on cars and car parts alone could lift US core inflation by 0.6%/0.7%. This could be a short-lived shock, but labour market conditions could make it more persistent, and we keep an eye on the other negative supply-side shock about to hit the US: according to the Border Protection data, the crackdown on immigration is already triggering a very sharp decline in entries. This could keep wage growth high even if job creation starts to get wobbly. 

For Europeans, the tariff on cars gives a first taste of what is coming their way. Given Germany’s particular sensitivity to car exports, this validates the new policy approach in Germany, with the focus on reviving domestic spending. Yet, in the short run, pain is likely to be intense. The likely retaliation from the EU, quite possibly via the Anti Coercion Instrument designed in 2023, will be part of the equation. European businesses and consumers will have to contend with uncertainty around the final level of the US “reciprocal tariffs”, as negotiations will take time, while being unsure about the impact they will have on their own economy given the wide range for price elasticity estimates, as well as about the effect of any counter-measures the EU could take. This is a lot to take. 

We extrapolate from the bond market reaction so far to the fiscal shift in Germany to investigate how fiscal sustainability conditions could change in the Euro area. For Germany, the fiscal space would widen – the fiscal push would thus be self-financed – as the likely gain in trend nominal growth exceeds by far the rise in long-term yields. The same does not hold for France or Italy. This illustrates again the need for more joint issuance in Europe.