Tariffs and turbulence

President Trump's announcement of extensive tariff increases, along with new confrontations with the Federal Reserve (Fed), has left a clear mark on the financial markets throughout April. Significant fluctuations across asset classes have characterised market dynamics, and investors' confidence in American assets has waned, resulting in quite substantial price declines in longterm US government bonds. The development in Europe has been almost the opposite of the American situation, with strengthened expectations of easing measures from the ECB helping to lower market rates.

Looking ahead, uncertainty on the outlook for rates remains significant and is centred around the political priorities in Washington. Where does the Trump administration's threshold lie for financial headwinds, worsening polls, and economic deterioration due to its policies?

Recently, the market has seemed optimistic that a softening is underway. The EU and other key trading partners have been given a 90-day negotiation period before the new tariffs take effect, and Trump has recently expressed a desire to de-escalate the confrontation with China. Whether we are indeed witnessing a lasting change in course or merely a temporary softening remains uncertain, and this uncertainty will contribute to maintaining an elevated risk premium in US interest rates for quite some time. Ultimately, the question is whether slightly milder tones from President Trump will prove sufficient to halt the negative economic dynamics that have begun.

The uncertainty is already evident in the US economy – but the Fed remains calm

Already in the preliminary economic indicators for April, the storm of uncertainty associated with the trade policy line is beginning to impact activity. The regional activity measure from Philadelphia, which has typically been a good proxy for national development, showed the largest monthly decline in April since the COVID-19 lockdowns back in 2020, and the University of Michigan's measure of consumer confidence likewise showed a significant decline in recent data. Due to the tariff changes, the US economy faces a significant supply shock, putting the Fed in a difficult position. Should it even react – the policy could change tomorrow – and which of the two opposing effects of the tariff increase (higher prices, lower growth) should be given the highest weight in the assessment?

So far, the Fed has remained patient in its assessment, and we expect this stance to be maintained until June, when we anticipate the next interest rate cut of 25 basis points. The Fed's patient approach throughout April, as in its first period, has led to threats from Trump to fire central bank chief Powell, which, if it actually happened, would permanently damage the central bank's credibility and further erode investors' confidence in US assets. The latest reflections from the president seem to indicate that this may be too high a price after all.

For the ECB, the question is no longer whether, but how much rates should be cut

A somewhat different interpretation of the significance of American trade policy for monetary policy has emerged in Europe, where the combination of economic uncertainty, financial turmoil, and currency strengthening has added new pressure on growth. Concerns about upward risks to inflation seem almost to have disappeared from ECB communication since 'Liberation. Day', opening speculation in the market on more aggressive rate cuts – and perhaps even a ‘jumbo’ 50bp cut along the way. We are, in our opinion, still quite far from ‘jumbo cuts’, but the market's expectation towards the ECB has quickly converged with our forecast, which we have maintained since October 2024. We anticipate that the ECB will further reduce rates by 3x25 basis points at the meetings in June, July, and September.

Download The Full Yield Outlook