Trump’s return and his protectionist policies are putting markets under renewed pressure. Additional tariffs on Canada and Mexico, plus an additional 10% tariff hike on Chinese goods, are adding to inflationary pressures and outweighing the impact on economic growth. “With a rising consumer price index, a Fed rate cut is virtually impossible in the coming months,” says Mark Dowding, CIO at RBC BlueBay Asset Management.
However, markets continue to price in more than 75 basis points of rate cuts, which Dowding believes is unrealistic. “We see an opportunity to shorten the average duration of our portfolio,” he adds. At the same time, scepticism about the US is growing among international investors, which could drive capital flows into European assets, especially as the interest rate and growth differential between the US and the EU narrows.
A fall in US stock markets could soften the tone of trade policy. “If stock prices come under further pressure, it is likely that Trump will moderate his rhetoric to prevent market instability from continuing,” says Dowding. In the medium term, a constructive trade relationship remains in everyone’s interest. Ultimately, a compromise with tariffs at a manageable level of 10% seems a likely outcome in the coming weeks or months.
Meanwhile, the change of course of new German Chancellor Merz is bringing about a structural shift. “By taking defence spending above 1% of GDP outside the budget rules, Merz is creating additional investment space, a move we expect more broadly in the EU,” says Dowding. Germany could spend almost €1 trillion over the next decade, which could boost economic growth to 1.5% per year and stabilise inflation around 2.5%. This raises the question of whether the ECB’s recent rate cut to 2.50% was not the last of this cycle. “We see an opportunity to take a short position in Euribor futures, as the policy rate is unlikely to fall further to 2%.”
“It is interesting to see the unintended consequences of US policy. Trump has long wanted to weaken the EU as an institution, but by pushing Germany to loosen fiscal rules, his policy may have ultimately contributed to a stronger European economy. This seems to fit a broader shift, with ‘MEGA’ (‘Making Europe Great Again’) trades replacing the now less attractive ‘MAGA’ trades,” Dowding concludes.
