Japan and the EU secure U.S. trade deals

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It was a quiet week in the markets as investors began to head off for the summer, taking some liquidity with them. Earnings season hit full stride, and the reports were generally good, providing some support to indices.

The general backdrop was somewhat supportive, with additional trade deals announced at lower-than-expected tariff rates. Trade deals haven’t resulted in a pivot back to the low tariff environment that existed before President Trump returned to power, but they have reduced uncertainty about the future trading environment. This is evident in a reduction in the VIX Index of expected volatility to the lowest level since 14 February.

Japan and the EU secure U.S. tariff deals

A number of trade agreements were reached over the last week, with the European Union (EU) and Japan being the most significant.

Both deals saw a reduction in the baseline tariff rate to 15%; Japan’s tariff rate was 24% on ‘Liberation Day’, and the EU had been threatened with a 30% rate at one point. The deal includes cars, which represents a significant improvement on the 25% global auto tariff previously announced by the Trump administration. Pharmaceuticals should also be covered, mitigating the effects of more tariffs due to come on the sector.

Source: RBC Brewin Dolphin

The U.S. has prioritised making commitments to inward investment a part of the deals. The White House announced that Japan will invest $550bn in a range of U.S. strategic industries, with the U.S. apparently retaining 90% of the profits from those investments. On the face of it, that seems an intolerably bad deal for Japan, so we await more details on exactly how, or why, this would happen. The EU is understood to have committed to $600bn of inward investment into the U.S. and the purchase of $750bn worth of energy products.

Overall, more trade deals appear to have been achieved with lower tariff rates compared to those announced on ‘Liberation Day’. Obviously, this still represents a significant increase from pre-Inauguration Day levels, which could weigh on growth by driving higher inflation. Despite this, the markets seem to have responded positively.

With days to go until the new tariff rates come into effect, many countries still haven’t come to agreements with the U.S., and President Trump has been vague about what the new universal tariff rate might be.

Will the Federal Reserve hold interest rates?

The president has continued to needle Federal Reserve (Fed) Chairman Jay Powell while maintaining that he has no intention to replace Powell before his term as chair expires in 2026. But President Trump and members of his administration continue to be critical of Powell in relation to monetary and non-monetary matters. In doing so, they seem to be normalising the idea that the president should influence monetary policy.

The Fed will announce interest rates this week. It seems highly unlikely that there will be any change because the economy and inflation have been holding up. However, interest rates are still expected to fall later in the year as the economy gradually loses further steam.

Source: LSEG

Eurozone outlook remains uncertain

The European Central Bank (ECB) has held its deposit rate steady at 2%, which was widely expected. However, the future direction of interest rates is uncertain and will depend on how the tariff drama between the U.S. and EU plays out.

If the U.S. imposes a 15% tariff on the EU, as is currently being discussed, it may negate the need for further rate cuts by the ECB. Markets are currently pricing in a better-than-50%-chance of a rate cut between now and March, despite the trade deal (without which the economic outlook would be more precarious.)

The ECB’s latest bank lending survey shows strong residential mortgage demand, suggesting that this interest rate-sensitive sector may not need additional stimulus. Meanwhile, recent data has shown an uptick in new orders in the Eurozone.

Despite improved sentiment towards the Eurozone, the French economy is likely to weigh on the upside. France has the second-largest government budget deficit in the region and is facing a debt crisis. The government has announced a package of spending cuts, tax hikes, and reforms aimed at shrinking the deficit, but these measures are unlikely to be passed into law due to political opposition. The budget deficit is expected to remain unchanged over the next couple of years, and developments in France are a reminder that the upside for the Eurozone should be limited.

Overall, while the Eurozone has shown signs of improvement, the ongoing tariff drama and challenges in France mean the outlook remains uncertain.

Coming up this week

• More earnings reports: It will be another bumper week for earnings, with Microsoft, Amazon and Apple amongst those reporting.
• Disappointment for President Trump: The Federal Reserve will leave interest rates on hold.
• Trade remains in focus: Trade talks will continue between China and the U.S. as deals with other countries come into effect.

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