It’s been a week of mixed returns in financial markets as investors continue to ponder the consequences of the US tariffs and the lack of progress in talks between the US and their trading partners.
President Trump complained that President Xi Jinping is “extremely hard to make a deal with” but a phone conversation between the two leaders may just have put things back on track. This week saw the submission date for ‘best offers’ from the US’s trading partners ahead of the 9 July deadline for the ‘pause’ in reciprocal tariffs. Legal uncertainties over the validity of the tariffs continue in the background. With the exception of the UK framework for tariff reductions, and the easing back in the retaliatory tariffs from the 100% plus levels between the US and China, we have seen no ‘deals’ yet.
President Trump took to social media in the middle of the night on Tuesday to bemoan the fact that President Xi Jinping is “extremely hard to make a deal with”. The US has been pushing for a phone call between President Trump and President Xi, but China has consistently preferred trade talks to take place at a lower level first. We saw something of a breakthrough yesterday, with the first phone call taking place between the two leaders since Trump’s inauguration back in January. Trump described the call as “very good… we’ve straightened out any complexity, it’s very complex stuff. I think we’re in very good shape with China and the trade deal”. Chinese state news agency Xinhua said that Xi told Trump that China had strictly implemented the agreement reached in Geneva and the US should withdraw the “negative measures” taken against the country. The Presidents agreed for high level trade talks to begin “soon”. Tensions had been rising between the US and China, with both sides accusing each other of breaking the agreement made in Switzerland last month to de-escalate tariffs. China accused the US of “seriously violating” the trade truce agreed in Geneva by issuing warnings on the use of Chinese Huawei chips globally, halting sales of chip design software to Chinese companies and cancelling Chinese student visas. The US accused China of failing to deliver on a promise to approve licences for the export of rare earths, an issue that is causing concerns globally over potential supply chain disruption.
China has 48% of known reserves of rare earth elements globally – the next biggest country is Brazil on 23%. In contrast, the US only has 2% of known reserves. Production wise, China completely dominates, with 69% of global mine production of rare earths last year. Just after ‘Liberation Day’ in early April, the Chinese government imposed restrictions on the global exports of six heavy rare earth metals, which are only refined in China. In addition, controls were placed on the export of rare earth magnets, 90% of which are produced in China. These metals can only be shipped with a ‘special export licence’ but the mechanism for setting up and issuing these licences has barely begun, meaning the prospect of supply chain stresses in industries reliant on these raw materials. They are used in the production of products as diverse as wind turbines, electric vehicle motors, weapons, lighting, medical devices, oil refining and nuclear power. The US took the view that the agreement struck in Geneva covers rare earth exports, but China has said that the export restrictions are a global policy not related to tariffs and are not covered by the Geneva deal. This leaves European companies equally exposed as their US counterparts. Japan, which suffered a rare earth export ban previously, has relatively high levels of inventory; the same cannot be said for manufacturers in the US and Europe. It will take time for the impact to become clear, but the continued stalling in rare earth exports, and the data showing a continued relative lack of container ships leaving China for the US, suggests that while punitive tariffs may have come down, there will still be further economic consequences.
In the actual economic data, we’ve seen inflation numbers reported for the eurozone and Switzerland. The latter is of interest because Switzerland has returned to deflation, with CPI down 0.1% in May compared to a year ago. Switzerland has seen inflation fall as a result of the strength of the Swiss Franc, which has been a popular haven this year, not least with the US Dollar out of favour. The Swiss Franc is up over 10% against the Dollar this year, and markets are expecting the Swiss National Bank to cut interest rates back into negative territory at some point to weaken the currency and push back on deflationary pressures. Markets are currently pricing interest rates to be -0.5% by the end of the year. Negative rates and negative bond yields may feel like a distant memory after the inflation and rate hikes across western economies, but not so in Switzerland. Meanwhile, eurozone inflation came in below the European Central Bank’s 2% target rate for only the second time in the past three years. It stood at 1.9% year on year in May.
As expected, the European Central Bank cut interest rates by 25 basis points when they met yesterday, taking the policy rate to 2.0%. This was the eighth cut in the past twelve months, but the language from the ECB suggested the end of the cutting cycle was either close, or already upon us. ECB president Christine Lagarde said the central bank had “nearly concluded” the latest monetary policy cycle, which has seen interest rates fall from 4% to 2% since June 2024. Lagarde said that with rates at the current level the eurozone would be “in a good position to navigate the uncertain conditions” facing the currency bloc. This suggests the ECB is done with cuts but markets are still pricing one further reduction over the rest of 2025. The ECB cut their inflation forecast for 2025 to 2% and for 2026 to 1.9%. GDP is expected to grow by 0.9% this year and 1.1% next year. Lagarde said that while “uncertainty surrounding trade policies” posed risks to “business investment and exports, especially in the short term”, higher real incomes and a “robust” labour market would “allow households to spend more”. The ECB statement said that while policy uncertainty around trade would be a short term drag, “rising government investment in defence and infrastructure will increasingly support growth”.
Notwithstanding persistent elevated levels of policy uncertainty, the economic backdrop remains relatively benign, but we are still seeing growth downgrades for 2025 and beyond. This week saw the OECD warns the global economy is heading for its weakest spell of growth since the Covid-19 pandemic as the trade war weighs on economic momentum. The organisation cut their global growth forecast to 2.9% for both 2025 and 2026, with the US seeing a particularly sharp slowdown, from 2.8% growth in 2024 to just 1.6% in 2025 and 1.5% in 2026. The OECD also expects higher US inflation to prevent the Federal Reserve from cutting rates this year. OECD Chief Economist Alvaro Pereira said countries urgently needed to strike deals to lower trade barriers, “otherwise the growth impact is going to be quite significant…. this has massive repercussions for everyone”. China is expected to see growth of 4.7% in 2025 while the eurozone will expand by 1% and the UK by 1.3% this year. The forecasts were based on mid-May tariff levels, after the 100%+ tariffs between the US and China were lowered. The de-escalation between the US and China is clearly a big positive, though this is a ceasefire rather than a cessation of hostilities, and the news flow this week highlights that considerable tensions remain. That said, both sides appear willing to engage in talks. We will have to wait and see if economic pragmatism will outweigh political ideology over the coming months. If pragmatism prevails the outlook for both economic growth and financial markets is a lot more positive than the alternative.
Source: Columbia Threadneedle Investments as at 06 June 2025
