Key Takeaways
- US policy initiatives are coming thick and fast. Europe’s under pressure from proposed tariffs and US/Russia discussions around Ukraine have unsettled its leaders.
- US tariffs on European steel and aluminium look set to be implemented. In response, Europe is offering to lower some EU tariffs and buy more US LNG and defence equipment. Agreement is yet to be reached.
- A focus on services together with a broad trade balance with the US means that the UK has been less impacted by new US tariffs.
- The US’s approach to Ukraine has led to a deterioration in relations with Europe. If Europe is forced to spend more on defence, we could see fiscal expansion, and this would be good news for Europe’s economy.
- Upcoming purchasing managers’ indices will provide clues around how much geopolitical uncertainty is deterring investment and spending. We will be watching data closely.
- Despite uncertainty, the global economic recovery remains intact. And with falling interest rates we remain cautiously optimistic on risk assets with a preference for US equities.
US policy initiatives are coming out thick and fast. The tariff blunderbuss is now being aimed at Europe and the prospect of a peace deal in Ukraine has put European leaders in disarray. In this week’s update, we will try to work out the impact on the economies of Europe and the UK.
Let’s start with tariffs. Whereas threatened tariffs on Columbia, Mexico and Canada have not been implemented (not yet at any rate) we think that tariffs on Europe will go ahead. We expect tariffs on steel and aluminium to be implemented from 12 March with reciprocal tariffs at the beginning of April. Tariffs on steel and aluminium if set at the full 25% would obviously have a big direct impact but the overall size of US-EU trade is small in this area. Reciprocal tariffs – where the US levels up its tariffs to match those levied by Europe – could be more wide-ranging. For some specific product categories the impact could be significant. The EU is offering to lower some EU tariffs, such as those on autos and buy more LNG and defence equipment from the US if Trump pulls back from implementing tariffs. This would be good news from a macro perspective for both sides but there is – as of yet – no concrete agreement. The UK is less affected by all this given that we run a broad trade balance with the US and are focussed on services, which are not subject to the threatened tariffs.
Relations between Washington and the EU are distinctly frosty at present as a result of Trump’s approach to Ukraine. He is attempting to secure a peace deal directly with Putin and effectively cutting out Ukraine and Europe. Europe’s political leaders cannot agree amongst themselves and are terrified by the prospect of having to face Russia directly via a peacekeeping force without US support. Article 5, the mutual defence agreement that allows Europe to shelter under the wing of US defence could then be called into question. From a macro perspective, there’s a good chance that this will lead to a fiscal expansion in Europe. Europe’s leaders will be forced to increase defence spending and Brussels is contemplating easing its fiscal rules to facilitate this. Meanwhile in Germany, if next week’s elections deliver the two-thirds majority for centrist parties needed to amend the constitution, it is likely that the ‘debt brake’ will be eased. With low interest rates and weak economic growth fiscal easing would be good news for Europe’s economy. UK fiscal policy is heavily constrained, and the prime minister has recently said that there are no plans to further increase defence spending.
Energy prices, forced up by war in Ukraine have been rising recently for other reasons but are likely to fall significantly over the medium term whether or not there is a ceasefire in Ukraine. We discussed this topic in a recent update.
Added to the direct effects of the policy blitz from Trump is uncertainty which itself can deter investment and spending more generally. Purchasing managers’ indices, released later this week will give some clues here.
All this is taking place against a background in which the eurozone economy has been slowly improving. Although the UK enjoyed some better-than-expected GDP data last week, the next few months will be distinctly challenging as hefty tax changes are likely to raise inflation and unemployment.
So where does this leave financial markets? We are cautiously optimistic on risk assets given a global economic recovery and falling interest rates. Indeed, equities, notably in Europe have generally shrugged off all the negative geopolitical news. We hold to this view, though we prefer the US market, where the uncertainties are less.
