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Things can certainly change very rapidly! The trend of accelerating US growth and negativity around European growth came to an abrupt halt over the last month. Market participants, who were until very recently arguing why the Fed would probably not begin to hike rates this year, have quickly returned to the 2-cuts this year and likely next year camp. Trade policy uncertainty is the primary cause of this mini growth shock facing the US. In Europe, the German election results have spurred the chancellor-in-waiting to urge the outgoing parliament to ratify significant changes to Germany’s debt brake, with enormous increases in infrastructure and defence spending over the next decade. The announcement caused the biggest rise in German bond yields since reunification, and the largest three day rise in the euro since 2008. Meanwhile, President Trump’s reciprocal tariffs loom with April 2nd being the planned announcement date. The general consensus had been that deregulation would support business sentiment and capital expenditure throughout 2025 and that his tariff policies would be used as a negotiating tactic and implemented later in the year, if at all. However, his hawkish tariff policy thus far and continued threats about treating value-added taxes (VAT) as tariffs in the calculation of reciprocal tariffs has meant a reassessment of the seriousness of the tariff threat.

US

Tariffs on Mexico and Canada, increased tariffs on China, looming reciprocal tariffs on everyone, deportations, firing of government employees, and a sudden stop to many government programs have led to a significant increase in policy uncertainty. The president even warned about near-term growth prospects being in a “period of transition”. Consumer confidence has declined significantly, consumer inflation expectations have soared, and small business confidence has begun to sour. Granted, most of the concern about economic prospects is only showing up (so far) in the “soft” data – surveys about how consumers and businesses feel. “Hard” data – what they are really doing – hasn’t shown many signs of weakness, except perhaps at the margin. Retail sales in January were soft but showed some resilience in February. Delinquencies are on the rise however, albeit from a very low base. The February payroll report was ok. Nevertheless, GDP tracking for the first quarter has fallen significantly. The most closely followed GDP tracking model, the Atlanta Fed’s, plunged following the release of trade data which showed surging imports. Mathematically on their own, imports will reduce headline GDP, but those imports will show up somewhere – so it is unlikely to be as weak the Atlanta Fed model currently shows (-2%), but very likely a lot weaker than what was expected at the beginning of the year.

Inflation, which had looked a little sticky for the last several quarters, looks to have resumed its downward trend. But for how long? Will the Federal Reserve be able to view any tariff-induced rise in inflation as “transitory”? Potentially higher inflation coupled with weaker growth prospects makes life difficult for the Fed. Markets are pricing two more cuts this year and next. Whether the Fed can deliver more cuts will depend on the inflation outlook. Whether they need to deliver much more than that will depend on the growth outlook.

Europe

Europe’s challenges will not be resolved with Germany’s fiscal spending package, but it should help. As pointed out recently, the German economy hasn’t grown since 2019, potential growth prospects were also falling, public investment as a percentage of GDP is at the bottom of the EU

ladder, both households and corporations are saving, the only domestic sector not saving being the government. The risk that the government sector would turn to contraction as the debt brake was re-applied has certainly abated.

It would appear however that much of the good news from an economic perspective has been front loaded. President Trump’s reciprocal tariffs beckon in early April. The impact of these will be determined by the extent to which VAT is counted as a tariff or not. If they are excluded, the impact will be small, but their inclusion would represent a significant negative.

China

China’s lead indicators and credit impulse are moving higher, indicating that the policy announcements are indeed drawing a line under the cyclical weakness of the last few years. Inflation numbers are still moving lower however, and the increase in US tariffs, from 10% to 30% continue to create a murky short-term outlook.