Markets under the spell of US trade policy

Monetary policy in times of uncertainty

Capital market participants expect further interest rate cuts in both the Eurozone and the US this year. We expect two interest rate cuts of 0.25% each by the US Federal Reserve and one interest rate cut by the ECB. In the US, the still strong labor market weakened somewhat over the course of last year and GDP growth in 1Q25 was negative at -0.3% q/q annualized, due to massively front-loaded imports before the introduction of the US tariff regime. The new US tariffs had cast their long shadow ahead and the preliminary escalation peak was reached after the announcement of reciprocal tariffs on "Liberation Day" at the beginning of April. Strong distortions on the global capital markets ultimately acted as a corrective for US President Trump's trade policy agenda, and so the enormously high reciprocal tariffs were suspended again for 90 days after a few days and reduced to a level of 10% grosso modo. During this period, the US administration intends to conclude trade agreements or at least framework agreements with its most important partners, such as with the UK and China. As in the US, the Eurozone economy can also tolerate a less restrictive monetary policy, as the new US tariff regime will take its toll on the economy and the German economic stimulus package and Eurozone-wide defense spending, including second-round effects, have yet to take effect. What both central banks have in common is that an annual inflation rate of two percent is the target, or one of them (the US also has full employment as a target). The latest inflation data on both sides of the Atlantic showed encouraging downward trends, which will gradually increase the central banks' future room for maneuver. In the US, however, a significant, tariff-induced rise in inflation is to be expected at the same time, which will make it more difficult for the Fed to lower key interest rates, as this could additionally fuel rising overall inflation. Consequently, the Fed must succeed in separating tariff-induced inflation from general inflation as precisely as possible in order to be able to argue for key interest rate cuts in a phase of rising overall inflation. In addition, the expected duration of the tariff-induced effect should be short and the underlying inflation rate should be close to the inflation target of 2%.

As always, in this interest rate outlook, we present our expectations for both central banks, the ECB and the US Fed, as well as for the respective government bond markets. We also focus on the economic policy issue of government debt. This has returned to the spotlight, due to the tense fiscal situation, both in the US in the wake of the US tariff announcement on Liberation Day at the beginning of April and the associated turmoil on the capital markets, as well as in the Eurozone, due to rising defense spending and the German infrastructure program.

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