Weekly focus – Fed, and the economy, in wait-and-see mode

Not without reason, the US central bank is unsure about the direction of the economy and inflation given the tariff increases and the uncertainty about what will happen to them. That was clear from the monetary policy decision this week where the bank kept interest rates unchanged and stated that risks have increased in both directions - both the risk of higher inflation and the risk of a weaker economy. The Fed can to some extent afford to be patient as the labour market continues to look strong, with 177,000 jobs added in April. However, the labour market reacts with a delay to the rest of the economy, and we expect to see a clear tariff impact on growth in the second half of the year. On the other hand, inflation is still a bit higher than targeted and inflation expectations have risen strongly, which in itself is a problem for the Fed. In the coming week, we will get consumer prices for April where we could start to see an effect of higher tariffs, and new consumer confidence data including inflation expectations. That could have a significant impact on whether the Fed can cut rates at its next meeting in June. We see a June cut as the most likely outcome, but of course with significant uncertainty.

However, we could see markets paying more attention to trade talks than to data releases. Thursday this week, the US and the UK reached a trade agreement which reduces the tariffs that the US have recently introduced on British cars and metals, but still maintains the general 10% tariff even though the US has a trade surplus in goods with the UK. If this is a template for future trade deals - that extra tariffs on for example cars can be reduced or scrapped, but that the "reciprocal" tariffs announced on 2 April stand - then the deals will not make much difference for the overall tariff level. It is of course highly uncertain if other deals will resemble the UK one, though.

Progress towards a much more significant tariff deal could come already this weekend as US and Chinese negotiators meet in Geneva. Tariffs far above 100%, as they currently have against each other, are clearly going to have a seriously negative effect on both countries' economies as supply chains are disrupted and there is a risk of empty shelves in US stores. Hence, there is a strong incentive to reach a deal to lower the tariffs. In our interpretation, markets are expecting tariffs to land around 60%, and there are possibilities for both positive and negative surprises relative to that.

This week, we also got the approval of the new German government which plans to ease fiscal policy by maybe 2% of GDP and hence give a boost to growth and interest rates in Europe. The new government had to be voted on twice though, as it lost its first vote, a reminder that it only has a narrow parliamentary mandate. We expect that the fiscal easing will have only a limited impact on the economy in 2026 with the full effect seen the following year, and hence that it is not a hindrance for the European Central Bank in lowering interest rates further over the coming months. Next week, the European Commission publishes its economic forecasts which will likely discuss that issue in more detail and could influence also how the ECB sees the situation.

The Bank of England cut interest rates as expected by 25bp, but the Monetary Policy Committee is highly divided.

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