Weekly focus – Positive trade developments spur risk-on sentiment

This week has been dominated by risk-on sentiment in markets following the positive outcome of the US and China trade negotiations during the weekend in Geneva. The cuts to tariff rates were larger than we and consensus had anticipated as the US announced a 115-percentage point reduction of the previous tariff rate from 145% to 30%. Adding the 10% universal tariff rate Chinese goods are now faced with a 40% tariff when entering the US compared to around 10% before Trump took office. We estimate there is a good chance of the US cutting tariffs by an additional 20 percentage points by striking a deal on the Fentanyl issue. Following the announcement, the risk of a recession in the US has been significantly reduced and we estimate that growth will likely experience a hit of around 0.5 percentage points which is manageable. For more details, see US-China Flash - Trade talks succeed in de-escalation, 12 May.

On the data front, we received a host of data this week from the US. Inflation data for April surprised slightly to the downside as headline inflation declined to 2.3% y/y (cons: 2.4% y/y) from 2.4% y/y and core inflation remained at 2.8% y/y, as expected. There was little evidence of tariff-driven price pressures, as core goods inflation remained slow (+0.06% m/m) and food prices even declined slightly (-0.08% m/m). Interestingly, core services inflation excluding shelter and healthcare remained negative for the second consecutive month (-0.02% m/m), which suggests that underlying price pressures have remained in check despite the trade war - a conclusion that was also supported by the April PPI data. The trade war does not seem to have caused US consumers to be significantly more cautious when evaluating the latest retail sales data for April. Retail sales recorded a small monthly decline in the control group due to weaker spending on clothing and electronics, while spending on restaurants and bars continue growing at a solid pace. We think the weak retail sales figure might reflect reversal of front-loading effects more than true underlying weakness.

In the euro area, data showed that employment continued to grow in the first quarter of the year, rising 0.3% q/q after growing 0.1% q/q in Q4 2024. Hence, the labour market continues the strong footing it has been on in the past years despite weak economic activity. Employment growth was once again driven by Spain that recorded 0.8% q/q higher employment, while both France and Germany reported unchanged employment in Q1. The strong labour market is a hawkish argument for the ECB. In Germany, the final inflation data for April showed that much of the increase in core inflation was due to the timing of Easter pushing up costs for package holidays and airfares, which suggests the increase in April should be seen more as a one-off than a resurgence of price pressures in core services.

Next week, focus turns to the May PMI data for the US and euro area, which will be interesting to follow as they previously have remained stronger than feared amid the trade war uncertainty. On Monday, China releases a large batch of data for April, which will show the impact of the peak escalation of trade tensions, and the central bank announces its interest rate decision, and so does the Australian central bank. In Japan, we will receive inflation data on Thursday, and in the euro area we focus on the negotiated wage growth data for Q1 released on Friday and the EU Commission's economic forecasts on Monday.

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