Yield outlook: Trade policy reconciliation – But will it last?

Market optimism has once again been fuelled by positive tones in the trade negotiations between China and the USA. Global equities have recovered what was lost since 'Liberation Day', credit spreads have narrowed significantly, and expectations for rate cuts from the Fed/ECB have been downplayed. The shift in market sentiment has added renewed upward pressure on European rates, and in the short term, the risk seems to point in the same direction, provided the Trump administration maintains its conciliatory approach. However, there is no guarantee of this, which means the outcome space for rates, as well as the global economy, remains considerable.

USA: A more conciliatory trade policy means a larger bond supply

At the beginning of May, China and the USA reached a somewhat surprising 90-day trade agreement, which will reduce the tariff rate on Chinese goods from 145% to 30%. Although the trade peace is initially only temporary, the development has increased confidence that a progressive solution with continued trade between the two major economies will be the result of the negotiations. The Federal Reserve (Fed) has, with the change in the trade policy stance, gained yet another reason to adopt a waiting position. Along with continued stability in the US key figures, such as the labour market, this challenges our expectation for a rate cut in June. Recently, the market has pushed the timing for the next rate cut out to September.

Apart from greater caution from the Fed, the challenge for the bond market associated with the US easing of trade policy is also related to fiscal policy and its sustainability. Lower tariffs on trading partners reduce the Republicans' fiscal leeway concerning the upcoming tax reform, where the most crucial element is the desire to make the tax cuts from Trump's first term permanent. If the plans succeed in passing through Congress, despite lower tariffs, it will lead to a significantly greater financing need over the coming decades. We assess that this should at least partially be reflected in a higher term premium.

Europe: ECB goes to 2% in June, but from there things get harder

In Europe, the significant uncertainty regarding the USA's trade policy line has so far not had a substantial impact on the manufacturing sector, which actually showed improvement in soft indicators for April. Whether the development reflects a slow impact on activity from trade turmoil, temporary tailwinds due to the advancement of goods exports, or merely that the significance of the uncertainty is more limited than feared, remains unclear. The poor visibility regarding both the scope and significance of the trade conflict, however, continues to create significant uncertainty about the outlook, even though Washington, with its temporary trade agreement with China, has now indicated that the most extreme scenarios for the trade war are likely off the table.

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