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Capital Market Flash: Relaxation after the financial market tensions
The capital markets continue to be characterized by extreme human-made volatility. A "tariff retreat" or a noticeable de-escalation by President Trump — a comprehensive global tariff pause except towards China — initially provided relief in the financial market. However, the stock market euphoria following the de-escalation and the outlook for negotiations "in good faith" is still overshadowed by partial financial market tensions in the US capital market and the hardening of the US-China tariff dispute. Recent yield movements in the US give some cause for concern and may have contributed to the de-escalation. It remains unclear whether only "technical market" factors, a declining economic policy credibility of the US itself, or a geopolitically motivated selling pressure are at play in the background.
Geopolitical confrontation beyond economic policy rationality
Donald Trump continues to dominate the global news flow and financial markets in an unprecedented manner. For the first time, the US President is now sending a clear signal of a return to economic policy rationality. Initially, yesterday's trading day seemed to be slipping into "hyperprotectionism," as the US announced escalatory high tariffs against China. There was also talk of potential escalation against European pharmaceutical companies. Then, Donald Trump delivered a comprehensive relaxation signal to the rest of the world. During a 90-day suspension of the escalatory global reciprocal bilateral extra tariffs, exploratory talks are to be conducted "in good faith" with willing countries. For the rest of the world, including Canada and Mexico—but excluding China—a manageable 10% base tariff is expected to apply for 90 days following the "tariff retreat." This is a noticeable de-escalation and allows for some degree of international policy coordination on economic issues. US tariffs on aluminum and steel imports are apparently set to remain in place.
The strong stock market recovery in the US that began yesterday is indeed justified. We have always considered global tariff policy de-escalation as a prerequisite for sustainable market stabilization, especially since this de-escalation significantly reduces the risk of a deep US recession. However, caution regarding further financial market volatility is still warranted. The geopolitical conflict between the US and China appears to be intensifying, leaving the risk of a significant economic slowdown in both countries. Moreover, this geopolitical conflict could further extend beyond economic relations and the financial market (see the following remarks). This is relevant because yesterday's signals of noticeable tensions in the US Treasury market indeed sparked concerns about broader financial market tensions—but could also be a reason for the de-escalation.
Despite stock market recovery, signs of financial market tensions?!
Yesterday's trading day—before Trump's relaxation signals—was marked by increasing signs of financial dislocations beyond the stock markets. The sharply rising US Treasury yields, especially at the very long end of the yield curve, are a notably confusing market signal in the current environment. Particularly noteworthy was the opposing trend between safe-haven assets like German Bunds and US Treasuries. It's important to emphasize that noticeable increases in US capital market rates can also strain consumer and debtor confidence in the US, in addition to stock market losses. Moreover, such erratic US interest rate increases during a market phase characterized by risk aversion signal certain tensions in what is otherwise the most liquid financial market in the world.
It remains unclear to what extent the sharp rise in US yields is "only" due to declining confidence in the economic policy credibility of the US, additional technical market factors among US investors or hedge funds, or possible active sales of US Treasury holdings by China. The latter is somewhat contradicted by the lack of a significant downward movement in the USD yesterday. Beyond the relaxation in stock markets, a "weaponization" of economic relations and financial markets cannot be ruled out. This is evidenced by efforts from the Trump administration to pressure the Fed towards interest rate cuts, even as capital market yields have risen sharply and the Chinese currency continues to depreciate.
In light of the outlined tensions in the US interest rate market yesterday, we view it positively that the Trump administration at least provided some relief in the stock markets. Increasing financial market tensions alongside weak stock markets would have posed growing challenges to financing conditions in the US and globally, significantly raising recession risks in the US.
As long as there is no further substantial escalation between the US and China involving the use of financial markets, stock markets could now stabilize sustainably. However, the ongoing news flow regarding US tariff policy is likely to keep volatility elevated. We believe the US administration may continue to make tough demands on the rest of the world to reduce bilateral trade deficits. For Europe, this could imply not only trade liberalizations but also substantial energy deliveries from the US and payments for the US security umbrella.
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Gunter DEUBER
Austria Gunter Deuber is heading the Economics and Financial Analysis division (Raiffeisen Research) at Raiffeisen Bank International (RBI) since 1 January 2021. Since 2011, Gunter Deuber has held leading positions in RBI's Economic and CEE Research and has continuously expanded the cooperation with his research colleagues in RBI’s subsidiary banks in CEE. Since the early 2000s, he has been analysing economies, banking sectors and market topics with a focus on CEE and EU/euro area topics for RBI in Vienna, but also in the international (investment) banking context in Frankfurt. He regularly presents the views of Raiffeisen Research and his research team at meetings with investors and clients. He is a well sought-after speaker at landmark events in the finance and banking industry and a guest lecturer at several universities/teaching institutions. In 2019, he was nominated for the US State Department's IVLP (International Visitor Leadership Program). Gunter has published several edited volumes on Euro/EU crisis issues and published various articles in professional journals and industry magazines. Outside the office, Gunter enjoys travelling with his family and long-distance running.
Last week’s tariff hammer has caused a setback in the capital markets, similar to what we usually see with sudden (external) shocks such as Covid-19, the Global Financial Crisis, or the Euro Crisis. It is currently unclear whether a rational international policy coordination with the USA will succeed, as it has in the past with (external) economic shocks. Without signals of rational economic policy cooperation and further actions from the "Orange Swan", we do not expect the stock market to stabilize quickly and, above all, sustainably! |
At present the US is inflicting the most severe protectionist escalation on the global stage in a hundred years. The world's largest importer is rewriting its trade policy and is likely to do so for the longer run. The overall effective tariff rate for US imports will rise to 20%+ for the first ever time since decades as a result of US tariffs announced this week (baseline tariff + bilateral tariffs). In the last few decades, the overall US import tariff was estimated at around 5% or less. We expect significantly higher US tariffs in the medium to long term, even if a reduction in bilateral “reciprocal tariffs” is possible in the course of 2025 and in the coming years. We see rather tough negotiations ahead. From a global economic perspective, however, we do not expect a slide into a scenario like that of the 1930s. |
The de facto abandonment of the debt brake after 14 years and the announcement of significantly higher military and infrastructure spending in Germany led to a marked increase in Bund yields. However, this is not due to a loss of confidence in Germany's debt sustainability, but rather to the resulting more optimistic medium-term economic outlook, a rising bond supply and possible medium-term spillover effects on inflation and ECB monetary policy. However, German Bunds should enjoy strong demand from non-resident investors in the eurozone and globally at current levels. We therefore believe that a great deal of issuer-specific factors are already priced in here. |
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Europe's stock markets are experiencing a renaissance. Although increasingly isolated in geopolitical terms and rarely united within Europe, there has recently been something of a collective mood of optimism on the stock markets. In view of the depressing news situation, this may come as a surprise. However, a closer look shows that the price gains since the beginning of the year are not unfounded. |