Investment Viewpoint: tariff news trumps US budget bill

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Markets and macro insights with Sebastian Orsi CFA, Senior Research Analyst

What happened in financial markets last week?

• Trade concerns re-escalated on Friday, but these were scaled back over the weekend. The US president Donald Trump recommended a 50% tariff rate on EU goods from June 1st, as trade talks were deemed to be making insufficient progress; this is higher than the currently paused 20% reciprocal tariffs. The US president also threatened iPhone maker Apple with higher tariffs if its products continue to be made outside the US. A call with EU officials over the weekend has seen the June 1st tariffs paused as negotiations continue. While the initial market reaction was slightly negative – equities fell about 1.5%, bond yields fell, and the US dollar strengthened slightly – these moves were largely reversed by the end of the day Friday. The market’s reaction was more measured given the narrower scope of the announcements, as well as recognition of the US’s negotiation tactics.

• Until Friday, the US budget reconciliation bill was the main event for markets last week. There was concern about the level of US debt combined with deficit growth under the proposed budget, which saw long-term bond yields tick higher over the week. Equity markets had a minor sell-off and the US dollar weakened as the US 30-year bond yield moved up over 5%. Overall, global equities declined 1.8% last week (local currency terms), leaving them up 4% so far in May, and 2% year-to-date.

• The US administration’s proposed budget passed through Congress but has yet to go through the Senate for approval, so changes remain likely. Nonetheless, the net impact of the tax cuts and spending proposals is estimated to add US$3T to the US national debt over the next 10 years (on a current US$32T base, which is 120% of GDP). There may be a near-term fiscal policy boost to growth, offset by tariff impacts, but analysts are more concerned about the 7% annual deficit and medium-term debt sustainability with higher rates on a higher debt pile. The debt sustainability concerns aren’t new news, but eventually they could reach a tipping point.

• While there have been some major developments so far this year, our high-level view is broadly back to where we began the year. The trajectory is likely slightly lower, but we remain in a mature global economic expansion. Our asset allocation stance remains neutral. Within equities, given the cycle maturity and relative high valuations compared to history, our preference is for defensive and secular growth segments of the market.

What were the main recent economic developments?

• The preliminary Markit Purchasing Manager Indices, PMIs were the main data releases last week. They showed a slight uptick in European manufacturing, and weaker than expected results in services. The European Composite PMI came in at 49.5, lower than the 50.2 forecast and down from last month’s 50.4. It suggests weaker than anticipated growth in Europe. In the US the PMI indices came in slightly ahead of expectations for both manufacturing and services, so the Composite PMI came in at 52.1 compared to expectations for 51.1. The improvement from last month’s 50.6 is notable, but price increases and inventories (likely both related to tariff impacts) were key drivers of the increase.

The week ahead: what to watch out for

UK and US holidays this week make for a quieter news week. The main economic release will be Friday’s US Personal Consumption Expenditure index, which is the US Federal Reserve’s preferred measure of inflation. It’s forecast to come in at 2.2%, down 0.1% from last month. Core PCE inflation is expected to remain stable at 2.6%.