Since the April 9 pause in the reciprocal tariffs, the de-escalation trend saw the markets pricing out a global slowdown and pricing in a rebound. Sure enough, that’s what happened as we started to get an improvement in the soft data.
The current expectations are for continued improvement in global growth and for the disinflationary trend to remain intact. That’s also what the central banks have been telling us as they keep their reaction function skewed towards easing.
There are two main risks to such expectations: renewed trade war and inflation.
Regarding the first risk, there’s lots of complacency around the TACO (Trump Always Chickens Out) trade. I can’t even blame people for that because actions speak louder than words, and we’ve seen countless times Trump escalating to de-escalate soon after.
I guess that’s his negotiating strategy. He wanted others to accept around 10% tariffs as a good thing, so he needed to set them much higher to make it look like an improvement.
We are in the final month of the 90 days pause though and what happens after the deadline is still unknown. It’s pretty clear though that the market will keep on fading any fear until the deadline because of wishful thinking. Therefore I wouldn’t expect much from this front until the actual deadline.
In any case, I think the risk that we get a breakdown and a renewed trade war is low but it’s worth to keep an eye on because it has the potential to change growth expectations and therefore move the markets a lot.
The second risk is inflation. And this one has higher probability compared to renewed trade war, in my opinion. This comes from the expectations that economic activity could rebound strongly in the next months after kind of a pause in Q1.
Moreover, we continue to have a global easing cycle, and tax cuts and de-regulation ahead. These are all strong drivers for growth and could increase inflationary pressures. Remember that inflation is a lagging indicator and it takes time before you see it in the actual data.
Some leading indicators like the US PMIs have been showing a pretty notable pick up already.
US PMI inflation
There’s been lots of media coverage on rising long term yields and they’ve been blaming it on fiscal spending. The reality is that the market has been just pricing in stronger growth and more inflation risk. For long term interest rates, the market takes into account three main
factors: future central bank policy, inflation expectations and future
supply and demand of Treasury debt issuance.
The US 10yr yield is currently at 4.45%, which is more than fine considering the risks and the policy rate at 4.25-4.50%. If the Fed was to hike tomorrow, you would see long term yields falling across the board as the market would price in slower growth, lower inflation and risk of recession.
As long as this inflation risk remains intact, the path of least resistance for long term yields will remain to the upside. And if it increases in the next months, we will see the market pricing out the rate cuts expected for 2025 and beyond. This will have implications for many markets.
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