Latest European economic and market outlook.
Though President Trump has dropped his threat to impose tariffs on Mexico, trade tensions between the US and China continue to fester. There are growing fears that the trade war will undermine US growth at a time when fiscal stimulus is already fading. These concerns can be seen in the bond market, where the 10-year yield has fallen below 2.1% for the first time since 2017. While not our base case, the risk of a US recession within the next 12 months is clearly growing. As a result, it looks increasingly likely that the Fed will cut interest rates.
Eurozone economic momentum remains soft, with the manufacturing sector firmly in contractionary territory. Activity is likely to remain subdued as a tougher external backdrop dents exports and hinders investment. That said, the continuation of ultra-accommodative monetary policy, some fiscal loosening and growing wages should help to offset these negative factors. On the political front, the European parliamentary elections revealed increasing divisions within the union. Populists and eurosceptic parties increased their share of seats to 25%, up from about 20% five years ago. The feared populist wave was more of a large ripple, but centrist parties will clearly need to adapt to survive.
The Chinese government still has a range of tools it could use to offset any impact from the trade war.However, with economic activity still solid, Beijing seems to be adopting a wait and see approach, assessing the impact of the trade war before announcing any more significant stimulus measures. Indeed, there is little point in revving up easing efforts and potentially creating more asset bubbles and financial imbalances when the authorities have spent the last couple of years trying to manage these mini bubbles out of the system. They clearly favour slower but more sustainable growth, which in our view is eminently sensible. However, even if there is some form of a trade deal hammered out over the coming months, it is clear that relations between the US and China will not go back to being how they were. There has been a structural change. This is a strategic decision by the American political class, which now recognises China as an existential threat to US power. We therefore expect the US to increasingly use its economic might, currency, security links and access to technology and intellectual property in order to slow China’s ascent.
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