Watch the Tone

We would not overstate the signal from the drop in the US GDP in Q1 – the imports surge to “beat the tariffs” should not hide the resilience of domestic demand, and job creation remains decent – and we continue not to expect any pre-emptive support from the Fed, which we think will affirm this week its “wait-and-see” mode. Yet, the awareness of looming economic damage weighing on an already souring public mood may play a role in the change of tone on the trade war front at the White House. More concessions were announced last week, and negotiations with China may finally start. Meanwhile, the EU has made an offer to the US in terms which could go some way towards fitting the US view on trade matters. Still, the starting positions across stakeholders are very far apart. We suspect it may take more tangible damage in the US – and/or more concessions from the rest of the world – before the landing zone is effectively in view.

 Meanwhile, the Euro area started the year on a stronger footing than expected with a 0.4%qoq gain for GDP in Q1. We remain however convinced – and that is the message from surveys – that headwinds will push economic activity down, making forceful accommodation from the ECB necessary. Still, while Philip Lane opened the door to using 50-bp cuts, we think that the lingering price pressure in the services sector – manifest in the April CPI print – will make the central bank wait until the impact of the trade war materializes more clearly, or that the negotiations disappoint, before using this tool, keeping to a 25bp increment at the June meeting. 

While we remain reasonably confident Beijing will choose a cooperative approach towards the rest of the world – outside the US – on trade issues, we think the trade war will in any case further diminish hopes of a financial liberalization in China. Financial repression will remain very tempting to deal with intensifying pressure on public finances as the fiscal stimulus is scaled up to make up for lost foreign demand.