The relative period of calm that allowed equity markets to rally off April's lows was halted this week as President Trump threatened a 50% tariff on the European Union and concerns over US deficits remained prominent. Trump cited a lack of progress in talks with the EU in announcing plans to impose the new tariff from June 1. Meanwhile, Trump's bill to fund the extension of tax cuts by reducing spending in safety net programs was narrowly voted through the house and now heads to the senate. The bill is estimated by the Congressional Budget Office to increase US debt by over $2tn over the next decade, reflecting the concerns that prompted the ratings downgrade from Moody's last week. Term premium - the additional compensation investors require to hold long-term debt securities - has been all the talk this week as yield curves steepened, a headwind for equity markets as higher discount rates put downward pressure on company valuations. The US dollar saw renewed weakness to be 4.5% below its early April levels prior to Trump's tariff announcements.
The second 25bps cut of the RBA's easing cycle lowered the cash rate to 3.85% this week. In contrast to the hawkish messaging that accompanied the previous rate cut in February, the RBA has subsequently turned more dovish as Governor Bullock revealed in the post-meeting press conference that the Board discussed the case for a larger 50bps cut. Market pricing is shifting towards factoring in 3 further rate cuts this year, reducing the cash rate to 3.1% by year-end. With inflation returning to the 2-3% target band in the March quarter, the RBA's latest forecasts in the May Statement on Monetary Policy highlighted downside risks to the outlook for both growth and inflation in Australia stemming from the tariff war. More on this week's RBA meeting can be found in my review here.
Markets continue to reassess the outlook for the Bank of England's easing cycle. Data this week showed inflation rose more sharply than expected in April, arguably giving more impact to the hawkish elements at the last BoE meeting that surprised markets. A shallower market curve that prices in between 1 to 2 further rate cuts by year-end reflects these factors, implying less confidence the BoE will continue with its sequence of quarterly rate cuts.
UK inflation was expected to pick up in April due to seasonality and increases in household utilities costs, but headline CPI rose from 2.6% to 3.5%yr to exceed the expected figure of 3.3%. Additionally, core CPI lifted from 3.4% to 3.8%yr, above expectations for 3.6% as services prices - the key area of the basket under the BoE's scrutiny - pushed up from 4.7% to 5.4%yr. Inflation was skewed higher in April by Easter holiday prices rises, higher utility costs and an increase in road tax, factors the BoE took into account in its decision to cut rates earlier this month. Still, the report adds to the uncertainty around the inflation outlook that is already significantly clouded by the tariff war.
In Europe, the threat of a 50% tariff on its exports bound for the US market has only amplified expectations for ECB rate cuts. Market pricing has increased to three 25bps rate cuts over the remainder of the year from two cuts at the start of the week. Even prior to Trump's tariff threat the account of the ECB's previous meeting in April pointed to the continuation of rate cuts with rising confidence that inflation was increasingly under control. Wage pressures also showed a notable cooling to a 2.4% annual pace in Q1, well down from 4.1% previously. Some slippage in the PMI readings in May indicated growth in the bloc was stalling due to tariff uncertainty.
