Last week, the Trump administration announced tariffs against the entire world which, added to those of previous weeks, will raise the average external tariff of the United States to 22%, compared with 2.5% at the end of 2024. Financial markets have reacted extremely badly, and suggest even more serious fears for US growth than for global growth. Many unknowns remain, but this scenario is the most plausible. For the United States' trading partners, it would be better to resist the temptation to escalate and instead to double down on strengthening the engines of domestic growth. Europe is particularly well placed to do this.
The tug of war between the United States and the European Union has begun. On March 12, the US administration raised tariffs on imports of aluminum and steel by 25%. In response, the EU has announced that it will reinstate, in mid-April, tariffs introduced during Donald Trump's first term, suspended since 2020
In recent weeks, with the erratic announcements and implementation of the first Trumponomics 2.0 measures, a less favorable wind has been blowing across the US economy, whether it be Main Street or Wall Street. Between rising fears about inflation and growth, how long can the Fed extend the status quo on its policy rates?
President Donald Trump has promised to bring manufacturing jobs back to the USA and make America again “the manufacturing superpower of the world that it once was”. This, of course, is the foremost objective of his radical tariff policy (alongside raising revenue and pressuring trading partners to deliver non-trade-related concessions). In his analysis, the US persistent trade deficit is evidence that the rest of the world is “ripping off” the US, through unfair trade barriers and overly weak exchange rates. As a result, the argument goes, the US industrial base is being hollowed out, undermining the living standards of Americans.
After being left reeling by the unexpected money-market crisis during its first round of quantitative tightening (QT1), the US Federal Reserve (Fed) intends to manage the second (QT2) with the utmost caution. This means reducing its securities portfolio without creating a shortage in central bank money, in view of the liquidity requirements imposed on banks under the Basel 3 framework. As it is unable to estimate the optimum amount of central bank reserves needed to ensure that its monetary policy is properly implemented, the Fed aims to reduce the stock of reserves to a sufficiently "ample" level.If QT2 is ended too early, it would have to activate its liquidity draining tools in order to limit the downwards pressure on short-term market rates
The FOMC kept the target range for the Fed Funds rate at 4.25% - 4.5% at the 18-19 March meeting, as widely expected. Jerome Powell and the committee have started to price in downward risks to economic activity and upward risks to inflation. In the short term, the stability of the dot plots, the downplaying of the long-term tariff related risks and the consistent message of patience are aimed, implicitly, at providing stability in the midst of the current turmoil. In our scenario, the FOMC is expected to cut the rates quite sharply in 2026.
In a 1933 article on national self-sufficiency, British economist John Maynard Keynes advised “those who seek to disembarrass a country from its entanglements” to be “very slow and wary” and illustrated his point with the following image: “It should not be a matter of tearing up roots but of slowly training a plant to grow in a different direction”. Nearly a century later, what are the precepts of the author of the General Theory worth?
They say the Davos consensus is always wrong, but it usually takes longer than a couple of months to be apparent. Not so in 2025.
Concerns are mounting over US growth. Fears of a rebound in inflation and the shock of political uncertainty are weighing on households and businesses. Initial hard data for Q1 are adding to fears of an ongoing deterioration. And at this stage it is unlikely that the Fed will come to the rescue of the economy. Here is a quick overview of the warning signals sent out by the US economy.
Household sentiment deteriorated in February according to the Conference Board (98.3, -7.0 pts) and even more in March according to the University of Michigan (57.9, -6.8 pts), dragged down by worsening expectations. According to the University of Michigan survey, the jump in 1-year inflation expectations (+4.1%, +1.0 pp) was accompanied by a 30-year record for 5-year expectations (+3.5%, +0.3 pp).
Inflation is no longer the No. 1 economic problem that it has been for the past three years, but it remains a major challenge. While it has not reached its 2% target yet, and the last pockets are slowly deflating, new inflationary pressures are mounting. At this stage, those pressures are limited but not negligible and new inflationary risks, linked to the economic and geopolitical context, are taking shape. The Fed's task is becoming more complicated by the risk of a US stagflation, and the ECB's one happens to be slightly trickier when balancing between downside and upside risks on growth.
To reduce the United States' bilateral trade deficits, a subject already raised in a previous Chart of the week, the Trump administration has broadened its angle of attack, by attacking the differences in customs duties between the country and its trading partners. The introduction of reciprocal tariffs, still under study, would be specified at the beginning of April.
In France, we could think that the increase of public debt is a general consequence of the Covid-19 crisis. However, the chart we are commenting here shows that it is not.
Who's next? As soon as he became the 47th President of the United States, Donald J. Trump drew the weapon of tariffs, “the most beautiful word in the dictionary”, as he put it. Mexico, Canada and China were the first to be hit, while the European Union (EU) was explicitly targeted.
While the Fed lowered its target rate by 100 bps from 18 September 2024, bond yields rose by around 80 bps (as at 7/2/2025). This rare divergence is reminiscent of an inverse version of the ‘Greenspan conundrum’ (2004–2005): during this episode, which spread to Europe, the rise in short-term rates had little effect on long-term rates. What are the reasons for these contrary movements between short- and long-term rates, and what might the implications be?
The US economy ended 2024 with its real GDP growing +0.6% q/q in Q4, a solid figure, though slightly down on the previous quarter (-0.2 pp). Household consumption (+1.0% q/q, +0.1 pp) was once again the main growth driver. The government also contributed positively, in contrast to private fixed investment (-0.1% q/q), despite the growth in residential investment and intellectual property products.
The consensus view currently holds that the great divergence between the US and EU economies observed since the pandemic is bound to continue. As a snapshot of current conditions, it is certainly true that the US economy has a strong growth momentum and bullish animal spirits, while Europe has neither. But extrapolating from a snapshot, as instinct tempts us to do, is often wrong. In fact, there are solid reasons to expect the gap between US and Europe growth to shrink in 2025—as envisioned in BNPP’s central scenario, with the US economy slowing down and the Eurozone’s accelerating (albeit modestly so). Beyond the year-ahead outlook, there are at least 5 reasons to challenge the view that Donald Trump’s economic policies will make Europe even weaker. Let’s consider them in turn.
Energy policy was at the top of the agenda during the election campaign and in the first few weeks of the Trump presidency. Its objectives are to reaffirm America's domination of the global hydrocarbon market (the United States has been the world's leading oil producer since 2019) and to ensure low prices for US consumers. In practice, this is manifesting in a desire to increase US oil and gas production by three million barrels of oil equivalent per day, for an average crude oil production of over 13 million b/d in 2024. But is this goal realistic?
The first FOMC meeting of 2025 (28-29 January) should result in the target rate being held at +4.25% - +4.5%. In our view, this would mark the beginning of a pause lasting until mid-2026, due to the anticipated pick-up in inflation that would result from Donald Trump's economic policy.
According to an unpublished study conducted within the Single Supervisory Mechanism (SSM), if it were to perform its functions in the Eurozone, the US supervisor would be stricter, in terms of risk-weighted capital requirements, with respect to the systemically important banks (G-SIBs) established there, than the single supervisor of the Eurozone. The methodology of the exercise on which this conclusion is based has not been shared. However, it seems very complex to define.
On 20 January 2025, Donald Trump once again became President of the United States. With a ‘clear mandate’, the Republican intends to harness his victory by addressing his favourite issues. His return to the Oval Office comes at a time when the dollar is witnessing one of the biggest rallies in history. The real effective exchange rate of the greenback is now at a comparable level to the one which led to the Plaza Accord of 1985, and its appreciation has a high likelihood of continuing. This trend is likely to frustrate the new President, who is keen to denounce weak currencies as penalising US industry
The latest Employment Situation report prior to the next FOMC meeting (28-29 January) points to the surprising strength of the US labour market, illustrated by job creation at its highest level since March 2024. Publication concluded a week marked by a significant rise in bond yields against a backdrop of expectations of rates "higher for longer", leading to sharp movements on the financial markets.
2024 was marked by further progress in disinflation, in both the United States and the Eurozone, sufficient to pave the way for rate cuts. However, 2025 may be quite different from 2024, with expected divergent inflation trajectories between the United States and the euro area and, therefore, a decoupling of monetary policies (extended status quo for the Fed, continued gradual rate cuts for the ECB).
The Fed ended the year with a reduction in its target rate (-25 bp), which now stands at +4.25% to +4.5%. Meanwhile, median expectations by committee members of the number of cuts fell from four to two for 2025. The response from the financial markets was abrupt.
A turbulent 2025 is expected to follow a 2024 marked by dynamic growth and the start of a monetary easing cycle. While growth is expected to slow towards its long-term level, the political plans associated with the change of president and Senate majority suggest an increase in inflationary risk. As a result, the Federal Reserve is expected to put a premature end to rate cuts.
