Nero's court
Monday, 10 March 2025 14:30
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Tempers are flaring. After Vice-President JD Vance has launched a scalding attack on European democracies, they are answering. The title of our report echoes a speech delivered last week by a French Senator that has gone viral on both sides of the Atlantic. He compared Trump to Nero, a Roman emperor known for murdering his mother and wife and scapegoating Christians for a fire that devastated the empire, calling his administration “Nero’s court, with an incendiary emperor, submissive courtiers and a jester high on ketamine in charge of purging the civil service.”
The rollercoaster. Financial markets have had to adapt to rapidly changing conditions. Within a single week, the Atlantic military alliance was weakened, prompting significant defense spending announcements across Europe. Combined with an ambitious infrastructure plan unveiled in Germany following the federal elections, this caused bond yields to rise sharply last week in the euro area. Additionally, trade tariffs on Canada, Mexico, and China were implemented, but Trump eventually announced a one-month reprieve for Canada and Mexico as US equities experienced steep losses.
The fortress is under attack. Investors faced a whirlwind of policy announcements in the US, sometimes contradictory, causing significant market jitters. Taking a broader perspective, the big picture is as follows.
- Markets are now concerned about the risk of a recession in the US, as consumer sentiment surveys are sending red flags. Trade tariffs will hurt consumers, a self-inflicted pain by the new administration. The US economy was running at its best prior to the US election, and now the fortress is under attack. Job creation released at the end of last week shows nonetheless that the US economy remains on solid footing.
- Trump has offered another one-month reprieve to Mexico and Canada, but markets need visibility.
Make a rod for your own back. The surprise, which we underestimated, is that the US equity market has been the most vulnerable to trade uncertainties. Europe and China’s markets have significantly outperformed in the past three months. This is a surprise since they are more sensitive to global trade wars than the US economy, which is more reliant on domestic demand. But the market is right; harming the US consumer can indeed backfire dramatically.
A pivotal moment for Europe? The “whatever it takes” on defence announced last week is definitely a turning point. Also, the German €500bn infrastructure plan is big, a bit more than 10% of German GDP, even if spread out over 10 years. Additional factors will boost fiscal expenditures (loosening of the debt brake for the Länder, scrapping the debt brake for defence spending above 1% of GDP). Yet, keep in mind that a fiscal “whatever it takes” is unlikely to have the same market impact that Draghi’s monetary “whatever it takes” in 2012. Overall, we believe that euro area bond yields are unlikely to move much higher compared to current levels as growth conditions remain weak, the ECB remains on rate-cut mode, and fiscal discipline remains an important objective.
Going forward, we believe that Trump remains receptive to market signals. In our report, we show that US households are significantly invested in equities, and Trump’s approval ratings are declining. Also, the fall in energy prices is a tailwind for consumers, that will partly compensate for higher trade tariffs. We believe Trump’s strategy is eventually to find fiscal room to cut the corporate tax rate. Shifting from trade wars to tax cuts would be much more supportive for risk assets. In our model portfolio, we slightly reduced the exposure to US equities to the benefit of US bonds, and reweighted Europe and EM Asia equities earlier in the year. But we refrain from “trading the newsflow”.
Week ahead: US CPI and PPI, US JOLT survey, Michigan consumer sentiment survey. In China, new credit will be reported for February.
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