Revolutionaries vs. Realists
- 10 March 2025 (7 min read)
Decrypting the US reaction function has become even less straightforward last week. In a “revolutionary” reading of the administration, there would now be an acceptance of transitory pain – in the form of higher inflation and slower growth – as a trade-off against the overhaul of a global economic order which “has not served US interests”. This however is contradicted by a new – partial – reprieve on tariffs levied on Canadian and Mexican products, as well as by Donald Trump’s recommendation to DOGE to cut federal employment “with a scalpel” rather than a hatchet. Yet, while it may be that the administration is hesitating between the “revolutionary” and the “realist” approaches, there is a tangible risk that the market simply decides to “stop guessing” and conclude that uncertainty is simply too high and will erode growth and corporate earnings. The fact that the S&P500 did not immediately salute the rumours, and then the official announcement of the reprieve on Canada and Mexico is striking, in our view.
Where there is definitely a “revolutionary” mood, it’s in Berlin. The announcement that the new coalition would seek to change the debt brake before the new MPs take their seats in the Bundestag was striking. The package is a game changer for the German economy. While it is undeniably a positive for Europe as a whole, it is however difficult at this stage to get a sense of the magnitude of the uplift. This will depend on the import content of the defence effort, whether the EU manages to pull through more joint issuance, and/or if national governments choose to use the spending leeway offered by the reform of the EU fiscal surveillance proposed by the Commission.
The ECB now needs to deal with two opposite risks: on the negative side, the still very tangible possibility the US will slap tariffs on European products. On the positive side the possibility the new fiscal stance in Germany – and maybe elsewhere – lifts growth and inflation. We are still inclined to think that the ECB will have to go lower than 2%, because the tariffs will likely come faster than the impact of the fiscal turnaround, but it has become a closer call.
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