Tariffs, Trade and Geopolitics: An Unexpected Turn?

“But its all right now, in fact its a gas” ? ??????? Rolling Stones, Jumpi’Jack Flash

Written by Neil Staines, 14th February 2025.

Last week, we discussed two specific macro points: the Bank of England’s ‘Gradual and Careful’ dovish pivot and our non-consensus view that the US Administration under Trump 2.0 will prioritise and attain spending restraint rather than the unchecked fiscal expansion that markets expect.

In the UK, the vote split in the Bank’s decision to cut rates 25 basis points (from an expectation of 1 hawkish dissent to a vote with 2 dovish dissents) skewed the committee's bias more dovish. Indeed, we argued that the main narrative that Bailey expressed at the press conference was that progress on inflation had enabled the Bank to take another step to reduce interest rates and that the Bank expected to be able to take more such “gradual and careful’ steps as the disinflationary process evolves. Thus emphasising the rate cutting path rather than the risks to the current rate - despite the uncomfortable expected inflation projection.?

Updated and Downgraded

For a long while now, we have maintained the view that the underlying strength of the UK economy is significantly weaker than the high-frequency data suggested. Indeed, we have also argued that the fiscal expansion in the 2024 Autumn budget would likely feel like a fiscal tightening at the consumer level (not the textbook impact of a fiscal expansion). Thus, we argued last week that the updated projections from the BoE show sharply lower growth expectations for Q1’25 (modestly lower for Q1’26), higher inflation, a higher unemployment rate, and a negative output gap throughout the forecast horizon. Not a positive iteration for the Bank’s assessment of the UK economy at the current juncture. Notably, the Bank’s Agents forecasts for wage growth in 2025 suggest a decline to 3.7%. This is important as the BoE projections see inflation rising to a high of 3.7% in 2025 - Thus, real wage growth disappearing, albeit temporarily, in a further blow to confidence and the expected growth trajectory in the UK.

This week the OBR updated its economic forecasts where it downgraded its growth projections in line with Bank of England forecasts. Importantly, this removed the headroom by which the Chancellor achieves her ‘fiscal rules’, thus pointing more firmly to a fiscal tightening (the unenviable choice of spending cuts or tax rises); a move likely to further dent UK near-term growth prospects.??

Four Candles?

Last week, we also outlined our continued view that the new Trump Administration will be more fiscally prudent - far more than consensus expectations of the opposite. We also highlighted the key message from the Fed - that US monetary policy was likely a function of the 4 variables of the fiscal policy agenda: (i) Tariffs (ii) immigration policy; on the inflationary side, and (iii) regulatory loosening and (iv) fiscal consolidation; on the disinflationary side. Both in terms of sequencing and magnitude.?

Returning the Compliment?

The implications of the fiscal and economic policies of the Trump Administration remain the dominant factor for the global economy. This week, there have been some significant developments. We have some thoughts.

This week, President Trump's Director of the National Economic Council, Kevin Hassett stated that “reciprocal tariffs are a work in progress” and that “conversations with other countries began earlier on Wednesday”. We view this as very significant for a number of reasons. There has been an acute concern in financial markets for some time now that Trump tariffs will be significantly inflationary and bad for the global economy. Particularly if there were retaliatory measures that increased the risk of a more protracted and uncertain trade war scenario. Two parts of the Hassett statement argue against this: i) the term reciprocal is much more conciliatory in that it suggests a matching of the tariffs other countries impose on the US - which they are, of course, free to lower at any time, and perhaps more importantly ii) ‘conversations have begun’. The process of discussions before tariffs are imposed facilitates discussion on mitigating factors (already we have heard of the prospect of a bilateral India-US deal outside of this regime), and it likely reduces, perhaps significantly, the prospect of retaliatory tariffs or escalating tariff tensions - by extension this reduces tariff and trade war economic tail risks and should thus be a positive for risk assets and long end bonds. This appears to be playing out.

Subsequently, the suggestion from Trump that the ‘negotiated reciprocity’ may start from April 1st - at the end of the US investigation/report into global trade practices, further outlines the careful emphasis on addressing the perceived issues without risking an escalating tariff standoff or a deterioration into trade war. Again, consistent with our more sanguine view of the medium term impact of tariffs.

Peace in Our Time?

The other major development we have seen this week is the start (albeit early stages) of the negotiations to end the war in Ukraine following headlines this week that Trump and Putin had “a lengthy and productive phone call” [Trumps words on social media] and agreed to start negotiating an end to the war. Trump even suggested that he may meet with Putin in Saudi Arabia in the not too distant future.?

This is clearly a positive for global risk assets especially if, as we would expect, the return of Russian Oil and Gas to the global energy supply chain will be part of the negotiated peace agreement. This is a positive that would likely be felt most acutely in Eastern and continental Europe, with positive growth and inflation components and the additional boost of likely significant rebuilding contracts across the continent's construction firms.

EU(R)phoria?

If we add the potential positives of the reduced tariff threat (at least the tail risk scenarios) to the huge potential benefits to the eurozone from a return of abundant (and cheaper) gas supplies - not to mention the significant potential benefit to Germany in particular from the ‘rebuild’ contracts in Ukraine. AND we add into the mix that the market is very short EURUSD on the combination of divergent growth expectations, tariff threat, risk hedges and US exceptionalism (all dominant sell side arguments) then the unwind could be significant.?

Lastly, we would like to comment on the US labour market. This week has seen a continued flurry of companies (post Q4 earnings season) outlining plans for worker layoffs (some as high as 20% - Chevron). At the individual stock level, the bottom line effects of reduced costs are stock positive, but at the macro level, the impact of aggregate job losses is negative. In this regard, we suspect that there will be more acute weakness in the labour market over the coming months for a couple of reasons: i) The rising corporate streamlining and ii) the discontinuation of the significant Government hiring under Biden. Under Biden, the direct job gains amounted to around 40K per month in 2025 (indirect through healthcare and education even bigger). This week, the courts lifted the freeze on Trump’s government employee buyout plan. Negative government jobs over the coming months is not impossible and would have very significant implications for the headline payroll gains and the unemployment rate - Thus, by extension, for monetary policy.?

The Long & short of it…

There continue to be many moving parts in the global macro narrative at the current juncture. However, we see the evolution of tariff policies and progress (albeit nascent) in the Ukraine war as very significant. If we also add in the prospect of significant cost-cutting under DOGE, then we get three factors that shape the global inflation and growth narrative in a different trajectory than the general market consensus. We continue to see disinflation and growth moderation as the dominant macro factors in the global economy. For Europe in particular, it could well, to quote the Rolling Stones be “all right now, in fact it’s a gas”!

What is happening next week?

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