Dangerous Complacency
Thoughts on Trump's latest trade salvoes, who's afraid of the strong euro, and how Italy and France have traded places
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In this newsletter:
Trump’s tariffs: Are markets complacent?
Strong Euro: Do not be afraid
Italy and France: Trading places
1. The End of the Economic World as We Knew It (redux)
So the European Union received one of Trump’s letters after all, just days after Brussels had said that it didn’t expect to receive one. EU negotiators had believed they were on the cusp of reaching a similar deal to that agreed by the UK, whereby the bloc would accept a 10 percent baseline tariff on its exports to the US in return for exemptions from sectoral tariffs. It even signalled it was willing to drop plans for a Digital Tax to get the deal over the line. Instead Trump posted a letter on Truth Social that looked as if it had been typed up by some MAGA-hatted illiterate stating that the EU would face a 30 percent tariff from August 1.
EU trade ministers will meet on Monday to decide how to respond. Clearly the aim will be to clinch the deal that they thought was so close last week. But they must also decide whether and how to retaliate if that proves impossible. It is hard to imagine that the bloc could take a 30 percent tariff lying down. But should they retaliate, Trump has threatened to escalate further: “whatever the number that you choose to raise them by, will be added to the 30 percent that we charge”. A full-blown trade war between the US and EU is therefore very much on the cards.
What remains remarkable is the extent to which the financial markets continues to take Trump’s trade wars in its stride. Although the EU letter only landed on Saturday when the markets were closed, it followed a week in which Trump announced a new 35 percent tariff on Canada, a 25 percent tariff on Japan and South Korea, a 50 percent tariff on Brazil as a punishment for the country’s legal pursuit of former president and Trump ally Jair Bolsanaro on charges of trying to forment a January 6 style insurrection, and a threat to raise the baseline tariff from 10 percent to 15 to 20 percent on anyone who doesn’t receive a letter.
Yet the S&P500 closed only a fraction lower on the week, the VIX volatility index (often referred to as the Wall Street fear gauge) fell, and the gold price declined. Indeed, Nvidia last week became the world’s first $4 trillion company. That suggests the markets have become desensitised to Trump’s tariff threats. Even Jamie Dimon, the JP Morgan boss, thinks this is complacent. So what lies behind this insouciance? The most common explanations include:
the TACO trade: so far, the bet that Trump Always Chickens Out has paid off for investors. Indeed, for all the latest tariff threats, the real impact of Trump’s latest letters has been to push back the deadline for countries to reach deals by three weeks to August 1. Whether this deadline is any more real is an open question. According to one White House insider quoted by Politico: “It’s all fake. There’s no deadline. It’s a self-imposed landmark in this theatrical show, and that’s where we are.”
US earnings momentum: so far there is little evidence that Trump’s trade wars are having an impact on the economy or corporate earnings. Inflation has not noticeably picked up, nor has growth slowed, despite predictions of imminent stagflation in the wake of “Liberation Day” on April 2. Instead, renewed confidence in US exceptionalism, driven by optimism about AI and technology, has seen some Wall Street banks raise their forecast for the S&P500 this year. Goldman Sachs, for example, expects the index to rise a further 6 percent to 6,600 by the end of the year.
the Trump trade: investors are betting that any negative consequences of higher tariffs will be offset by other aspects of Trump’s economic agenda. His “One Big Beautiful Bill” which appears to bake in budget deficits of six percent per year as far as the eye can see may pose serious questions about America’s long-term debt sustainability, but as Marco Annunziata notes in his latest Substack post, “in the long-run we are all insolvent”, while in the short-term, the budget is likely to boost growth. Add to that hopes that bank deregulation will boost demand for US Treasuries, thereby helping keep borrowing costs down, and the domestic outlook looks positive.
Nonetheless the biggest bet that investors are making is that globalisation remains in tact, as David Bowers and Ian Harnett of Absolute Strategy Research argued in a recent presentation to clients. Investors are sticking to this view that the old rules of the game will continue to apply despite everything that leading members of the Trump administration have said and despite all the evidence that the US president is determined to disregard all constraints on his power.
At one level, this assumption may be reasonable. As Rana Foroohar noted in the FT last week, how badly globalisation has been damaged depends on where you are in the world and what industry you are in:
According to a recent McKinsey report on changing global trade, of today’s 50 largest trade corridors, 16 would grow strongly even amid a 10 per cent rise in global tariffs and a 60 per cent increase on tariffs to China and Russia. These are the new pathways that link emerging economies from India to the Middle East together.
Several CEOs and supply chain experts I’ve spoken to recently say that there has been so much post-pandemic supply chain optimisation in large companies that many will be able to buffer 80 per cent or more of tariff-related inflationary pressure with increased efficiency.
Nonetheless, I am with Jamie Dimon. I’m sticking to my view that what we are witnessing is the End of the Economic World as We Knew It. The past week has surely shown that Trump is never going to give up tariffs as a weapon to bludgeon other countries in pursuit of whatever goal he has in mind, by no means limited to trade, as Brazil has discovered. For that reason too, any “deals” he might make can only be considered temporary, adding to the uncertainty and the long-damage to supply chains which will inevitably carry a cost.
The question is what might shake the markets out of their complacency? Perhaps only the reality of Trump carrying out his tariff threats, and even then for a sustained time. The problem is that the market’s very complacency makes it more likely that he carries out those threats, starting with the EU. Dangerous times.
2. Who’s Afraid of a Strong Euro?
The one place where Trump has had an obvious impact is on the dollar. The US currency got off to its worst start to a year in more than a century, falling by 10.6 percent in the first six months of 2025 against a basket of other currencies. Arguments have raged in the markets as to what extent this fall has been driven by foreign investors questioning the dollar’s role as a safe haven and what implications this might have for its reserve currency status. But the flipside of dollar weakness has been euro strength, and this is now becoming a source of concern among European policymakers and investors.
Of course, there is an irony about European central bankers fretting about the strong euro when Christine Lagarde gave a speech only last month talking up the prospects for a “global euro” moment. But how big a problem is the 12.4 percent rise in the euro against the dollar since the start of the year for the European economy? Not as much as you might think, according to GaveKal.
The exchange rate that matters for Europe’s economy is the real effective one, which measures the single currency’s value against a trade-weighted basket of currencies adjusted for bilateral inflation differentials. On this metric, the euro is up a more modest 5% since the start of the year and by 2.8% since Donald Trump’s election last November.
What’s more, the strong euro is not all bad for growth:
On the one hand, the euro’s concentrated appreciation against the dollar and renminbi amplifies the external shock stemming from the trade war and China exporting its excess production (eurozone exporters can take comfort from the euro’s limited rise against the currencies of non US/China trade partners making up two thirds of their sales). But on the other hand, a strong euro eases financing conditions for domestic residents by reducing the price of imported energy and lowering the cost of domestic capital. This suggests that while euro strength will hurt Europe’s exporters, it could accelerate a rebalancing from external demand towards domestic demand.
In other words, the eurozone has the tools to offset some of the negative consequences of euro strength in its own hands, though lower interest rates and steps that will boost domestic growth, including structural reforms and trade deals. The broader question is what impact in the meantime the stronger euro might have on European equity valuations. According to Katie Martin in the FT:
Researchers at Barclays point out that strength in the euro is one of the main reasons why analysts have been slashing earnings expectations for listed European companies this year. Outlooks for growth in earnings per share have dropped from 9 per cent all the way down to 2 per cent, and exporting companies lag far behind their domestic-focused peers in their share-price performance so far this year. “Typically, euro strength if it comes with a stronger growth backdrop as in 2017 or 2020-21, then it is not a big headwind,” said Magesh Kumar at the bank. “This time around we are looking at a weaker growth backdrop in [the second half of the year] from the tariff impact and a simultaneously stronger euro. So it’s a double whammy to earnings.”
Given that some European stock market indices have risen more than 20 per cent since I pointed out how cheap they were at the end of last year, the best bet must be that they will struggle to rise much from here, at least until the EU can demonstrate convincingly that it can foster greater domestic growth. Besides, Deutsche Bank reckons the dollar would need to fall a further 34 percent to bring its external deficit back within historic norms. Ouch!
3. Italy versus France
This year marks the 100th anniversary of the last time that Italy ran a budget surplus, noted Deutsche Bank’s Jim Reid in a note last week. But while the southern European country has long been a byword for political and financial instability, this caricature looks increasingly outdated. In fact, Reid says, we’re currently in a rare period of stability for Italian finances and politics.
The Meloni government is two and three-quarter years old, making it the 9th longest administration since WWII. It’s a year short of being the 4th longest and within a few weeks of being the 2nd longest without an election or realignment of the coalition under the same leader.
Financially, Italy looks relatively stable these days too:
Italian government debt has actually declined from around 158% of GDP during covid to around 135% today. Remarkably, apart from during the covid shock, it's now been stable at 135% since 2014. Over the same period since 2014, French, US and UK debt, for example, have risen 17pp, 21pp, and 14pp respectively to 113%, 121% and 101%, using gross debt for comparability. Italy has actually run a primary surplus in 27 of the last 33 years back to 1992 so Euro membership and rules have provided a straitjacket that hasn’t been generally good for political stability, while other countries have spent, but has finally got Italian debt stable in a world of rising debt.
In fact, France looks much more vulnerable that Italy these days in terms of fiscal sustainability. On four key drivers of fiscal risks identified by Deutsche Bank - public finances, external position, political developments and growth prospects - “Italy wins 4-0”. A year ago, I wrote a post asking “Is France is becoming the new Italy?” On this evidence, the answer appears to be yes.
Totally agree. Total complacency. Tariff deals are good narrative has taken over in markets. True, these will save a global economy heart attack, but instead, a cirrhosis process or something like is in the making. First, tariffs have not hit the economy quite yet because the anticipated imports in 1q lead to a slow down in 2q (which will show 2q GDP growth nearing 3%). It’s the 3q when we start seeing the real impact. Second, the real effective tariff market estimate of between 13-18%, is completely outdated after this new round of bullying. Looks like anywhere above 20% will be the next reference, enough to suscribe to the brave new world overhauling the tenets of globalisation. Think about a full trade war US-EU and we are done. That TACO acronym of which Trump is very aware of because he was asked in a press conference, is playing out the most pernicious effect in the whole process through the president’s psychology.
Just piling up effects to the day of reckoning.
Markets acting chill while the tariff threats keep piling up is wild. Feels like we’re all just waiting to see if the trade wars actually hit hard or stay another “theatrical show.”