Bad or beautiful EU trade deal?

The meeting between EU Commission President Ursula von der Leyen and US President Donald Trump, which took place in Scotland on 27 July, ended with an agreement on trade tariffs between the two large economic blocs. In line with the US’s deal with Japan a few days before, EU goods will be taxed at 15% and the bloc agreed to substantial purchases of US goods as well as investments in the US. Critically, the agreement maintains US goods imports in the EU at zero tariffs. The market’s initial relief on 28 July was short-lived, as some EU countries, probably more impacted than others, expressed concerns, while some commentators described the outcome as a capitulation by Europe. Admittedly, at first sight, the deal looks very asymmetric, with the US raising tariffs on EU goods and the EU hardly retaliating at all.

What the dynamics reveal, and who is impacted

Since Liberation Day on 2 April, we have come a long way and gained some understanding of the current trade negotiation dynamics. First, the tariffs, which US customs statistics confirm are quite real, seem to be absorbed partly by foreign exporters, partly by US importers, and mostly by US consumers, who effectively experience a tax increase.

In this respect, US real personal consumption growth seems to have come to a complete standstill year to date despite positive asset inflation (which creates a positive wealth effect) and supportive labour market trends in income and jobs. All in all, evidence points towards confirmation that the US tariffs are somewhat stagflationary for the US economy and deflationary for the rest of the world. Stagflation, or slower growth paired with higher prices, is one of the most complex and constraining environments for economic policy.

Ursula von der Leyen mentioned that the EU trade surplus with the US is large and unsustainable and that some rebalancing is indeed welcome. We will never know for sure whether this statement is truly genuine or more about employing Donald Trump’s own tactics, but, in any case, we think it is the smart way to approach the matter.

The bigger picture: No trade war, but rebalancing

Donald Trump is determined to raise government revenues by raising tariffs. This is a critical part of his economic agenda to rebalance the US economy and move away from chronic deficits. Part of this US masterplan to rebalance global trade implicitly targets China. Beijing has made it very clear that every sovereign state is free to make a bilateral trade agreement with Washington but that it cannot be at the expense of Chinese interests. If other states end up imposing no tariffs on US imports, it will then be hard for the US administration to argue that they do not benefit from the ‘most favoured nation’ clause.

Markets have been discounting the trade war for quite some time and rightly so. Collective wisdom is probably right that there will not be a trade war. However, the rest of the world has an opportunity to move forward and continue supporting a friendly trade framework.

Fed-bashing is risky

More broadly, we believe that the US administration’s rebalancing strategy, led by Treasury Secretary Scott Bessent, is to grow the economy out of the current public deficit. This approach to reducing the deficit requires the private sector to borrow again and step in as the federal government retrenches. President Trump needs a new private sector credit cycle, and the enabler is affordable loans, which require lower interest rates. Although the US president reiterated that he does not want to fire the Fed’s chair, he mentioned that the federal funds rate should be 1% rather than the current 4.25%–4.5%. 

The pitfall of this logic is that lowering short-term interest rates is beneficial only if long-term rates follow suit. Sowing doubt about the Fed’s independence is risky in this respect. For now, we see three institutional guard rails with regards to the integrity of the Fed’s independence:

1. The Federal Open Market Committee Meeting’s governance framework, which is a decentralised decision-making body with 12 voting members, including seven governors and five regional bank presidents;
2. Congressional oversight, with the Senate required to confirm both the Fed’s chair and governor nomination;
3. Good old market forces, which should ultimately keep the current administration under control.

Should the last guard rail come into play as Jerome Powell’s mandate ends next May, rising long-term rates (above 5% on the 10-year US Treasury bond) would most likely be the straw that breaks the market’s back.

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