While many economists may find it reassuring that even the most advanced artificial intelligence appears unable to foresee President Trump’s next decisions on tariffs, not knowing what’s coming next does not really help investors.
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Another round ofUS trade policy announcements surprised markets (yet again) on Friday 23 May, with a threat of 50% tariffs on European exports to the US from as early as 1 June. The US administration felt European negotiators were not acting in good faith and should no longer benefit from the 90-day tariff pause it had granted on 9 April.
Just two days later, after speaking with European Commission President Ursula von der Leyen, Trump (yet again) decided to push the deadline back – it is now 9 July. The goal is to reach a ‘good deal’ on trade with the European authorities.
Meanwhile, trade talks between Japan and the US are progressing. The US Treasury Secretary is expected to participate in the bilateral discussions scheduled for this week. Japan’s prime minister would like to achieve an outcome during the G7 summit in Canada from 15 to 17 June.
How to read US trade policy? Donald Trump appears to oscillate between a (very) hot and (very) cold treatment of US trade partners to move negotiations forward. It looks unlikely he will be thrown off course, but when financial markets scatter and turmoil breaks out, he tends to suddenly ease up on the pressure. Such a volatile strategy implies volatile markets.
‘One Big Beautiful Bill Act’
As if protectionist policies were not enough to occupy investors’ minds, questions about the sustainability of the US’s ballooning government debt have returned to the forefront and may remain there in the coming months.
The House of Representatives passed a bill on 22 May which, as it stands, is expected to lead to an even larger budget deficit. Donald Trump’s ‘One Big Beautiful Bill Act’ (OBBBA) would extend his first-term income tax cuts beyond their current 2025 expiry date. The bill has yet to be discussed in the Senate. It had only the slimmest majority in the House (215 votes to 214).
According to first estimates, the House of Representatives’ fiscal year 2025 reconciliation bill would add $2.5 trillion to the US’s primary deficits over the coming decade, thus raising the debt including interest by $3.1 trillion.
These calculations do not consider amendments likely to be introduced in the Senate, which could require the bill to be returned to the House of Representatives for another high-stakes vote.
Moreover, the boost from the bill to US growth this year should be modest in relation to the extent to which the deficit would widen. The estimated figures explain why investors in the US Treasury market are nervous. Recent debt auctions have seen weak demand (particularly the auction of 20-year bonds on 21 May).
OBBBA v2?
Democratic Party members have already denounced the planned cuts in social benefits and healthcare and several Republican senators have warned that significant changes will have to be made to the proposed legislation.
Some Representatives and Senators believe the spending cuts are too small. Others worry that the targeted areas (healthcare via Medicare, food and social benefits via SNAP – the Supplementary Nutrition Assistance Program – and the energy transition) could lead to massive voter disaffection at the midterm elections in November 2026.
Another risk that may worry both Republican and Democrat members of Congress is that of a recession in the US which generally pulls the rug from under the labour market. Economic indicators for now have been reassuring. The composite purchasing managers’ index beat market expectations on the back of improved activity in manufacturing (52.3) and services (52.3). At 52.1 in May, however, the composite is below the near-55 level seen in the second half of 2024.
Indices reflecting price pressures are tilted to the upside. Over the next few quarters, it would make sense to expect higher inflation and a slowing economy as a result of the tariff-induced supply shock and likely fall in business and consumer confidence due to Trump’s policies.
Any worries about bond supply and monetary policy?
In the US, we are seeing an unusual combination of
a) (Effectively) full employment in the economy
b) A large general government deficit
c) Planned policy measures that will not reduce the deficit – already at 7.3% of GDP in 2024, according to IMF data – or stabilise the fiscal trajectory.
Understandably, such a constellation will have investors wonder about the course of monetary policy and the outlook for high government bond issuance.
A larger supply of government bonds in the face of an already ballooning federal debt could also awaken ‘bond vigilantes’ – bond market investors who protest against monetary or fiscal policies they consider inflationary by selling bonds.
Rating agency Moody’s caught up with fiscal reality, downgrading its rating of the US from Aaa (negative outlook) to Aa1 (stable outlook). This was simply a catch-up with the other two main agencies’ views. Given the relative scarcity of top-rated AAA bonds at slightly over 10% of the global bond market, a lower rating is not likely to trigger any forced selling of US Treasury bonds.
One thing an investor (vigilante or not) certainly does not need when the outlook for the long end of the market could be at stake is uncertainty over the short end of the curve, which is typically more sensitive to (the outlook for) central bank moves and equally to worries about the Federal Reserve’s ability to set policy independently.
On the latter, there has now been some reassuring news.
On 22 May, the US Supreme Court granted the Trump administration’s request to pause orders by federal judges that required government officials to allow board members at two independent federal agencies (Gwynne Wilcox and Cathy Harris) to stay in office. The decision allows President Trump to remove without cause these two officials.
However, the Supreme Court also said the structure of the US Federal Reserve Board is not threatened because it is “a uniquely structured, quasi-private entity that follows in the distinct historical tradition of the First and Second Banks of the United States”.
In short: the ruling on firing agency officials without cause does not apply to Fed governors.
That is good news for the Fed’s independence and should reassure investors, or at least not add to their concerns. President Trump has vocally criticised Fed Chair Jerome Powell and hinted he should be fired. The Supreme Court has now signalled that is beyond his remit.
It’s always good to have even just one stable element in tumultuous times.
