Tariffs are back on again, the EU received a letter from President Trump that he would impose a 30% tariff rate on the Euro area, dashing hopes from last week that the EU would agree a deal with the US for a 10% tariff rate. There is still time for a negotiated solution, as the tariffs do not come into effect until August 1st, and the EU is holding off from applying retaliatory tariffs.
Financial markets are acting like the 30% rate is a mere tactic from Donald Trump, rather than a reality. Eurostoxx 50 futures are lower by 0.6%, and EUR/USD is down 0.1% so far on Monday. At the start of the week, tariffs are the focus, however, with 2 weeks to negotiate better terms, we could see European stocks also stage a recovery after initially selling off at the start of this week.
• Resilience to tariff threats
Financial markets are becoming resilient to these tariff threats, and so far in July, the Eurostoxx 50 index is higher by 1.5%, the FTSE 100 is higher by 2% and the Cac is also higher by 2%. European stocks are also outperforming US stocks so far in July. While stocks are resilient, FX traders have flocked to the dollar this month as Trump’s tariff rhetoric heats up.
The FX market is where tariff fears are showing up. However, while the FX market clearly sees tariff risks as being a threat to the rest of the world, US stock underperformance last week vs. European indices, suggests that stock investors think the opposite.
As we move deeper into the summer months the question is are markets too optimistic or complacent in the near term? If a good deal between the EU and the US is not negotiated by August 1st, risk sentiment could sour, and the euro could come under pressure.
• European stocks continue to attract value investors
It is worth noting that tariffs are not the only concern for investors, which could also blunt some of their impact. There is still value in the European market, for example the P/E ratio of the Eurostoxx 50 is 16 times earnings, compared to 26.6 times for the S&P 500.
The Dax is catching up with the S&P 500, and its price to earnings ratio is 20.7 times. It will be interesting to see if investors focus on European value markets outside of Germany as we move through the second half of this year. Investors also need to weigh up the impact of interest rate cuts that are expected in the next couple of months.
There is an 89% chance of a cut expected from the Bank of England in August, there is a 60% chance of a cut from the Federal Reserve in September, and there is a near 40% chance of another cut from the ECB in mid-September.
• Europe weighs up options as trade war fears recede
The latest news from the EU is that it will step up its engagement with other countries hit by Trump’s tariffs, for example Canada and Japan, it is also looking to reach a trade deal with India by year end.
This suggests that the EU is willing to retaliate in a measured way, it is also looking to diversify its trading partners outside of the US. Thus, we do not think that fears of a trade war will impact market sentiment as we start a new week.
This is reflected in the price of safe havens, the gold price is higher by a mere $15 per ounce, and is up 2% so far in July, about the same as some European equity indices. Added to this, the oil market does not seem concerned about the tariff hit to the global economy. Brent crude oil is back above $70 per barrel and is higher by more than 4.5% so far in July.
• Bank of England primed to cut rates in face of economic threats
The pound is also in focus on Monday, after Bank of England Governor Andrew Bailey said that he believes that the path is downwards for interest rates, and that the bank will cut rates if employment continues to fall due to the national insurance increase at the last budget in October.
GBP/USD initially fell back towards $1.3450 on this report, but it has since picked up and is making its way back towards $1.35, as the UK markets have a neutral start to the week.
Ahead this week, the focus will be on the torrent of economic data and the start of earnings season. Below we focus on two key events that are not to be missed.
1. US inflation data
This is a data heavy week, and US CPI is going to be worth watching. The market is expecting an uptick in US inflation for June, the headline rate is expected to rise to 2.6% from 2.4%, while the core rate is expected to jump to 2.9% from 2.8%.
The Fed is looking for larger tariff related price increases to start showing up in the US this summer, however, the relatively small increases in CPI may ease fears about tariff related inflation for now.
We expect only modest pass-through from tariffs to consumer prices, and service price inflation may continue to cool. Interestingly, after years of disinflation, goods price inflation is rising again in the US, although this inflation is much easier to control than service price inflation.
Overall, US price data may not move the dial for markets, however, a weaker reading than expected may weigh on the dollar and boost expectations for a Fed rate cut in September.
2. Q2 earnings season
There is a torrent of earnings data this week from both sides of the Atlantic. In Europe, the focus will be on industrials and chemicals, companies with big global footprints, to see how tariffs have impacted their earnings, and how the strong euro will impact profit levels.
More than 50% of blue-chip European companies’ earnings are dollar denominated. EUR/USD surged by nearly 10% in the second quarter, so there could be a big FX impact on earnings as USD revenues are converted back to euros for reporting purposes.
In the US, the key earnings to watch out for this week include JP Morgan, Wells Fargo, Citigroup, Goldman Sachs, Bank of America, Morgan Stanley and Netflix. So far 4% of companies on the S&P 500 have reported earnings, and 71% have reported earnings above expectations.
However, this is below the 5-year average of 78%. However, revenues have been stronger. As we progress through earnings season, this data will change, so this week will be crucial to see how Q2 earnings season is panning out.
Overall, analysts have been downbeat about this earnings season. During Q2, analysts revised lower their EPS estimates and 10 out of 11 sectors saw earnings expectations revised lower. The question is whether this has lowered the bar enough for earnings to exceed weak expectations and give risk sentiment a boost.
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