I’m still baffled at the desperation in markets to believe that the macro backdrop is fine.
We wrote about this recently so this is a shorter post, but it’s worth recapping given we’re heading into crunch time and there are tonnes of catalysts for a left tail outcome.
We have the tariff deadline on 1 August, with the key risk being negotiations between the EU and US breaking down.
It’s 50-50 that the two sides agree to a deal which will lower the “reciprocal” tariffs to a 10-15% range (literally, 50-50. Trump on Friday: I would say that we have a 50-50 chance, maybe less than that, but a 50-50 chance of making a deal with the EU). The way this works out is completely dependent on the whims of President Trump:
If Trump decides he doesn’t like the EU’s proposal, we get the EU rate at 30% introduced. Around 20% of US imports come from the EU, so that is a huge headwind to US consumers and corporates.
I’m also pretty sure that whatever happens, the only rate we know the EU will not get is 30%. If Trump tariffs the EU at 30%, the EU will respond, likely introducing targeted counter tariffs. It could also use its Anti-Coercion Instrument. After an array of bureaucratic steps (it is the EU after all), the instrument can allow the bloc to introduce a variety of measures against US firms:
Should the EU retaliate, we know that Trump will escalate (11 July letter: If for any reason you decide to increase your rates and react, the amount, whatever increase you choose, will be added to the 30% we charge). We either get EU reciprocal rates at 10-15% or closer to 50% after tit-for-tat. Not 30%.
Beyond the EU, some of the established “trade deals” are fraying at the seams with there being obvious disagreements between Japan and the US on the nature of the profit sharing on the USD550bn that Japan is supposedly investing in the US. As a side note, it is clear that no one on the Trump deal team understands BOP – a big jump in the financial account surplus is consistent with a big jump in the current account deficit, the opposite of Trump administration aims.
Trump also appears to be unilaterally deciding deal terms, with Vietnamese officials believing they had secured an 11% tariff rate, blindsided by Trump’s announcement of a 20% rate.
And beyond the 1 August tariff deadline, we also have a tone of economic data coming in over the next week. These could come in contrary to the “everything is fine” narrative that has prevailed in the last couple of months. Consensus on that Q2 GDP print of growth of 2.5% SAAR is quite lofty all things considered.
And beyond the tariff deadline and the economic data, we’re also part way through Q2 earnings releases. So far we’ve largely seen upward surprises:
But we could see some downside surprises in another period for releases next week:
We’re clearly in crunch time. Maybe things pan out, but there are plenty of catalysts for a left tail scenario over the next two weeks. That’s why I’m still super interest in mid August expiry S&P puts, with downside protection looking super cheap right now all things considered.
The whole this is all gonna be fine approach doesn’t make sense to me. The risk of no trade deals is high. Even if trade deals are signed to keep the US effective tariff rate at around 15%, that is still a bad outcome.
JB Macro is my blog, where I splurge out my brain. I’m building a following for my passion, writing about economics and markets, and it would be really great to have you on board. Please consider pressing the subscribe button below (it’s free!!). Thank you, James.
This newsletter is for informational purposes only. It does not constitute investment advice or an offer to invest. The views expressed herein are the opinions of JB Macro exclusively. Readers should conduct their own research and consult with professional advisors before making any investment decisions.
Interesting thoughts James. In my opinion, the indifference of markets to economic developments (not just trade but also recession risk) reflect the increasing disconnect between financial markets and the real economy.
The balance sheet structure of firms, particularly the mega caps with huge cash piles and captured markets, provides them (and their share price) with natural insulation in the event of exogenous shocks. This might explain why markets don’t seem to give a hoot about what is happening in the real world.