Middle East uncertainty continues and Trump Administration announces new tariffs
With a lot of uncertainty surrounding the situation in the Middle East, markets were in somewhat of a holding pattern. There remains hope a peace deal can be agreed, but there was no positive news yesterday and uncertainty about whether Israel will cease its Lebanon attacks to bring Iran fully back to the table. Oil prices edged up slightly, with a barrel of Brent crude up about 1% to nearly $96/barrel. The dollar strengthened somewhat, to around $1.1620 to the euro and $1.3450 to sterling currently, with EUR/GBP largely unchanged at 86.4p. Meanwhile President Trump announced new tariffs of up to 12.5% on most countries overnight to replace tariffs that have been struck down by the US Supreme court.
Government bonds rallied yesterday, particularly in Europe, though some of this may have been retracement from a sizable rise in euro yields on Monday. German 10-year yields fell 3bps back below 3%, while French 10-year yields were also down 3bps to 3.6%. The euro bond markets shrugged off higher-than-expected Euro Area core inflation in the “flash” HICP print, with the bond market already baking in a 25bps ECB hike next week. In the UK, 10-year yields were down 4bps to just above 4.86%, while in the US, 10-year yields were down 1bps to 4.44%. The AI boom continued to push equities higher, with indices on both sides of the Atlantic posting gains on the day, with the S&P up 0.1% for the day, setting a record high for a ninth consecutive day—the best run of this kind since 1995.
President Trump opened a new front in his tariff campaign, after previous tariffs were struck down, putting tariffs of 10% on several trading US trading partners -including the EU- and 12.5% on others who ‘have failed to address importation of goods made by forced labour’. The Trump administration is now using ‘Section 301’ of the Trade Act 1974 to impose these levies which commentators say is more legally sound than previous methods though the tariffs will not come into place immediately and are now subject to a review period with a panel convening on July 7th. Several other ‘Section 301’ investigations may be ongoing so other tariff or non-tariff trade actions may be announced in the future. This action will not breach the EU-US trade agreement agreed last year – though not ratified yet – if this 10% tariff is not an additional tariff on the EU but is part of the total of a maximum of a 15% tariff agreed under the deal.
Headline Euro Area HICP inflation rose to 3.2% in May, according to the “flash” estimate released yesterday. This is in line with expectations but is up from 3.0% in April and the highest since September 2023. In terms of specific countries, German inflation was slightly softer than expected – at 2.7% – with a temporary fuel tax cut helping to lessen energy inflation, while French inflation was also slightly softer than expected at 2.5%, but Italian (3.3%) and Spanish (3.6%) prints were to the upside of forecasts.
European core inflation picks up. While energy price inflation remains the main driver of headline inflation in May in the Euro Area, core inflation rose sharply, to 2.5%, from 2.2% in April and ahead of expectations. Services inflation was the culprit here, rising to 3.5%, from 3.0% in April. This will be a key concern for the ECB as it debates if this is a sign that second-round effects are beginning. A 25bps rate hike next week is more or less a racing certainty, but the concerns will then shift onto whether more is needed, and faster, to counter rising cost pressures, or whether this one hike will be enough for now – with the ECB’s Rehn saying yesterday a June rate hike would just be an ‘insurance hike’ – especially considering the signs of weaker demand in some key Euro Area economies like Germany.
In contrast, the Bank of England is in more of a “wait and see” mode. Governor Bailey’s comments yesterday acknowledged the delicate situation facing the MPC. He said the inflation overshoot is “entirely due to Gulf events” and the committee faces a growth/inflation trade-off, with the outlook for slower growth and not recession. However, he did add the committee “can’t wait for hard evidence on second-round effects”. MPC member Greene was more hawkish than that, saying the longer the Mid East conflict goes on for, the stronger the case for a rate hike and that the ‘risk of acting is less severe than the risk of not acting’, while the speed of the BoE’s response is as important as the size of the response. Markets continue to think the MPC will hold off for now, with only a circa 10% chance of a hike at the June meeting.
For today, on the data front, it’s mostly US, with ADP employment, ISM services, factory orders, and later on the Fed Beige Book. We also get final May PMI services and composite readings for major economies.