The US | Is inflation returning to the US?
US inflation in January was higher than expected at around 3% for both headline and core inflation (which strips out volatile components). This was mainly due to rising energy prices, along with price increases in used cars, motor insurance, medical care commodities, and airline fares. However, it wasn't all bad. Clothing prices fell, while medical services and new car prices remained flat.
While the inflation surprise spooked markets, with US bond yields rising on reduced expectations of Fed rate cuts, a sustained pick-up in inflation is unlikely. Inflation needs to average just below 0.2% per month to reach the 2% target by the end of 2025. This is challenging, but inflation is expected to moderate and settle slightly above target.
Firstly, oil prices should remain stable, limiting their contribution to inflation. OPEC will start easing production cuts in April 2025, and Trump's drilling plans will add more supply. With demand stable, prices should remain steady. Secondly, housing inflation should ease. House prices and rentals have stabilised and should feed through to the inflation print. A Federal Reserve of Cleveland study supports the view that housing inflation will moderate.
It's true that Trump's tariffs present uncertainty. But the relationship between tariffs and inflation isn't linear. A complex web of responses takes place with new tariffs. Companies and countries adjust supply chains, businesses may absorb costs, and consumer behaviour shifts. Currency effects also play a role. Targeted currencies weaken against the USD, making imports still affordable. In 2018, Trump's tariffs led to a 4.5% USD appreciation, and the trade deficit widened further. It's worth noting that strong import growth is an underlying indicator of the good health of the US economy.
If tariffs were to push prices up, it would take time. The market's muted reaction to last week's tariff announcement reflects the complexity of implementation and it not coming until after April, allowing time for negotiation.
Europe | Can European equities continue to outperform the US through 2025?
In 2025, European equities have outperformed US peers despite Trump's pro-growth agenda, tariff threats, weaker European growth, and political uncertainty. Even in France, where political uncertainty is certainly running high, the CAC 40 index has returned 9% compared to 2.3% and 3.4% for the S&P 500 and NASDAQ respectively.
Two factors explain this. Firstly, US equities performed well in 2024 and took somewhat of a breather after Trump took office —a "buy the election, take profit at the inauguration" effect. Secondly, the Trump trade strengthened the USD and weakened the euro, benefiting European exporters with significant foreign revenue.
This outperformance may not last without fiscal support and structural reforms to boost productivity and investments. Ongoing tariff threats keep us neutral on European equities. While they may rise, they could underperform US markets.
However, economic data surprises in Europe could provide upside potential. A weak euro may support exports and manufacturing, which showed signs of recovery in January. Without broad tariffs on European exports and with a potential Ukraine peace deal, our stance could change.
This week | Economic activity in Europe and UK inflation before the German election
Next week, as the Q4/2024 earnings season continues, we monitor White House developments on geopolitics (Russia/Ukraine) and tariffs. Key economic data include February's purchasing managers' indices, indicating whether the eurozone's recent improvement continues and if US softening is confirmed.
Additionally, the UK January inflation release could support further Bank of England rate cuts. Finally, on Sunday, the German parliamentary election results will be in focus, with CDU/CSU leader Friedrich Merz potentially leading a new coalition government.