Diverging paths: Trump’s economic uncertainty contrasts EU growth prospects

In Natixis CIB’s latest webinar Bastien Aillet, Economist Germany & Eurozone, Benoît Gerard, Rates strategist, Nordine Naam, Forex strategist, Cyril Regnat, Head of Research Solutions In the EU, discuss the real and potential market repercussions of the new policy regime coming out of Washington.

In the EU, Germany’s new coalition controls a weak mandate but hopes to deliver growth with an ambitious fiscal package, fortified by the ECB’s upcoming rate cuts. Prospects differ in US markets, as the White House tries to stabilise US Treasury yields after hostility to the Federal Reserve shook investor confidence. The Trump administration’s eagerness to allow US dollar depreciation signifies a deeper policy regime change that prioritises the competitiveness of domestic manufacturing over investment.

The EU is showing resilience so far in the face of trade uncertainty. Although Trump’s special 20% tariff is still on hold, the EU has been subject to the implementation of several tariffs against it, including 25% on steel and aluminium since March 12; 25% on cars and light trucks since April 3; 10% universal tariff since April 5 and 25% on car parts since May 3.

So far, the EU is managing to weather the trade policy upset, seeing GDP grow from 0.2% in Q4 last year to 0.4% in the first quarter of this year, beating expectations. However, a recent survey released by the European Commission indicated demand as the main factor limiting business growth at the moment – particularly in the industrial sector – which is set to worsen even more if the bloc fails to make a trade deal with the US.

Internally, the EU faces problems of its own as Friedrich Merz becomes the first German Chancellor in post-war history not to be confirmed in the first Bundestag vote. Despite the weakened coalition, Germany’s new government must hit the ground running. The primary goal is securing long-term growth, with a plan to boost potential growth to more than 1% by identifying new sources of productivity. Optimistic forecasts suggest that Germany’s recent fiscal package will boost economic activity in Q4 of 2025 and continue into 2026.

With services inflation set to normalize and headline inflation falling below 2% and expected to remain below this level into the middle of 2026. Consequently, we now expect that the ECB willreach a terminal rate below the neutral level (estimated between 2.25% and 1.75%). Considering this forecast, Natixis CIB is changing its anticipated ECB’s terminal rate to 1.5% down from 2%, with three 25bps cuts expected over the next three ECB meetings.

The interdependency of economic activity, fiscal conditions, and monetary policy can keep the EU on a growth trajectory, exhibiting a synergy between the EU and the ECB that contrasts with the antagonism between the US government and the Federal Reserve. As investor confidence in US Treasuries weakens and the Trump administration pursues deliberate currency devaluation, the EU is set to shore up investment.

News headlines are full of stories around investors doubting the long-standing reliability of US Treasuries because of Donald Trump’s trade policy turmoil and open antagonism towards Jerome Powell, the Chair of the Federal Reserve. After 10-year US Treasury yields increased to 4.5%, indicating a crisis of investor confidence and the possibility of significant selloffs going forward, Trump softened his remarks.  Investors fled risky assets, fixed-income markets, and the US dollar. The situation drew comparison to the UK’s episode under Liz Truss, with both caused by policy interventions instead of exogenous macroeconomic shocks.

Long term appetite for US Treasuries will go with an assessment of sustainability of US debt levels which is correlated with US Treasury dynamics.  One measure of monetary regime orthodoxy is the correlation between the sustainability of debt (the difference between nominal growth and average interest rate on US federal debt) and the term premium (a proxy for appetite for US Treasuries).  Markets should remain steady as long as the nominal growth rate is higher than the interest rate on the federal debt.  The White House and the Federal Reserve will nevertheless continue to face additional risk due to the volatility in growth rate projections brought on by trade policy disruptions.

The Federal Reserve policy will remain an anchor for the US Treasuries market for the foreseeable future. The Federal Open Market Committee (FOMC) is keeping its interest rate stance cautious due to trade uncertainty for now. Since inflation is still above target and despite US growth expected to slow to less than 1% by the end of the year, the FOMC, which makes monetary policy decisions for the Federal Reserve, decided this week to postpone rate cuts. However, in order to balance the risks of a recession in the second half of the year, the Fed is anticipated to lower rates in response to slowing growth. According to Natixis CIB's scenario, this will result in a 75bp reduction in 2025, reaching a terminal rate of 2.75% next year.

Although the stability of US Treasury yields appears to still be a priority for the administration, the depreciation of the dollar denotes a departure from the previous administration.

Historically, due to their depth, liquidity, and financial infrastructure, the US dollar, dollar assets, and US Fixed Income Markets remain strong and reliable. This makes financial markets attractive, Trump’s plan to devalue the dollar is part of a strategy to make US economy more  more competitive for global manufacturing.

The US dollar has fallen since the beginning of the year, fuelled by market turmoil caused by tariffs.  On foreign exchange markets, most major currencies rose against the dollar, which struggled to recover despite the 90-day tariff pause.  Weakness is likely to persist as speculative accounts reduce their long positions in the dollar in favour of the Euro.  The real effective exchange rate (REER) shows that the US dollar has been overvalued by more than 20% since 2021, so its rapid depreciation may be viewed as an acceleration of an unavoidable trend. US and China recent tariff reduction in 90 day cool off period will support temporarily the dollar but the trend in medium term remains negative.

Outflows from US assets are expected to continue, with equities showing a slower trend due to expectations of slowing growth in the coming quarter.  These allocations will put additional pressure on the US dollar.  FX hedging may be another source of pressure, as most foreign positions are not hedged against currency risk. The US is signalling a strong regime change by shifting priorities away from investors and towards domestic manufacturing ambitions.

US capital markets can continue to rely on their dominant status in the global financial system, but there is a growing risk of a slow decline in the US Dollar. As the Trump administration continues in its efforts to devalue the dollar and shore up domestic manufacturing, investors with a capital preservation mandate will look to more stable markets. With the EU’s signalling greater investment in growth and its more favourable interest rates, it is well-positioned to capitalise on outflows from US assets.