ECB Preview: A Disputed 25bp Rate Cut

Central Bank

Summary:

Next week, the ECB is set to cut rates for the fourth time this year. Unlike the previous three cuts, the outcome of next week’s rate decision is not given as 1) the restrictive policy stance, 2) the deteriorating growth outlook, and 3) inflation at target has opened discussions of a 50bp cut. While a 50bp cut will certainly be discussed, we judge that the ECB will ultimately deliver a 25bp rate cut, and guide that they are open to any size of rate cuts at future meetings, subject to the incoming data. A 25bp cut next week will bring the ECB’s deposit rate to 3.0%. In the coming year, we expect a string of rate cuts, leading to a terminal rate of 1.5% being reached in September 2025.We expect a benign market reaction, even if Lagarde decides to twist guidance towards an increasing likelihood of a faster rate of normalisation.

Change guidance of policy restrictiveness

Since last year, the ECB has included a reference that it aims to keep monetary policy ‘sufficiently restrictive’ for as long as necessary. Following the disinflationary process that has gained traction through 2024, the updated staff projections next week are likely to forecast inflation on target from 2025 and onwards. Thus, whether monetary policy should stay restrictive is likely going to be debated. We believe that the slightly hawkish bias in the ECB’s communication is set to change as the need for a restrictive monetary policy stance in the Eurozone is no longer obvious. But the camps inside the GC are obviously divided. In a recent interview the ECB’s Schnabel said that in her view the restrictive part of the monetary policy stance is already fading. At the same time, we see the dovish camp, for example Villeroy, saying that there ‘won’t be any reasons’ for policy to remain restrictive.

A 25 or a 50bp rate cut? It is not the most important question

With activity indicators looking bleak heading into 2025, the case for a 50bp rate cut has strengthened, as the starting-point for financial conditions is restrictive based on most measures. However, given the ECB’s sole inflation mandate, and the ‘political’ aspect of having a gradual rate cutting cycle, we believe it will favour a 25bp rate cut.

However, whether the ECB will deliver a 25bp rate cut or 50bp rate cut in December is not that important in isolation, as the communication around it will be key as well. There seem to be diverging views on how to cut the cake. Most recently, Schnabel’s interview clearly suggested that she would opt for a 25bp rate cut, as would Vujcic, while others such as Lane, Villeroy and Centeno are more open to discussing a 50bp rate cut.

That said, rather than focusing on the rate cut next week, we should focus on where the policy rate will end in this cutting cycle, albeit we do not expect any verbal guidance on this. Markets may though interpret a 50bp cut as a signal of a lower terminal rate – and that may even be a signal that the ECB wants to send.

But as we do assume the ECB does not want a hawkish reaction from markets, leading to tighter financial conditions, we expect it to opt for a dovish 25bp cut, focusing on the communication on a potential jumbo cut.

Macro data since the October meeting has mainly given ammunition to the doves

Since the October meeting, the momentum in underlying inflation has fallen further and growth indicators have weakened. The composite PMI indicator declined sharply to 48.3 in November mainly driven by the service sector, which is now also in contractionary territory. Data indicates that the eurozone’s two largest economies, Germany and France, are likely to contract in Q4 while Spain should drive aggregate euro area growth together with Portugal and Greece. The deteriorating growth indicators combined with rising political uncertainty since the October meeting have mainly given ammunition to the dovish members of the ECB. However, the hawks’ last battalion, namely the labour market, continues to show resistance with the unemployment rate remaining at a record low of 6.3% in October and the national account data showing increased employment in Q3.

Underlying inflation has eased further

While headline inflation has increased from the three-year low in September, mainly reflecting base effects, the underlying momentum has continued to ease. The average month-on-month increase in seasonally adjusted core inflation has been 0.14% in the past three months, which is well in line with 2% annualised inflation. Importantly, the lower momentum in underlying inflation has been driven by service inflation where momentum is also quickly approaching the 2% target, according to the ECB’s own seasonally adjusted data. Hence, inflation developments have clearly also supported the doves in the ECB. For the hawks, an argument for a cautious cutting approach is wage growth that remains elevated given the tight labour market. Negotiated wage growth increased to 5.4% y/y in Q3, albeit largely driven by one-off payments, and has averaged 4.6% so far this year, compared to 4.4% in 2023.

Staff projections to show lower growth and inflation

We expect the ECB staff to take note of the recent easing in the momentum of underlying inflation and incorporate this into a lower forecast for core inflation next year relative to the forecast in September. We expect core inflation to be revised down to 2.2% y/y in 2025 (from 2.1%) and headline inflation to 2.1% y/y (from 2.2%). Oil futures were 6% lower at the cut-off date for the staff projections compared to December, but gas and electricity futures were higher, so we expect only a marginal reduction in the headline forecast. We expect the growth forecast to be revised down in 2025 to 1.1% y/y from 1.3% y/y due to the continued struggles in the manufacturing sector combined with cautious consumers and a weak German economy. In contrast to the ECB’s previous projections, consumers continue to have an elevated savings rate, which prevents consumption from picking up in the near term. The new staff projections will also include an additional year, albeit we do not attach significant weight to those projections given their embedded uncertainties.

Limited FX market reaction on 25bp rate cut

Speculation around a 50bp cut has diminished, with markets now largely positioned for a 25bp move, with only 27bp priced in. However, the post-decision communication will be crucial, given divisions within the Governing Council that could drive a range of market responses.

We view a dovish 25bp cut, where the ECB signals flexibility to adjust the size of future cuts, as the most likely scenario. Such an outcome would likely have a limited impact on EUR/USD, and with the probability of a jumbo cut still being priced in markets. However, should the ECB indicate a preference for continuing the easing cycle in 25bp increments, market pricing could shift, potentially triggering a hawkish response and a moderate EUR/USD rally, albeit given the meeting-by-meeting approach and thereby keeping full flexibility about future monetary policy decisions, we see that as a low probability outcome. By contrast, a 50bp cut – an outcome we believe is underappreciated despite weak euro area growth and inflation – would likely prompt significant EUR depreciation, with EUR/USD potentially dropping sharply.

Looking ahead, the Fed’s December meeting is likely to have a more decisive impact on EUR/USD’s near-term trajectory, with Friday’s US jobs report a critical input. While markets currently assign a decent probability to a Fed pause, we expect a 25bp cut. If this materialises, it should help contain further EUR/USD downside into year-end. Seasonal trends and our short-term valuation models support this view, as EUR/USD appears oversold after its sharp decline since October. We expect the pair to close the year at around 1.06.

From a strategic perspective, we maintain our bearish EUR/USD outlook, driven by the relatively stronger US growth narrative. Our 12M target remains 1.01, making parity a plausible level over the coming year. On the rates side, we note that the significant decline in rates over the past month has brought the spot level for long swap rates close to our 12- month forecast, thus offering a very limited declining profile from here, see more in Yield Outlook – Transatlantic decoupling but not for much longer, 28 November 2024. We do not expect a signal from the ECB to address the French spread widening to peers.

Source:Bank Financial Group

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JPMorgan

Economic

The dominance of Big Tech in digital services has enabled them to scale and grow in unprecedented ways, but has also raised concerns about their expanding power. As the world becomes increasingly reliant on a handful of tech giants and AI technology advances rapidly, governments worldwide are intensifying regulatory efforts.

Google commands 89% of the global search engine market, Apple holds 51% of the U.S. mobile phone and tablet market, Microsoft powers 62% of desktop operating systems and Facebook and Instagram together capture 57% of the social media market. With this stronghold, Big Tech wields significant influence in setting industry standards, shaping consumer behaviors and influencing public discourse.

In response, various proposals have been put forward, including antitrust actions, stricter data protection laws and increased transparency requirements. The U.S. Department of Justice's recent antitrust case against Google marks a historic move against tech monopolies. After a landmark court ruling found the company monopolized the search market, the case could potentially require Google to divest parts of its business. Regulators have also scrutinized companies like Apple and Nvidia, while foreign governments are taking aim over U.S. dominance in digital markets.

The incoming Trump 2.0 administration will play a key role in shaping tech regulation. While uncertainty remains, early indications suggest:

AI Innovation over Regulation: Trump’s approach will likely be shaped by figures like Elon Musk, who emphasize the need for a freer environment for AI development that enables the U.S. to maintain its competitive edge. This likely involves undoing President Biden’s executive order on AI in favor of a more hands-off approach to regulation.

Evolving Antitrust Focus: The scrutiny on Big Tech’s market dominance will persist, but focus may shift towards issues like free speech and competitiveness rather than wholesale breakups of tech companies. FTC Commissioner Lina Khan will likely be replaced by someone with a less interventionist approach, slowing the pace of actions taken against Big Tech firms.

Semiconductor Independence from China: Trump could expand the semiconductor export restrictions introduced during the Biden administration and increase incentives for domestic chip manufacturing.

Loosening Cryptocurrency Guardrails: A friendlier stance on blockchain and digital currencies could reduce SEC enforcement and reshape the regulatory framework for digital assets. These efforts could attract investment and spur advancements, encouraging blockchain applications in various sectors.

For investors, the takeaways are clear: the regulatory landscape for Big Tech is set for change, but the potential challenges from antitrust enforcement and AI regulation may be less severe under Trump. Focus on semiconductor independence, tech advancement and U.S. exceptionalism could create new winners and losers, but these changes will be highly sensitive to policy developments and enforcement. As tech developments evolve, investors should remain vigilant to capitalize on emerging trends while mitigating concentration risks to those companies most scrutinized. Could Regulatory Shifts Impact the Dominance of Big Tech?_1

Could Regulatory Shifts Impact the Dominance of Big Tech?_1

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Risk Warnings and Disclaimers

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PIMCO

Economic

If the prevailing theme in asset allocation since early 2023 has been that bonds are back, a nascent theme today is correlation: Specifically, the negative relationship between stocks and bonds has reemerged as inflation and economic growth moderate.

This is great news for multi-asset investors: It means they can increase and broaden their allocation to risk assets, seeking potentially higher returns with the potential for adding little to no additional volatility within the overall portfolio. Equities and bonds can complement each other in portfolio construction, and both are likely to benefit in our baseline economic outlook for a soft landing amid continued central bank rate cuts.

PIMCO’s multi-asset portfolios therefore focus both on equities, with a slight overweight in the U.S., and on fixed income – especially in high quality core bonds, which we believe offer notable risk-adjusted return potential. Strategic investments in options and real assets can help manage risks, and systematic equity trades may enhance returns and help mitigate risks.

Investors are also considering the potential impact of U.S. policy under the second Trump administration and a narrowly unified Republican Congress. Bond markets had largely anticipated the Trump victory, and given the prevailing economic landscape, we expect bond yields will remain in an attractive range amid the transition to new leadership in Washington. In equity allocations, investors may want to consider U.S. companies that don’t rely as heavily on imports (given potentially higher tariffs), as well as those likely to be buoyed by deregulation and more favorable tax policies. Finally, an allocation to inflation-linked bonds or other real assets could help hedge against the potential risks of increasing inflationary pressures arising from fiscal policy or tariffs.

In our view, staying invested in core, high-conviction trades within a well-balanced portfolio can help investors achieve target objectives while navigating unexpected twists ahead.

Equity markets in rate-cutting cycles

While this business cycle has experienced pandemic-related surprises, inflation has now moved down the list of concerns. The precise trajectory of monetary policy may vary, but the Federal Reserve and most major central banks have clearly indicated their intentions to lower interest rates toward neutral. (Learn more in our latest Cyclical Outlook, “Securing the Soft Landing”.)

How do rate cuts affect stocks? Basic principles of asset valuation teach that, all else equal, lower central bank rates (as proxies for “risk-free” rates) lead to higher equity prices. Yet all else is rarely equal, and our historical analysis shows that economic activity has been the dominant driver of equity returns during rate-cutting cycles. If an economy slides into recession, rate cuts alone may not prevent stock market losses. However, if economic activity stays buoyant, rate cuts have potential to boost stock valuations.

There is no guarantee, of course, that these historical patterns will continue, but they can offer a guide. In Figure 1, we focus on the performance of the MSCI USA Index, a broad measure of large and mid cap equities, six months before and after the Fed’s first rate cut in cycles from 1960 through 2020 (the most recent rate-cut cycle prior to the one that began this year). This dataset encompasses nine soft landings and 10 hard landings. In the median soft landing, U.S. equities rallied through the first Fed cut, but performance tapered off three months after the cuts began. In the median hard landing, U.S. equities declined both before and after the first cut, bottoming about three months after the cuts began.

Negative Correlations, Positive Allocations_1

In both hard and soft landings, the initial rate cut typically led to stronger equity performance, at least in the first month or so, as cuts generally boost sentiment and real economic activity. However, before long, equity markets usually start to reflect the prevailing macro environment.

Examining historical equity market performance by factor and sector in the six months after the first rate cut shows that, on average, growth outperformed value, large caps outperformed small caps, and dividend yield and quality offered positive returns overall. Homing in on the six rate-cutting cycles accompanied by soft landings since 1984, we find that later in the rate-cut cycle (approaching 12 months), small caps began to overtake large caps as economic growth accelerated. Additionally, technology, healthcare, and consumer staples generally outperformed, while energy, communications, and financials lagged.

Every cycle is different, as is the macro environment that accompanies it. However, the historical pattern suggests that an equity allocation today could effectively combine secular growth themes with more defensive, rate-sensitive beneficiaries, such as real estate investment trusts (REITs).

Bond markets in rate-cutting cycles

Historical analysis also shows that bond returns have been positive during Fed rate-cutting cycles across a range of macroeconomic environments. Moreover, analysis indicates that the starting yields of high quality core fixed income securities are strongly correlated (r = 0.94) with five-year forward returns. Thus, today’s attractive starting yields bode well for fixed income investments.

As the Fed proceeds with rate cuts, bond investors may benefit from capital appreciation and earn more income than what money market funds provide. In multi-asset portfolios, conservative investors can seek higher risk-adjusted returns by stepping out of cash and onto the curve, while balanced portfolios can increase duration exposure. Of course, high quality bonds may also offer downside mitigation in the event of a hard landing.

Within fixed income, high quality credit and mortgages can enhance yields and serve as diversifiers. In particular, agency mortgage-backed securities (MBS) appear attractively valued, with spreads over U.S. Treasuries near historical highs, making them a liquid alternative to corporate credit. Historically, agency MBS have also provided attractive downside resilience for portfolios: During recessionary periods, they have delivered an average 12-month excess return of 0.91 percentage points above like-duration U.S. Treasuries, versus −0.41 percentage points for investment grade corporates.

Negative stock/bond correlation: portfolio implications

The stock/bond correlation tends to turn lower and then negative as inflation and GDP growth moderate, as is the case in the U.S. and many other major economies today. Analysis of monthly measures of stock/bond correlation data since 1960 tracked against inflation rates indicates a clear trend: When inflation is at or near central bank targets (around 2%), as has generally been the case in developed markets since the 1990s, the stock/bond correlation has been negative or very narrowly positive.

In practice, a low or negative stock/bond correlation means that the two asset classes can complement each other in multi-asset portfolios, enabling investors to broaden and diversify their exposures while targeting return objectives.

For instance, investors with a specific risk budget can own a greater range and number of risk assets while staying within their tolerance, while investors with a predefined asset allocation mix can target lower volatility, smaller drawdowns, and higher Sharpe ratios (a measure of risk-adjusted return).

In general, negative correlations can enable asset mixes that experience lower volatility than any individual asset, while still targeting attractive returns. A hypothetical efficient frontier exercise helps illustrate this (see Figure 2): When the stock/bond correlation is negative, there are regions along the lower-risk portions of the frontier where investors may target an asset mix that offers a somewhat higher potential return profile despite a drop in expected volatility.

Negative Correlations, Positive Allocations_2

A lower volatility from portfolio beta could also free up space for more exposure to alpha strategies, such as systematic equities – more on this later.

For multi-asset investors able to access leverage, negative stock/bond correlations could allow even higher total notional levels for a given risk target, as long as the portfolio returns exceed borrowing costs. The value of leverage in a diversified portfolio tends to be greater when correlations are negative.

A look at the historical extreme (“tail”) scenarios of negative returns in a simple multi-asset portfolio consisting of 60% stocks and 40% bonds further illustrates the beneficial characteristics of a negative stock/bond correlation (see Figure 3). Periods with positive stock/bond correlation have typically seen more severe (worse) left-tail outcomes for multi-asset portfolios than periods with negative correlations. This is true even though most recessions have had deeply negative stock/bond correlations, because equity drawdowns were partially offset by gains in the fixed income allocation.

Negative Correlations, Positive Allocations_3

Mitigating risks

While the opportunity set for multi-asset portfolios is rich, elevated risks related to public policy, geopolitics, and monetary policy mean that investors should consider designing portfolios capable of withstanding unlikely but extreme tail events. Even as one of the biggest global election years in history (by voting population) concludes, uncertainty remains about how policies could affect inflation, growth, and interest rates. Additionally, ongoing conflicts in the Middle East and between Russia and Ukraine, and potential for geopolitical unrest elsewhere, could roil markets.

While the negative stock/bond correlation means portfolios may be better positioned to navigate downturns, it can’t prevent and may not mitigate all the risks of tail events. But investors have other strategies available, such as dedicated tail risk management. Active drawdown mitigation may include selectively using options when volatility is reasonably priced. The availability of volatility-selling strategies in recent years, including the rapid growth of options-selling ETFs, has increased the supply of volatility options, especially in the short end of the yield curve. This trend can make downside hedging more economical during opportune times.

We also believe it is prudent to hedge multi-asset portfolios against upside risks to inflation. Although restrictive central bank rates have brought inflation levels down close to targets, the long-term fiscal outlook in the U.S. includes continued high deficits, and geopolitical surprises could cause a spike in oil prices or snarl supply chains. Trade policies, such as tariffs, and deglobalization trends could also pressure inflation higher. We believe inflation-linked bonds (ILBs) remain an attractively priced hedge, offering compelling return potential as long-term real yields are currently near their highest levels in 15 years. Furthermore, long-term breakeven inflation rates are priced around or below the Fed’s target, reflecting little to no risk premia despite the recent memory of a sharp inflation spike.

Spotlight on structural alpha: equity factors

In any investing environment, it’s helpful to step back from the analysis of risks and opportunities to assess one’s investment process. At PIMCO, in addition to our investment views based on macro and bottom-up research, we use quantitative methods to help identify equity market inefficiencies and target structural alpha. Our process emphasizes diversification, minimizes concentration risk, and seeks to overcome behavioral biases.

First, we research and assign a composite score to a stock based on four key themes: momentum, growth, quality, and value. By integrating traditional metrics, such as earnings growth, with alternative data, such as insights from earnings transcripts and customer-supplier relationships, we aim to identify companies with potential for long-term outperformance.

The composite scores are then combined with considerations of risk and transaction costs to construct a highly diversified allocation that reflects conviction levels while adhering to various constraints. These include limits on active risk, market beta exposure, and concentration risk at the country, sector, and individual company levels, ensuring only modest deviations from the broad market.

With a systematic approach, rigorous research, and advanced analytical tools, including proprietary techniques, our strategies are designed to offer consistent excess return potential across different market conditions.

Takeaways

Investors can position multi-asset portfolios thoughtfully to seek to benefit from market trends while managing risks in an uncertain environment. As central banks continue to cut rates amid an outlook for a soft landing, both equities and bonds may do well. High quality core fixed income should be especially well-positioned.

A lower or negative stock/bond correlation allows for complementary and more diversified cross-asset positioning, especially for those with access to leverage. A robust options market can help investors hedge downside risks. Finally, making use of quantitative techniques and innovative tools can help smooth returns and lay the foundation for disciplined investing across market cycles.

To stay updated on all economic events of today, please check out our Economic calendar

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Saif

Economic

The U.S. economy added 227k jobs in November, in line with the consensus forecast calling for a gain of 218k. Payroll figures for the two prior months were revised higher by 56k.

Private payrolls rose 194k, with the largest gains seen in health care & social assistance (+72.3k), leisure & hospitality (+53k), professional & business services (+26k) and manufacturing (+22k). The gain in manufacturing were largely payback from the month prior following the resolution of the Boeing strike. The public sector added 33k new positions last month.

In the household survey, civilian employment (-355k) fell by considerably more than the labor force (-193k), which pushed the unemployment rate up to 4.2%. The labor force participation rate fell 0.1 percentage points to 62.5% – a six-month low.

Average hourly earnings (AHE) rose 0.4% month-on-month (m/m), matching October’s gain. On a twelve-month basis, AHE were up 4.0% (unchanged from October). Aggregate hours worked rose sharply, up 0.4% m/m.

Key Implications

This morning’s release provided further evidence that October’s soft employment report was more to do with temporary effects stemming from hurricanes and labor disputes, and not a sudden deterioration in the labor market. Not only did job creation regain its vigor in November, but revisions to prior months were also a tad higher, and aggregate hours worked grew at the fastest pace in eight months.

Smoothing through the recent volatility, job gains have averaged 173k over the past three-months, or only a modest stepdown from the 186K averaged over the prior twelve-month period. But this likely overstates the degree of “strength” in the job market. A broader sweep of the data suggests that the labor market has already come back into better balance, and is no longer a meaningful source of inflationary pressure. Moreover, the fact that the labor force has contracted in each of the past two-months suggests that job seekers are starting to internalize the fact that jobs are becoming harder to come by – a further indication that the labor market is cooling. This should give policymakers the assurance they need to cut by another quarter-point later this month. But with inflation progress showing early signs of stalling and some of the incoming administration’s policy proposals (including the potential for tax cuts and tariffs) viewed as inflationary, the Fed is likely to proceed more cautiously with easing its policy rate in 2025

Source:Bank Financial Group

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SAXO

Economic

Energy

The AI revolution is a power-hungry one. The tech giants see that current electricity supply falls far short of what is required to power the massive new AI data centres they hope to build. They are already taking dramatic steps to secure stable, long-term power sources. Microsoft has contracted with Constellation Energy to reopen one of the old nuclear reactors at Three Mile Island. Google and Amazon are striking deals with US utilities and other providers to create small modular nuclear reactors (SMRs) for their planned AI data centres. But these are all long-term projects - for 2030 and beyond in the case of the latter two. What about the energy needs right here and now, as the AI arms race reaches new white-hot intensity already in 2025?

In 2025, US power prices spike higher in several populated US areas, as the largest tech companies scramble to lock in baseload electricity supplies for their precious AI data centres. This inspires popular outrage, as households see their utility bills skyrocket, aggravated by the huge spikes in power prices for electricity consumed at home during peak load periods in the evening. In response, many local authorities move in to protect political constituents, slapping huge taxes and even fines on the largest data centres in a move to subsidise lower power prices for households. The taxes incentivise investment in massive new solar farms with load balancing battery packs, but also dozens of new natural gas-driven power stations, even as the demand for ever more power continues to rise faster than supply. Rising power prices drive a new inflationary impulse.

Potential market impact

A massive boom in US investment in power infrastructure. Companies like Fluor rise on signing massive new construction deals. Tesla’s accelerating Megapack gets increasing attention. Long-term US natural gas prices more than double, a significant contributor to a more inflationary outlook.

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ING

Economic

Political

With Donald Trump soon making a return to the White House, the trade deficit with the EU is likely to come under renewed scrutiny. The President-elect has been vocal about what he perceives as unfair trade practices, particularly in the automotive and agricultural sectors. He has threatened to impose blanket tariffs ranging from 10% to 20% on all imports and to match tariffs raised by other countries to achieve a level playing field. But is the difference really that significant?

The differences in effective tariffs between the EU and the US

Effectively applied tariffs are not vastly different between the two countries, with the simple average standing at 3.95% for products from the US and 3.5% for EU products – but there are notable differences in certain sectors.

Trump has a point regarding tariffs on cars, agriculture, and food. For example, the EU tariff rate is 10% compared to 2.5% in the US for cars, and there is approximately a 3.5 percentage point difference for average tariffs on food and beverages. Additionally, tariffs on chemicals are on average 1ppt higher in the EU than in the US. However, the EU faces higher tariffs on commodities and transactions not classified elsewhere (miscellaneous or unspecified items) when exported to the US. Given this context, the EU might indeed face intense tariff threats and challenging negotiation rounds moving forward.

Effectively applied tariff rates on goods trade between the EU and the US (in %)

Source: WITS database for 2022, ING

The US is the EU’s top export partner

In 2023, the US emerged as the leading destination for EU exports, accounting for 19.7% of the EU’s total exports outside the bloc, followed by the UK at 13.1%. When it comes to imports, the US was the second-largest source (after China), providing 13.8% of the EU’s total extra-EU imports; China accounted for 20.6%.

On balance, trade with the US has evolved positively for the EU over the last decade. It peaked in 2021 at 1.1% of the EU’s GDP, as seen in the chart below. Despite a slight decline from 2022 onwards – partly due to increased energy imports – the EU maintained the highest trade surplus with the US in goods trade, amounting to EUR156.7bn (0.9% of GDP) in 2023.

Evolution of EU goods trade with US as a % of GDP

Trade of the EU vis-a-vis the US (% of GDP)

Source: Eurostat, ING Research calculations

Ireland has the largest relative export exposure to the US

Not all EU policymakers need to be equally concerned about US trade dependencies, though. There are significant differences in trade exposure among member countries and sectors. Nations with strong chemical and pharmaceutical sectors, such as Ireland and Belgium, or robust machinery and transport sectors, like Slovakia and Germany, lead the way in terms of trade exposure. Ireland and Belgium's overall exports to the US are particularly high at 10.1% and 5.6% of their GDP respectively, compared to the overall EU export exposure of 2.9% of GDP.

On the import side, the Netherlands and Belgium, with their major Atlantic ports, import mainly energy and chemical products from the US. Their total imports are valued at 7.1% and 6.1% of their GDP respectively, compared to the overall EU import exposure of 2% of GDP.

Largest EU-US trade dependencies in 2023

EUs export & import flows to the US in 2023 (% of a county's GDP)

Source: Eurostat, ING Research calculations

US dependencies are large, but strategic dependencies balance in favour of the EU

Some EU countries therefore have more significant levels of exposure, particularly in the chemical and transport sectors – but the EU still holds an advantage. These exports include strategically important products, i.e., goods that cannot be easily replaced due to limited supply, high dependency from the importing countries, specialised production, and stringent quality requirements.

In 2022, the EU traded 122 strategically important products, representing 4.9% of its overall imports. Yet, the bloc is strategically dependent on the US only for eight products, six of which are chemicals (see the chart below). For instance, the EU relies heavily on beryllium (HS 811212), a metal classified as a Critical Raw Material by the European Commission. Beryllium is essential for defence, transportation, and energy applications. The EU sources 60% of its beryllium from the US, which holds the majority of global resources in a Utah mountain deposit, making substitution difficult.

The US, on the other hand, relies on the EU for 32 strategically important import products, mainly in the chemical and pharmaceutical sectors. This dependency balance favours the EU and will provide it with some leverage in negotiations with the incoming Trump administration.

Strategic interdependencies between the EU and the US

Source: Lefebvre and Wibaux (2024), data for 2022

Trump trade pressure and a potential response

It's no secret that Trump is disgruntled by the EU's trade surplus and has the region in his sights when considering additional tariffs. But the President-elect deems himself something of a dealmaker, and that could make it crucial for the EU to identify areas for concessions and deals. What are the EU’s options?

Europe could increase its purchase of US products, such as further boosting LNG imports. While the promise to ramp up LNG imports from the US was perceived as a gesture to appease Trump during his first term without the expectation of significant impact, the energy crisis has made those imports more valuable for the EU. In terms of defence, the EU could propose increasing its defence spending to 3% of GDP, with a commitment to purchasing more from US companies. Additionally, the EU could open up defence funding initiatives to non-EU companies, as is currently being discussed. Increasing those purchases might be an easy way to reduce the bilateral trade surplus to some extent. Buying more from the US is likely to be a key point in the upcoming trade negotiations.

The EU could target US products by imposing retaliatory tariffs. The Commission is said to have already prepared a list of goods which would be subject to additional tariffs.

The EU could use the Anti-Coercion Instrument (ACI), its “new weapon to protect trade” by launching countermeasures against a non-EU country if negotiations fail. These could include trade, investment or funding restrictions.

Regardless, the EU will go to the World Trade Organisation to prove its case. However, even though WTO panels have found US practices to be unfair and have authorised retaliatory measures in the past, these rulings have not resulted in significant changes. So, while we believe that the EU will try to stand up against Trump, this might be easier said than done. This is especially true given the differing interests of its member states, which were recently highlighted in the vote on additional tariffs on electric cars made in China.

A long-term threat to European economic growth?

What about the economic impact on Europe? Protectionism is generally bad news for economies, especially export-oriented ones. Yet long before tariffs come into effect, the uncertainty surrounding protectionist trade policy will have an economic impact on sentiment, potentially resulting in delayed investments and hiring.

In the longer term, this may strain trade relations between the EU and the US, further eroding the EU’s struggling manufacturing sector. And as we've written previously, Trump’s second term in office hits the European economy at a much less convenient moment than the first. Back in 2017, the European economy was relatively strong. This time around, it is experiencing anaemic growth and is struggling with a loss of competitiveness. A looming new trade war could push the eurozone economy from sluggish growth into recession. As a result, growth is expected to remain low in 2025 and 2026.

To stay updated on all economic events of today, please check out our Economic calendar

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ACY

Economic

Dollar Resilience Amid Trade Tensions

The U.S. dollar has rebounded strongly, driven by President-elect Donald Trump’s renewed focus on trade policies. His threats to impose tariffs on BRICS nations attempting to reduce their reliance on the U.S. dollar underscore a return to protectionist strategies. This rhetoric, while not immediately actionable, signals a firm stance that may influence trade relations and the dollar's trajectory heading into 2025.

Eurozone Challenges: Politics and Monetary Policy

In Europe, the euro faces pressure as political uncertainty in France mounts. The National Rally party’s push for a no-confidence vote over budget disagreements has created friction with the French government. At the same time, the European Central Bank (ECB) is poised to cut rates by 25 basis points, reflecting a cautious approach to managing disinflation and weakening growth indicators. A larger rate cut, while discussed, seems unlikely for now.

December’s Financial Pulse Policies, Politics, and Market Trends_2

Inflation and Growth in Focus

Inflation in the Eurozone has consistently surprised to the downside, with forecasts now suggesting the ECB’s 2% target could be achieved sooner than anticipated, possibly by mid-2025. Growth, however, remains fragile, with mixed signals from recent data. While consumer confidence and wage growth offer some optimism, investment remains subdued, and broader economic recovery hinges on sustained demand.

The divergence in policy approaches among global central banks is becoming increasingly evident. The Bank of Japan’s hawkish tone , coupled with Trump’s trade measures, contrasts sharply with the ECB’s gradual easing. These shifts underscore the complexities of navigating interconnected economies where domestic policies ripple across borders.

As markets process these developments, a delicate balance between caution and opportunity emerges. Whether it’s the U.S. dollar’s resilience, the euro’s political headwinds, or the ECB’s evolving strategy, stakeholders must remain agile to navigate this period of economic recalibration.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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