Steady rates and shifting seats for the Fed, US-EU trade on the rocks and reading between the (market) lines

Amid sticky price pressures and lingering uncertainty on the effect of tariffs on inflation, the FOMC is expected to keep interest rates unchanged next week. For now, US firms have absorbed the impact on margins thanks to robust profits so far, while using up their pre-tariff stock. However, some price increases are emerging (e.g. apparel, audio and video equipment, toys) as business surveys and depleting inventories still suggest that output prices will rise in the coming months. We expect the FOMC to remain cautious for the rest of the year, with the first rate cut expected in December. With new FOMC appointees in 2026, increasing pressure on the Fed to lower interest rates should be expected. But new hawks from the regional Feds should ensure a balance between doves and hawks overall. Going forward, the Fed's communication will become increasingly blurry, potentially leading to increased volatility of US assets and inflation.

If no additional agreements are reached by 1 August, the average US import tariff will increase to 20%, causing significant economic damage. Though a few deals have recently been reached, notably with Japan (reducing the tariff rate from 21% to 13%), the administration has also escalated tensions elsewhere, such as with the +30pps tariff hike on Mexico and the +25pps tariff on previously exempt sectors, including pharmaceuticals and semiconductors. The EU could face tariff increases of +15pps from the 1.3% tariff before the trade war (with a downside of +30pps). In this context, the EU could lose USD53bn in exports to the US. Germany, Ireland, Italy and France would be most affected. EU GDP growth could shrink by -0.3pp annually and up to 250,000 EU jobs could be lost, raising the EU unemployment rate by +0.2pp. Additionally, a strong euro (EURUSD at 1.15 in 2025 v. 1.08 in 2024) entails an additional 5% drop in EU exports to the US (equivalent to a 1% increase in US tariffs). Lastly, if talks collapse, the EU is prepared to retaliate with tariffs on a total of USD93bn in US imports to match the 30% US tariffs, which could worsen the trade outlook for European exporters. To mitigate the impact, the EU will have to accelerate trade deals covering 25% of export losses with the US, boost intra-EU trade by 1.1% and promote strategic autonomy.

Equity markets are pricing in an exceptionally optimistic soft landing of the US economy, even outpacing the goldilocks eras of the 1990s and early 2000s. The current post-tightening equity rally is the strongest since at least the 1960s. But gold prices echo the stagflationary hard landings of the 1970s, signaling systemic tail risks and economic uncertainty. This divergence shows that the current momentum in equity markets has limited upside as underlying economic and geopolitical risks could quickly derail the optimistic market pricing. Against that background, we confirm our cautious equity market outlook that sees no further gains in equity markets from current levels until year-end.