(Bloomberg) -- Traders added to bets on interest-rate cuts from the Federal Reserve amid concern about the impact of US trade tariffs on global economic growth.
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Money markets moved to fully price three quarter-point reductions this year for the first time since the middle of December, following the imposition of US levies on Canada, Mexico and China. The curve steepened, with yields on two-year tenors falling six basis points to 3.89%.
The steepening moves were mirrored in Europe, with traders similarly amping up wagers on easing from the European Central Bank on concern that the euro area will be next to face levies. Meanwhile, an aggressive ramp up in EU defense spending pinned the spotlight on growing government deficits and pushed longer-term yields higher.
“Our view remains that tariffs are not an inflation story but a growth story,” said Mohit Kumar, chief economist and strategist for Europe at Jefferies. He expects steeper curves, particularly in the UK and Germany.
The imposition of tariffs marks a turning point for market participants, indicating Trump’s readiness to use threats as more than a negotiating tactic. The new 25% duties on most Canadian and Mexican imports — plus raising the charge on China to 20% — impact roughly $1.5 trillion in annual imports.
The US measures prompted retaliatory levies from both Canada and China, with Mexican President Claudia Sheinbaum on Monday saying her government would await Trump’s decision before reacting.
“The market has to reprice these tariff risks now that they have become reality,” said Kathleen Brooks, research director at XTB. “Markets may remain jittery for the next few days as we wait for the US payrolls report on Friday.”
Softer Economy
The increased trade tension is fueling worries about the outlook for the US economy. Data this week on factory activity suggests it is edging closer to stagnation, raising the stakes for the widely-watched labor market report.
If US economic data continues to soften, “the strong US dollar fundamentals of strong growth, elevated inflation, and a more hawkish Fed will come into question,” said Win Thin, global head of markets strategy at Brown Brother Harriman.
Beyond tariffs, markets were whipped on Tuesday by a barrage of headlines on the US pausing military aid to Ukraine and that the EU is looking to extend €150 billion ($158 billion) in loans to boost defense spending. That spurred a wave of risk aversion, with the Swiss franc and Japanese yen leading gains by Group-of-10 currencies against the dollar while stocks slumped.