Macro Views: Waiting for clarity

• The Fed is unlikely to cut interest rates soon, despite recent signs of cooling inflation. Officials remain cautious due to ongoing tariff-related uncertainties. While recent inflation data may have justified rate cuts in a non-tariff environment, the current backdrop of elevated tariffs complicates the outlook. Companies are expected to raise prices as pre-tariff inventories deplete, leading to a likely rise in core goods inflation. Despite a temporary easing in US-China trade tensions, average US tariff rates remain historically high. Therefore, we still expect higher inflation and slower growth, albeit not to the same extent as might have been the case with the “Liberation Day” tariffs.
• The Fed’s data-dependent stance risks falling behind if the economy slows unexpectedly. However, with inflation still above target and risks skewed to the upside, the Fed is expected to maintain its pause until labor market weakness becomes evident. Tariffs are projected to raise the effective rate to 15.4% of all goods imported into the United States, potentially adding 1.2 percentage points to core personal consumption expenditures inflation. Additionally, the weakening USD and a shift in imports from China to higher-cost countries add more upside risks to inflation.
• Wage disinflation has largely come to a halt over the past year despite a cooler labor market. That will likely keep up the pressure on the most wage-sensitive parts of inflation. Moreover, with companies likely to reconsider investment plans until there’s more clarity about US trade and tax policy, productivity gains may remain anemic in the near-to-medium term. Meanwhile, curbs on immigration could keep wage costs elevated. Weak productivity and elevated wages add to the upside risks to inflation.
• Despite an alarming level of deterioration in soft survey data, hard data like industrial production and retail sales remain resilient. Consumers are still spending, aided by credit and real income growth. Given these mixed signals and ongoing inflation risks, the Fed is likely to stay on hold until there is clear evidence of labor market deterioration without a simultaneous rise in inflation.
• The One Big Beautiful Bill Act 2025 (OBBBA), a reconciliation bill now in the Senate, could increase US primary deficits by US$2.8 trillion over the next decade. The bill's spending and tax cuts are front-loaded, leading to massive increases in near-term deficits. However, omitted elements like tariff revenues and federal job cuts, could in theory neutralize the proposed deficit increase. Note that the Senate’s budget resolution allows for a US$5.8 trillion net deficit increase, potentially expanding the bill’s fiscal impact.
• Bond markets are bracing for higher long-term interest rates. The rise in the term premium since September 2024 has largely driven yields on the 10-year US Treasury. Initially, much of this was likely due to the gradual shift in the composition of Treasury issuance toward notes and bonds. However, uncertain trade policy, which has raised stagflationary concerns, along with expansionary fiscal policy, likely provided another leg up to yields in April and May.
• We expect longer-term rates to continue to climb higher through the rest of the year. While a relatively quick and painless passage of the tax legislation and lifting of the federal debt limit may not prompt a knee-jerk response in bond yields, it is likely to still add momentum to the steady upward climb. However, political brinkmanship on lifting the debt ceiling may well provoke a swifter response in bond yields.

• Trade uncertainty still complicates the outlook. The end of the 90-day suspension of reciprocal tariffs looms on July 9, with the minimum tariff rate poised to go up to 20% together with a larger sectoral rate of 25% on autos, steel and aluminum. The EU's position is complicated, involving defense, energy and trade policies. The current tariff setup is a starting point for the United States but an upper bound for the EU. Key topics include tariffs on food, agricultural products, digital services and pharmaceuticals which could be tariffed in the future. The EU’s proposed zero-for-zero tariffs on industrial goods might not work, while purchases of gas and defense equipment to rebalance the trade surplus will likely be offered. Cooperation in protectionism against allegedly subsidized Chinese exports might be discussed. The China de-escalation trade talks can reduce the overall global demand impact, meaning trade diversion toward the EU will likely be lower than the previous semi-embargo regime.
• The EU is taking a cautious approach to retaliation, with a pause until July 14 to retaliate on steel and aluminum tariffs and in general to hold off until the North Atlantic Treaty Organization (NATO) meeting on June 24–25 to preserve political capital. The EU prepared a broader list including €95 billion of imports, covering 40% of total US exports excluding fuels. The list is predominantly skewed toward capital goods, industrial supplies and transport equipment, including aircraft, which should have a less relevant impact on inflation. Retaliation on services also seems to be excluded for now.
• The growth impact remains uncertain and dependent on the final tariff setup. First-quarter gross domestic product (GDP) benefited from tariff frontloading, with export dynamics pointing to a decent contribution to trade. The second quarter will likely be lower, with services and consumer confidence declining over the past months. Manufacturing instead is showing signs of bottoming out. Overall, we expect a GDP impact of slightly more than half a percentage point of GDP this year through export decline and higher uncertainty weighing on confidence and investments, although estimates remain fluid. With the suspension of embargo-like tariffs on China, trade diversion could be smaller.
• The German fiscal announcement is a game-changer in our view, but now all eyes are on its implementation. Germany is waiting for the July budget to increase defense spending. Other EU countries are also considering increased spending, with the NATO summit and EU council meetings being key events. The European Commission assumes that the infrastructure fund will boost German GDP by 1.25% in 2029 and by 2.5% in 2035, lifting EU GDP by 0.75% in the long run.¹ Industrial reconversion in Germany is happening or planned, which should increase domestic equipment procurement and increase growth multipliers over time.
• The European Central Bank (ECB) faces an uncertain outlook amid trade tensions and a potential inflation undershoot in 2026. Wages are well-behaved overall, with energy prices and a rising EUR implying a strong disinflation impulse. Nevertheless, the data-dependency mode is likely to persist. Subsequent shocks could disrupt the global order and the value chains in which the euro area (EA) is highly integrated, and which likely contributed to a low and stable inflation equilibrium. The ECB assumed a flat 10% tariff rate in its baseline and a total GDP impact of 0.65 percentage points, in line with our expectations, and a rougher tariff setup can push down growth, inflation and rates. Thus, unless trade relations sharply deteriorate, rates at 2% are reasonable to navigate the uncertainty for now, in our view. A July pause in rate cuts is very likely and, conditional to the trade impact, it could possibly last longer.
• The EUR and EGBs are becoming more attractive amid US policy unpredictability. Although the USD and US Treasuries will most likely remain the most important currency and liquid asset globally, the ongoing efforts at diversification away from US assets might relatively benefit the EUR and EGBs, both from international investors and from local reallocation. Many long-standing issues still remain in the EA, from a fragmented capital and political union to high debt burdens and low productivity growth. But rising medium-term growth prospects (via Germany), increasing credit quality and rising issuance make the EUR and EGBs relatively more appealing, in our view.

• While Japan’s GDP growth declined 0.2% quarter-over-quarter (q/q) (-0.7% q/q seasonal adjusted annual rate) in the first quarter of 2025, domestic demand was robust as business investment grew 1.45% q/q even as private consumption remained flat in the quarter. It was net exports that shaved 0.8 percentage points from growth as imports rebounded strongly after a weak fourth quarter print. Overall, therefore, growth was not as weak at the margin. High-frequency indicators remain stable in the second quarter, with manufacturing still struggling but services growth strong. April saw record tourist arrivals (3.9 million) in line with the Japanese Cherry Blossom season, aiding services categories like accommodation and hospitality. While tariff talks are ongoing, we continue to expect full-year growth at 1.0% year-over-year (y/y). Risks are to the downside.
• Multiple factors kept inflation above 3% for the fifth straight month in April. While energy subsidies were rolled back again and the waiver on tuition fees was extended nationwide, food prices continue to bite (especially a 98.4% y/y rise in rice in April) despite the government’s efforts to increase retail stockpiles. Continued increases are adding to costs across other categories like eating out and cooked food. We expect this trend to continue with core inflation (Consumer Price Index excluding fresh food) averaging 3.0% in 2025. Wage growth has been strong so far this year and more Japanese firms are passing costs to customers, including higher subscription rates for mobile phones and delivery charges.
• We believed the BoJ’s May meeting was broadly unbalanced amid uncertainty surrounding possible tariffs and their impact on the economy. Too much emphasis was given to growth concerns and its consequent impact on inflation and wages. Since then, inflation prints have proved price pressures are sticky, household inflationary expectations are rising and so are longer-term yields. We continue to see inflation risks material enough to demand attention, and although we think a rate hike will possibly be delayed to the fourth quarter, the BoJ will eventually pare back on its dovishness in the coming weeks. A supplementary budget may precede parliamentary Upper House elections in July, which should further support growth. While this has aggravated long-term yields, we believe this trend will be corrected as the government and central bank work together to correct the underlying supply-demand mismatches and liquidity concerns. For now, we remain committed to our call for higher terminal rates in Japan. The path could be delayed, but we will get there.

Currency outlook

USD

• The USD has followed a similar path to 2017 but for different reasons. While cyclical factors like favorable interest-rate differentials and potential tax cuts should support the USD, structural negatives are likely undermining confidence.
• Unlike in 2017, when global growth optimism and strong US consumer sentiment weakened the USD despite the US rate advantage, today’s environment is marked by trade policy uncertainty, a large fiscal deficit and deteriorating US consumer confidence vis-à-vis its developed market peers. Despite the recent de-escalation in trade tensions, the USD trades below what interest-rate differentials would imply, hinting at deeper structural concerns.
• Large US trade deficits (or its trade partners’ surpluses) have historically found their way back into US capital markets thanks to the USD’s reserve status. However, rising tariffs and shrinking trade surpluses abroad may reduce foreign demand for USD assets.
• Moreover, with countries such as Germany, China and Japan feeling motivated to ease fiscal policy to bolster domestic demand in response to US trade policy, global capital will have alternatives. US equities, for instance, could come under pressure given that foreigners have not yet really rotated away even after several years of outperformance.
• While we believe “de-dollarization” is not imminent, relatively high yields and net energy exports support the US dollar—diversification seems to be gaining ground. The USD might continue to hold up against smaller G10 economies and emerging markets but may struggle against other core or reserve currencies, especially the euro, due to US policy uncertainty.

EUR

• The status of EUR as a reserve currency might increase: The downward trend of EUR share in global central bank foreign currency (FX) reserves since the sovereign debt crisis has stabilized at around 20%. Other currencies seem to have benefited more from a de-dollarization of FX reserves, but EUR maintains a large margin vs. other individual currencies. Negative interest rates (for more than eight years) likely functioned as a constraint for reserve managers and credit risk likely played a role. Indeed, the surge in credit risk in the other European countries has led to a collapse of their bond holdings globally. For the reasons aforementioned, these trends are reversing. A rotation back into EUR to return to pre-sovereign crisis levels implies significant flows even when distributed over several years.
• The EA is a large creditor of the rest of the world and in particular versus the United States. From the financial account data, the EA held €4.6 trillion of US equity and €2.7 trillion of US debt, corresponding to approximately 60% and 38% of total foreign portfolio investment holdings. The net balance remains widely in favor of the EA, as the United States remains a small investor in EUR debt, while equity holdings increased somewhat over the past two years. A rebalancing of EA investors back into domestic assets thus could have large implications for the EUR (or for the USD); considering pre-pandemic shares of USD in foreign holdings, this would imply a flow of approximately €770 billion (excluding FX changes, thus an upper limit) between bonds and equity allocations. Even without actual flows, the increase of USD hedging demand can be a meaningful EUR positive.

Japanese yen (JPY)

• We see scope for further JPY gains, albeit gradual and laced with volatility. JPY is at its most undervalued level compared to its history, whereas the USD is the most overvalued since the Plaza accords of the 1980s. A reversal therefore seems imminent, in our view. JPY gains have come simultaneous to higher yields, and it is likely that Japanese investors may continue to repatriate funds offshore as yields climb. This is likely to be supportive of JPY. Meanwhile, seasonality generally favors JPY in the June-August period.
• However, Commodity Futures Trading Commission positioning shows long JPY positions remain at record highs, which could prevent a substantial pullback in USD/JPY to lower levels. The extent of yield pickup has not translated to a commensurate increase in JPY, which could be due to yields remaining elevated elsewhere globally. But given the risks to Japan’s growth amid tariff concerns and relatively slow progress on trade talks with the United States, a very strong JPY could further be detrimental to exports and overall growth.