Summary

• US equities and risk assets rallied as the Trump administration secured multiple new trade deals, locking in 15% tariffs with Japan and Europe and 19% with the Philippines

• These deals bring near-term relief to markets by removing ‘no deal’ risks, particularly for European exporters, and reinforce the US’s increasingly dominant trade stance

• The US is shifting away from its globalisation-era model of trade deficits and capital inflows, aiming instead to reverse the twin deficits and promote domestic industry and labour

• While tariff income is helping to reduce the budget deficit, lasting improvement would require either significant spending cuts or strong, sustained growth - the administration has opted for the latter

• Risks remain: inflation could resurge if growth overheats, and any external shock could blow out the deficit again, potentially forcing a shift to financial repression as a last resort

• In the week ahead, focus turns to Wednesday’s eurozone GDP and the US Federal Reserve (Fed) rate decision; growth in Europe likely stalled in Q2, while the Fed is expected to hold rates steady amid debate over the inflation impact of tariffs.

Market review

From victory to victory in Trump’s trade war

Risk assets continued their march higher last week, with Japanese and US equities leading the charge following a trade deal between the two countries. The agreement locked in 15% tariffs on all goods imports into the US - a level that drew sighs of relief in Tokyo, having dodged a threatened rise to 25%. But for all the relief, this deal carries serious concessions for Japan. It grants the US greater access to trade in Japan, it includes a large LNG (Liquefied Natural Gas) investment in Alaska, and hands the White House discretionary control over a $550bn investment fund (with 90% of profits going to the US).

The Philippines deal looks even more asymmetric. The US will impose a 19% tariff rate (only marginally down from the threatened 20%), while the Philippines agreed to impose no tariffs at all.

Then came Sunday’s announcement: another 15% tariff deal, this time with Europe. For markets, the threat of a ‘no deal’ outcome - the most dangerous scenario for European exporters - has been removed. European equities are nicely set-up for a rally today, extending the remarkable run for global risk assets.

The US has rarely looked more confident in its trade position. On current trends, the average US tariff rate is set to settle around 18% - in line with our base case - while the average tariff on US exports remains closer to 3%.

But the long-term implications are murkier. The US has been one of the greatest beneficiaries of globalisation. Persistent trade deficits have been mirrored by persistent capital account surpluses with foreign capital flooding into US assets. That dynamic has helped underpin US exceptionalism and the relentless outperformance of US equities. It has also helped fund a ballooning national debt, now at $36trn - nearly double what it was a decade ago.

Trump’s second-term agenda is a deliberate break from that legacy. His mandate is built on reversing the twin deficits - budget and trade - and recalibrating the US economy in favour of domestic production and working-class voters. Exceptionalism, in this view, has bred inequality, asset bubbles, and an economy that rewards capital over labour.

The budget deficit, the pivot to plan b and the eventual plan c

Of the twin deficits, the Trump administration has been most aggressive in attacking the trade imbalance. Efforts to reduce the budget deficit, by contrast, have largely fizzled. Offsets were stripped from the ‘One Big Beautiful Bill Act’ and talk around DOGE (Department of Government Efficiency) has gone quiet. Savings from the initiative are estimated at just $200bn so far, well short of initial hopes.

Yes, the deficit has fallen since Trump took office - but it still sits at a colossal $2trn. Government spending continues to rise, just at a slower pace than revenues, thanks largely to tariff income. The US has collected nearly $100bn in tariffs so far and is on track to raise $300bn this year. In June, tariff revenues were sufficient to balance the monthly budget.

But if Trump’s goal is to move away from income taxes and fund government via tariffs, spending as a percentage of GDP will still need to fall.

This is the pivot. The administration has effectively abandoned fiscal conservatism and is now about outgrowing the deficit. Deregulation, energy abundance, and lower rates are the new stratagem. If growth runs hot enough and borrowing costs fall, it could bring the debt dynamics under control and extend the era of US exceptionalism. But there are two major risks.

First, inflation. If stimulus and low rates push the economy too far, inflation could rise sharply hitting consumers, forcing higher interest rates and undermining the economy.

Second, a shock. It could be geopolitical, or even another pandemic, whatever it may be a sharp slowdown would send the deficit higher, even into double-digit territory. In that scenario, the growth needed to stabilise debt dynamics may simply be too high forcing the government to pivot again.

Plan C: financial repression. The last resort. Real rates held below zero, the debt inflated away quietly. As others have put it, “Inflation is taxation without legislation. It is the most universal tax of all - as violent as a mugger, as frightening as an armed robber, and as deadly as a hitman. It is the last resort of bankrupt governments.”

The week ahead

Wednesday: Eurozone GDP

Our thoughts: After a strong start to the year, the eurozone economy likely flatlined in the second quarter according to economist estimates. The boost in the first quarter came from a temporary surge in exports, as companies rushed orders ahead of new tariffs. At the same time, uncertainty around trade and the economic outlook likely held back both consumers and businesses in Q2.

Wednesday: Fed rate decision

Our thoughts: We expect the Fed to leave interest rates unchanged. Behind the scenes, the debate is intensifying. Some Fed officials believe higher tariffs will cause a lasting rise in inflation and want to keep rates higher for longer. Others, likely including Chair Jerome Powell, see the inflation spike as temporary and are leaning toward eventual rate cuts.

Powell is likely to signal a steady hand through the summer, despite political pressure from President Trump to cut rates. Incoming data, especially June’s PCE (Personal Consumption Expenditures) inflation numbers and July’s jobs report will be critical. If they come in hot, as many expect, the Fed’s caution may be validated.