The threat of tariffs is distracting the stock market public from an equally dangerous element that could jeopardize the growth of the stock markets.
In recent months, global economic discussions have increasingly focused on the impact of U.S. trade tariffs on Canada, Mexico, and China. While these measures undoubtedly disrupt supply chains and international competitiveness, a more structural and persistent threat to the economy lies in the trajectory of interest rates.
Rising bond yields and increasing credit costs have direct implications for consumers, businesses, and governments, with long-term effects on economic growth. Could it be that interest rates, rather than Trump’s tariffs, remain the central issue of the moment?
Trade Tariffs: Canada, Mexico, China, and Other Threats
In early February 2025, the U.S. administration announced the imposition of 25% tariffs on imports from Canada and Mexico and 10% tariffs on imports from China. These measures were justified by the need to combat illegal immigration and drug trafficking, particularly fentanyl, which is believed to enter the U.S. through these countries.
Following intense negotiations, the U.S. agreed to a 30-day delay in implementing the new tariffs on Canada and Mexico. This extension provided an opportunity for governments to explore potential trade compromises aimed at mitigating the economic impact on both sides.
Regarding China, the situation is even more complex. The new 10% tariffs on Chinese imports are designed to reduce U.S. dependence on Asian goods, but Beijing’s response could include stricter market access conditions for American firms, as well as potential competitive devaluations of the yuan.
The Tariff Challenge in Europe and Trade Surplus Rebalancing
The European Union is facing similar trade tensions. Historically, Europe has maintained a trade surplus with the U.S., which has become an increasing source of friction between the two economic powers.
One potential solution to rebalance the trade deficit with the U.S. could be an increase in purchases of liquefied natural gas (LNG) and defense products. Currently, Europe sources 40% of its LNG imports from the U.S., a figure expected to rise as post-Russia-Ukraine conflict energy diversification policies take effect. Additionally, European defense spending remains below NATO commitments, with the average defense spending-to-GDP ratio at 1.5%, well below the 2% target. Increased purchases of U.S. military technology and weaponry could serve as a pragmatic approach to alleviating trade tensions.
Monetary Policy Divergence: ECB vs. Fed
In January 2025, the European Central Bank cut interest rates by 25 basis points, bringing the deposit rate to 2.75%. This decision aimed to stimulate growth amid moderate inflation and economic slowdown. In contrast, the Federal Reserve opted to keep rates unchanged, signaling a more restrictive stance compared to the ECB.
This policy divergence has significantly impacted bond markets, with the 10-year U.S. Treasury yield surpassing 4.5%, while the 10-year German Bund fell below 2.5%. The widening spread between U.S. and European government bond yields has driven capital into dollar-denominated assets, strengthening the U.S. currency and increasing pressure on dollar-indebted emerging economies.
Implications of Rising U.S. Treasury Yields
The surge in Treasury yields has far-reaching consequences. On the consumer side, U.S. credit card debt grew by 8.6% in 2024. As interest rates rise, debt servicing costs for households increase, eroding purchasing power and potentially constraining spending on durable goods and discretionary consumption.
In the real estate sector, the default rate on commercial properties has exceeded 8%, reflecting growing challenges in refinancing mortgages at higher rates.
On the public side, the U.S. federal deficit surpassed $1.8 trillion in FY2024, with the deficit-to-GDP ratio rising sharply. Higher bond yields are making public debt financing increasingly expensive, with interest expenditures projected to exceed $1 trillion in FY2025. This scenario could prompt fiscal policy adjustments, including tax increases or spending cuts.
Impact on Corporate Balance Sheets
The rise in interest rates is also affecting corporations, particularly those with high financial leverage. While many companies still carry legacy debt at historically low rates, refinancing at current levels will significantly increase capital costs. This shift could lead to a downward revision of earnings expectations, exerting pressure on equity valuations.
Despite these risks, several factors indicate resilience in the U.S. economy. Federal Reserve Chairman Jerome Powell has suggested that the neutral rate could range between 2.6% and 2.8%, implying that the economy can sustain relatively high interest rates without tipping into recession. Additionally, continued investment in technology and artificial intelligence is bolstering growth, with major tech firms planning to invest over $300 billion in 2025 to expand digital infrastructure.
Ultimately, while tariffs and persistently high interest rates pose challenges to the global economy, there are reasons for cautious optimism regarding economic stability and growth.
Original article published on Money.it Italy 2025-02-12 10:24:00. Original title: Altro che dazi. Ecco il vero rischio per il mercato azionario
