White Smoke All Around

By Elwin de Groot, Rabobank head of macro strategy

White smoke! We have a new *American* Pope, the first, Leo XIV. And we also have the first trade deal! Over the last few weeks market participants had been anxiously awaiting results from the negotiations between the Trump administration and all those countries looking for closure. Expectations were riding high that it was going to be major trading partners such as India, Japan – or even the EU – that would clinch a deal first, but the happy receiver of the good news turned out to be the United Kingdom. Having a Royal Family (recall PM Starmer invited President Trump to Buckingham Palace on behalf of the King at his recent White House visit) may have actually paid out well. Those who like FTAs say it isn’t 3,000-pages and legally binding. Those who understand geopolitics know Tehran, Yalta, and Potsdam weren’t long on technocrats either. But they still changed the entire world order – the technocrats tidied things up later.

Earlier yesterday Trump had already posted that he would reveal a “full and comprehensive” trade deal with the UK. That turned out to be more like a framework agreement without creating any legal obligations right now. But there were some -important- details. 

• The US will get lower tariffs and can push special interests like beef and ethanol, creating a potential market access worth USD 5bn (although the ‘chlorinated chicken’ issue was avoided in the Oval office show). 

• And the UK will buy $10bn of Boeing jets (in fact it turned out to be Spain-based IAG SA, and as part of a broader package including Airbus jets). 

• There was no mention of the UK’s Digital Services Tax, a positive for the UK. 

• Yet the UK is still going to face 10% on most exports – for the closest US ally; a 100,000 car quota at 10% not 25%; and steel & aluminium (& pharma?) & engines for (fighter) jets **tariff free**.

The latter shows the UK in the US bloc for national security supply chains. But a more nuanced conclusion could also be that the US is simply doing damage control to ensure those engines – which were already part of existing (military) supply chains – will keep coming into the US tariff-free. In any case, as UK negotiator Peter Mandelson summarized it diplomatically: “we’re going to rebalance and rebuild international trade in a way that serves all our interests”. And he added that the agreement would serve as a springboard for further opening up of trade between the countries. Whether that means the 10% tariff on remaining goods is subject to renegotiations is unclear at this stage.

Remarkably, there was no mention of China, but this was called “an economic security blanket” – whom else does that cover? Indeed, the Telegraph says “Starmer hands Trump ‘veto’ on Chinese investment in UK” – as a start(?) Again, critics wanted more, as if this were still the Rules-Based Order. It isn’t. This deal undermines the WTO. Which is the point – and it was agreed by a UK government committed to the old global system because it couldn’t see anything better (unless it’s playing for time and isn’t serious, in which case Trump might really turn up the heat). The US template is now there for others to follow, as PIMCO warns Trump is really serious about keeping really serious tariffs for those who won’t play his new ball game.

Indeed, the broader message of this is that although the US is willing to climb down from the very high stakes it started this trade war with (“because we blew up the whole system, this [UK deal] worked out so nicely”, Trump said), it may not budge on the universal tariff and it wants a clear stake in strategic supply chains and (economic) security matters in exchange for a reduction in sectoral or reciprocal tariffs.

On that front, things aren’t going so well on talks with China, as those who understand the protocols point out. Meanwhile, the European Commission yesterday published a list of US export goods worth some EUR95bn that it would hit with higher tariffs if trade negotiations fail. The list includes aircraft, US cars and car parts, chemicals and plastics, machinery, electric goods and agrifood products, such as… bourbon. The actual level of EU tariffs that would apply will be decided at a later date. Politico argues that, as “Brussels moves ahead with its retaliation, conceding its transatlantic ties with Washington may be beyond repair.”  Whilst that may be too stark a conclusion at this point as the Commission is emphasizing the ‘rebalancing’ nature of the list and a strong wish to come to an agreement, we also note that European Trade Commissioner Maros Sefcovic already had hinted last week that the EU would not settle for a 10% blank reciprocal tariff. The UK, a country the US has a net trade surplus with (“balanced” says Lutnick), just did. Albeit with some exceptions to it.

Whether it is going to help that the EU actually has lots of kings and queens remains to be seen, although treating the US with great respect will obviously be a key prerequisite. But a far more important lesson we could draw from the US-UK trade deal is that the US has to be able to show its benefits in raw dollar terms to the US public (‘beef and ethanol’) and any agreement will have to include a clear path towards stronger influence and benefits for the US from key European strategic supply chains and free access to strategic goods, so that a common agreement can be sold as one that “rebalances and rebuilds international trade in a way that serves all our interests.” It remains to be seen whether the EU has the will and the mandate to do what PM Starmer just did. And, at best, the EU may have to settle at 10% blank.

Turning to markets, equities were up because we had a trade deal after all. Risk premiums fell and US treasury yields soared, as we had a trade deal after all (and note that if we follow the market’s reasoning thus far, which is that the trade war is bad for growth but not so big a concern for inflation, trade deals simply mean lesser negative economic impact and so higher rates). A rise in US unit labor costs of 5.7% q/q saar in Q1 did not help either there. The yield on the 5y Treasury note jumped more than 12bp; it’s German counterpart saw a 7bp rise.

Sterling appreciated vis-à-vis the dollar in the run-up to the US-UK trade agreement and this move was only briefly interjected by the Bank of England’s rate cut. However, as the trade deal ‘details’ emerged, sterling fell back. For even as the UK looks to have secured a deal, weaker global growth still weighs on demand for its exports, dragging down UK growth. And 10% is, well, still 10%. In that light, the rate cut by the Bank of England – which was widely expected – was well-timed . The vote, though, was split three ways. We interpret this as that there is simply too much uncertainty out there and the MPC wants to avoid the impression of groupthink and hubris. The central bank maintained its guidance for gradual and careful cuts. No hints were dropped about a potential cut in June. However, we think a very soft April CPI print might just push them over the edge. Even so, our baseline forecast remains quarterly cuts. We anticipate two more reductions this year, bringing the policy rate to 3.75%, with downside risks.

Habemas Happy Friday.