US President Elect Donald Trump is back to his usual market moving social media activity, even before taking office. Before the markets opened on Friday, he posted on Truth Social that unless c imported more oil and gas to offset the trade deficit with the bloc, there would be “tariffs all the way”.
The Euro (EUR) initially sold off in the minutes immediately after that, but then turned around to trend higher. Evidently there needs to be a lot more qualifying details before the social media post can be considered as policy. And Trump has to get into office, first. But, it adds one more complication for the Euro area, which has contributed to overall weakness in the shared currency over the last couple of weeks. Could the reaction in the markets be a sign that things are turning around for the Euro?
The Calm After the Storm
Just this week, a new French Prime Minister took on the task of trying to wrangle a budget through a fractious French National Assembly, giving himself a deadline for March. After the weeks of political fighting that lead to the destitution of the former Prime Minister, it seems France is returning to a measure of calm, at least to get through the holidays. However, the debate over spending has weakened the position of French President Emmanuel Macron, particularly as a leader within the broader European Union.
In Germany, Chancellor Olaf Scholz relatively quietly lost a no-confidence vote as was widely expected, effectively putting an end to his government. Polls indicate that the opposition CDU party led by Frederich Merz will likely be the winner of the election at the end of February, but will also unlikely secure enough votes to form a government. That could lead to the kind of prolonged and difficult coalition negotiations that produced the latest Scholz cabinet which ended in a debate over funding. While the electoral campaign is in progress, Germany’s leadership remains in a stand-by position, likely not to take up a major cause within the continent.
Can the Euro (EUR) Bounce Back?
While politics doesn’t have a direct impact on currency markets, generally speaking, the lack of a clear direction can end up giving the central bank a difficult task, shaking up the currency. The disputes over spending in European capitals highlights the difficulty in securing funding, as economic underperformance combined with restrictive monetary policy has left little in the way of funds for governments to spend.
The EU has no margin available to spend on its own initiatives, let alone increased spending to support Ukraine, build up its military and, now, buy more oil and gas from the US. EU exporters are struggling with high costs, particularly of energy, and trade tensions with its second largest partner – China.
What To Do Now?
Without a clear locus of leadership, it’s difficult at this juncture to see how the shared economy can organize to effectively address the major funding concerns. This might leave the only option a knee-jerk reaction to counter US tariffs with EU tariffs, intensifying a trade war that Europe – as a net exporter to the US – is already at a disadvantage in.
The bump up in the Euro (EUR) as a result of Trump’s threat seems to suggest this is the scenario the market is banking on. A trade war with the US would likely be inflationary for the EU, as it would increase the costs of goods – including energy, which Europe already imports a lot of from the US. As a result, the ECB would be forced to keep rates higher for longer, strengthening the Euro (EUR) in the short term. But, tariffs would be bad for economic growth, and likely worsen the political crisis to the point it could become a monetary one. But that’s a bridge European leaders will have to cross after January 20th.
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