Trumponomics Faces Market Test: Implications for Europe
Trumponomics Faces Market Test: Implications for Europe
The heightened risk aversion triggered by Trump's policies has not spread to Europe, where optimism prevails regarding more cohesive and responsive policymaking. A commentary by Lorenzo Bini Smaghi
Historically, financial markets reacted to geopolitical tensions and unexpected shocks—even those originating from the US—by redirecting capital flows across the Atlantic, strengthening the dollar. This time, however, markets appear to consider Europe a safer destination for investment.
Following negative market reactions, one wonders what might persuade Trump to reconsider recent policy decisions, particularly restrictive import measures against close neighbors like Canada and Mexico and those announced against Europe and other trading partners.
Wall Street fell sharply in response to news about new tariffs, dropping over 3% in a single day. US stock prices have now returned to pre-November election levels, wiping out gains made since Trump’s election and inauguration on January 20.
Technology stocks fared even worse. Nvidia, for example, has lost around 20% of its value over the past two months.
During the same period, yields on 10-year Treasury bonds declined by approximately 40 basis points, reflecting lower growth forecasts. Meanwhile, inflation expectations remained steady at around 3% and showed no signs of decreasing.
Recent consumer confidence indicators have raised concerns. Markets are now pricing in an increased likelihood that the Federal Reserve will cut interest rates at least twice in the coming months to support a slowing economy.
Such a rapid and negative reaction was difficult to anticipate, even among those who have long criticized the shortsightedness of the new administration's tariff measures, which ultimately harm the US economy itself.
Nevertheless, President Trump remains unfazed. Addressing Congress, he reiterated his intent to press ahead despite "some minor disruptions." His underlying rationale appears purely ideological: "Tariffs don’t just protect American jobs; they protect the soul of our nation," he declared.
There seems to be a profound disconnect between empirical evidence, as interpreted by financial markets, and the President’s convictions.
Moreover, recent announcements regarding tax cuts, deregulation, and significant investments in technology—which should theoretically benefit businesses—have thus far failed to reverse the downward trend.
The markets remain dominated by the negative impact of frequent yet contradictory announcements, creating uncertainty. The much-praised pragmatism of the new administration appears conspicuously absent.
Equally surprising is the opposite market reaction regarding the European economy. European equities have risen steadily since the beginning of the year, gaining over 10% on average. The euro has recovered from its decline following Trump's election. Long-term interest rates have increased, driven by stronger growth expectations, particularly in Germany following Friedrich Merz’s CDU victory and prospects of a grand coalition government.
Notably, rising long-term German yields have not adversely affected intra-eurozone spreads.
In short, the increased risk aversion provoked by Trump’s policies has not transferred to Europe; instead, Europe is benefiting from a favorable capital inflow, fueled by prospects of more unified and responsive policies.
This shift represents something of a novelty. Previously, financial markets typically reacted to geopolitical tensions and unexpected shocks—even those emanating from the US—by repatriating capital and strengthening the dollar. This time, markets perceive Europe as a safer investment.
Certainly, part of this shift is attributable to Europe’s accumulated performance lag, particularly in equity markets, which had become excessive and is now narrowing.
Yet, one should not underestimate the negative effect of uncertainty emanating from the new US administration’s stance on the institutional framework underpinning financial markets.
For instance, the decision to include certain cryptocurrencies among official reserves held by the US Treasury has raised significant concerns.
This effectively grants a public guarantee—implicitly backed by the central bank—to pseudo-currencies issued without transparency. Such a move not only threatens the independence of the Federal Reserve but also fuels suspicion that the administration might be influenced by private interests, jeopardizing the integrity of the dollar-based financial system.
A previous version of this article was published, in Italian, by Il Foglio
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
