By Michael Every of Rabobank

Shock Therapy

Markets were thrilled US inflation was lower than expected headline and core. Just don’t focus on the fact that Europe and Canada raised counter-tariffs on the US; and that Europe’s are up to 50% and aimed at Republican not Democrat states’ products, upping the ante hugely. 

USTR Greer has already stated: "For years, the EU has opposed US efforts to reindustrialize. The EU has rejected attempts under successive US administrations to cooperate effectively on dealing with global excess capacity on steel, aluminium, and other sectors, employing measures that are too little and too late. If the EU acted as quickly to address global excess capacity as it does to punish the US, we likely would be in a different situation today. The EU’s punitive action completely disregards the national security imperatives of the US – and indeed international security – and is yet another indicator that the EU’s trade and economic policies are out of step with reality."

President Trump has said, “We’ll win that financial battle.” Yet it’s not just financial: Europe is begging for US defense guarantees and needs US LNG as well as Fed swap lines.

Canadian PM-designate Carney says he’s ready to negotiate the USMCA if there’s "respect for Canadian sovereignty". However, statecraft logic dictates the US will want Canada to match whatever external tariffs it sets on China, in which case true sovereignty cannot be retained. Ontario’s Premier Ford will meet with US Commerce Secretary Lutnick today, and we will see if the result is a schmooze, kvetch, or plotz-fest. The BOC cut 25bps to 2.75% as expected yesterday, which was a snooze-fest compared to the geopolitical backdrop. Indeed, as lines on maps blur, arguments are made for Canada to move closer to the EU: it speaks French, has resources Europe needs, and the EU offers it a huge new market. However, Greenland could be literally in the way, as yesterday’s election tipped it closer towards independence, if not the most pro-US party wanting it. Moreover, Canada is adjacent to Russia and areas China is interested in yet spends little on defence even by EU standards; and the US will always border its key economic centers.

Mexico has yet to raise counter-tariffs, waiting until 2 April. Whether this is ‘Fortress North America’ plan, or a wait-and-hope approach remains to be seen.  

The UK hasn’t raised tariffs yet either and will be “negotiating an economic deal which covers and will include tariffs if we succeed,” while “[keeping] all options on the table.” If it were to get a US carve-out, that would point to a statecraft framework of splitting the UK from Europe.

Meanwhile, there’s growing recognition Trump is serious about radically reshaping the US. The Wall Street Journal asks if he is taking a “liquidationist approach”. The Financial Times underlines he sees the need for shock therapy to remake the US to make things again and argues a recession won’t stop him. Indeed, the more one hears ‘Main Street not Wall Street’, ‘national security’, ‘long term, not next quarter’, and ‘don’t focus on stocks’, the more it echoes ‘Common Prosperity’. After all, for a decade I’ve argued that neoliberalism would move closer to mercantilism to resist it. Ironically, however, the markets who didn’t see that China’s Common Prosperity was politically logical before it started, then called it “regulatory reforms”, and took years to finally bewail, “China is uninvestable,” are now floating a pivot from US to Chinese assets.

Regardless, all this market volatility helps cap US 10-year yields, now a White House focus: and how low do stocks have to go before the Fed does what it always does right after telling us that isn’t its role, and it won’t? One wonders, especially as stocks might then go right back up.

Meanwhile Europe’s reflationary rearmament --VW says it may make things for the German army (again)-- is already running into regulatory and supply-side bottlenecks which will only get worse – more so with a trade war with the US, or with a de-risking from it. Indeed, economic history says assuming the EU can rearm on a free market, big-profits basis without unleashing inflation is likely to be wrong. Such issues are explored in our latest global strategy special report, ‘EU economic statecraft update: it’s for real; and for realpolitik’. The conclusion is the EU needs transformational change to achieve its very grand strategy goals.

Of course, that doesn’t mean there won’t be some pampering for markets:

• EPA head Zeldin just offered “the largest deregulatory announcement in US history”, and tax cuts are floated for everything but foreign production, i.e., tariffs. Of course, that’s as Senate Democrats look to block the House government financing bill that maintains spending at Biden levels to protest DOGE cuts to government spending, threatening a government shutdown of the sort that DOGE could only dream of.
• China is trying to show it’s all about the private sector again; and yet it’s also saying that it will double down on its over-supply export-led model that leaves firms struggling to make profits in some cases – and to what US, EU, and global response?
• The EU is also promising a bonfire of the vanities paperwork.

That’s confusing enough a backdrop: but add geopolitics.

The US, having restarted military aid and intel sharing with Ukraine, is now threatening to devastate Russia’s economy if they won’t play ball on peace. Wasn’t that the gameplan from February 2022 up until recently, and how did that work out so far?

Iran has seemingly rejected the US offer of nuclear talks, which may only leave the hard way. And emphasis on the word ‘hard’ there for all involved – and those not involved, like Europe. If the EU thinks Ukraine is all it has to worry about just because it can’t focus on more than one geopolitical problem at once, then it’s sadly wrong.

Indeed, Russia, China, and Iran will tomorrow hold a joint high-level meeting in Beijing to discuss Iran's nuclear program and US threats. There we may also see if the US Noxin (reverse Nixon) geostrategy has any legs or not. Frankly, it would be a shock if it did - because try saying Noxin without saying No, and Xi is right in the middle of it.

However, understand that if that US strategy doesn’t pan out then hard choices could need to be made very quickly. For just one example, the US could have to decide what to do in the Middle East, or to let Israel decide and just lend it a hand; it could have to focus everything else on Asia ASAP; and Europe could find itself rapidly handed the keys and told to look after the continent as best it can while Russia and Iran and China cooperate even more closely. Obviously, the political-economy and market transformations implied in some such scenarios eclipse what has been seen --or, in Europe, promised-- so far.

That may sound shocking, but it should be. It’s not a forecast, but it’s a distinct fat tail risk. And, frankly, one vastly more important than the backwards-looking US CPI figure yesterday.