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Bond giant Pimco has warned that the fallout from the trade war launched by Donald Trump could push eurozone interest rates back towards “extraordinary levels” as policymakers seek to cushion the blow to the bloc’s faltering economy.
Andrew Balls, chief investment officer for global fixed income at the $2 trillion asset manager, said he expects there will be “multiple rounds of play” when it comes to tariffs, a policy the US president-elect has repeatedly threatened.
“The worst-case version of the trade situation would be difficult” for Europe, Balls told the Financial Times. “I tend to think that we run pricing pretty benignly.”
European assets were big losers as markets braced for Trump’s “America First” policy package. The euro has fallen more than 5 percent since late September to around $1.06 as investors expect more aggressive interest rate cuts from the European Central Bank as it offsets a weaker outlook for exporters in the region.
Traders in the swaps markets are now betting that the ECB’s deposit rate will fall as low as 1.75 percent, from the current level of 3.25 percent, before the central bank stops cutting.
But Balls thinks the ECB could go further. “I suppose you could easily factor in lower terminal rates, in the event of a worse-than-expected outcome, where the ECB goes to more emergency interest rate levels,” he said. As a result, Pimco expects the euro to fall further against the dollar.
Two years ago, the ECB ended eight years of negative interest rates as it battled a surge in inflation that followed the Covid pandemic.
Some investors saw Trump’s nominee for Treasury Secretary, hedge fund manager Scott Bessentas a moderating influence on Trump’s more radical economic policy. That belief caused the dollar to pull back from post-election highs.
“I think markets are generally pricing in fairly optimistic outcomes,” Balls said. “You can see the upside risks (but) it’s easier to see the downside risks.”
In the UK, the blow to the economy from a global trade war would also leave “plenty of room” for lower so-called terminal interest rates, Balls said.
Currently, investors expect three cuts of a quarter of a point from the Bank of England by the end of next year, lifting UK rates to 4 percent.
Pimco currently favors UK bonds over US Treasuries because it believes rates could fall further, he said.
Despite his gloomy view of the risks facing the eurozone economy, Balls said he did not expect further weakening of France’s sovereign debt, which has been rocked by the recent budget crisis that led to the collapse of Michel Barnier’s government.
France’s 10-year borrowing costs recently hit a 12-year high relative to Germany’s. Balls said the wider gap was a fair reflection of the worse outlook for French public finances.
He also said the lack of “contagion” in other eurozone markets showed the French crisis was unlikely to become a systemic issue for the currency bloc.
“We had the war, we had the (pandemic), we had a whole series of shocks, (a) radical government in Italy, political trauma in France and a whole series of stress tests, and European markets performed very well,” Balls said.
