International financial markets were also strongly influenced by political developments in the United States. For example, the US tariff announcements at the beginning of April triggered severe financial market reactions, which probably also showed that confidence in the safe haven status of the US currency had been damaged, at least temporarily. Some market participants also suspected that this policy initiative was part of a broader economic policy attempt to reduce the US trade deficit via a weaker US dollar. This perception was amplified by the US President’s repeated public and in some cases severe criticism of Fed officials. For all these reasons, market participants expected significant growth risks and investment risks for the US economy. The emerging concerns led to an extremely unusual financial market response: the US dollar came under marked broad-based downward pressure. At the same time, investors’ risk appetite slumped, leading to strong equity market losses amid high financial market volatility, and US Treasury prices fell markedly. The response thus differed qualitatively from the otherwise usual safe haven movements under financial market stress, in which the US dollar appreciates and US Treasuries gain in value. 

International government bond yields saw mixed developments amid high levels of uncertainty. Market participants’ concerns about a further significant slowdown in economic activity dominated at the beginning of the first quarter of 2025. The US administration’s tariff announcements amplified these developments, but abruptly halted the previous decline in US yields and caused a surge in US yields over German federal securities. This was partly due to the fact that Bund yields fell significantly, given their safe haven status among investors. Looking at the entire review period, however, this was offset by the impact of high planned fiscal spending on defence and infrastructure in Germany and the rest of the euro area, which, taken in isolation, is associated with medium-term growth impulses from the perspective of market participants, thereby supporting the picture of higher longer-term real interest rates in particular. The expected increase in free float of Bunds in view of the expected issuance volume also contributed to the rise in yields.

As a result of US policy, market participants’ risk appetite saw striking declines at times. The market for risky financial market investments thus came under massive pressure. For example, the tariff announcements led to sharp equity price losses, rising yield spreads on corporate bonds and an exceptionally strong increase in implied stock market volatility. However, the US administration’s announcement of a temporary suspension of a large number of tariffs then set a countermovement in motion and contributed to strong price gains, which more than offset the previous losses. The potential for downward corrections in the event of further volte-faces in US economic policy remains considerable. Given the comparatively favourable earnings outlook for European enterprises, the uncertainty still associated with US tariff policy weighed mainly on US earnings expectations. Overall, US equity prices rose slightly, while European equities recorded strong gains. 

The euro has appreciated significantly against the US dollar since the beginning of the year. In the eyes of market participants, the economic outlook for the euro area improved markedly at the beginning of March. This was because the negotiations between the parties to Germany's new coalition government had produced the prospect of a surprisingly comprehensive fiscal package aimed at significantly improving Germany’s defence capacity and infrastructure. Taken in isolation, this weighed on the US dollar against the euro. In addition, disappointing data on the US labour market, consumer confidence and, later, the business climate in the United States also weakened the US dollar. Following the initial optimism surrounding Donald Trump’s election victory, attention thus turned increasingly to the inflation and growth risks posed by his tariff plans. Against this backdrop, the Federal Reserve in mid-March revised its growth forecast for the United States downwards for 2025 and 2026. 

American economic policy weighed on the US dollar. The global import tariffs announced by the US administration at the beginning of April were significantly more extensive than expected. This increased expectations of interest rate cuts in the United States, and the US dollar depreciated by 2.8 % against the euro within the space of two days. This response was remarkable, as the adoption of import tariffs is usually accompanied by an appreciation due to the expected lower demand for foreign currency. There were two main reasons why the effect on the US dollar was different in this case: First, market participants apparently assessed the US tariff package as posing particularly serious risks to economic growth in the United States. Moreover, markets do not appear to have placed their usual high level of confidence in the US dollar during this event. This is suggested by the fact that the tariff announcement not only weighed on the US dollar, but also led directly to considerable losses in the prices of US shares and long-term US Treasuries as well as to a decline in risk appetite that was at times striking (see the “Securities markets ” chapter). Such a reaction is unusual because similar financial market turmoil normally results in increased demand for US government bonds, which are considered particularly safe. Although the US President partially suspended the newly adopted tariffs imposed on the EU and other trading partners, US tariff policy vis-à-vis China nevertheless had a marked impact on the euro-US dollar exchange rate. For example, the euro once again appreciated markedly when US tariffs on imports from China and Chinese countertariffs were raised considerably in a multi-step process of escalation (see the “Global economy buffeted by tariff storm ” chapter in the “Global and European setting” article). By contrast, when the two countries were later able to provisionally agree on a reduction in tariffs, the euro temporarily depreciated again. In addition to volatile tariff policy, the US President’s political pressure on the Federal Reserve also weighed on the US dollar. Finally, the US dollar also declined due to one of the major credit rating agencies downgrading the credit quality of US government paper. On balance, the US dollar depreciated against the euro and in effective terms against the currencies of advanced economies. Although high US import tariffs are likely to weigh heavily on emerging market economies in particular, the US dollar depreciated against an average of major emerging market currencies as well, which is also a rather unusual development. As this report went to press, the euro stood at US$1.13 and was thus 8.4 % stronger than at the beginning of the year.

On balance, the exchange rate of the euro against the yen has remained virtually unchanged since the beginning of the year. Following the Bank of Japan’s policy rate hike at the end of January, the euro initially depreciated against the yen. The Bank of Japan’s communication was seen as a signal that it would continue to raise interest rates against the global monetary policy trend, thereby narrowing the interest rate differential with the euro area. The publication of better-than-expected economic data and comparatively high inflation figures for Japan supported this assessment. At the beginning of March, the announcement of the planned German fiscal package and the associated positive economic expectations also supported the euro against the yen. Since then, the single currency has been moving against the yen without a clearly identifiable trend. Most recently, the euro was trading at JPY 163, meaning the euro’s exchange rate against the yen has remained virtually unchanged on balance since the beginning of the year. 

The euro has appreciated against the pound sterling since the beginning of the year. Over the review period, the exchange rate movements of the euro against the pound sterling were driven by factors similar to those influencing its movement against the US dollar. The euro also appreciated against the pound sterling following the announcement of the fiscal package agreed by Germany's future coalition government. A second surge in appreciation came after the US administration announced plans to impose high additional tariffs worldwide. The comparatively close political and economic ties between the United Kingdom and the United States made themselves felt here. The pound sterling gradually recovered in the wake of the United Kingdom’s tariff agreement with the United States. As this report went to press, however, the euro stood at £0.84, still 1.5 % up on end-December 2024. 

The effective appreciation of the euro has worsened Germany’s price competitiveness. As a weighted average against 18 trading partners, the euro has appreciated by 3.4 % since the beginning of the year. This was mainly due to the significant appreciation against the US dollar mentioned above. However, the euro also appreciated markedly against numerous emerging market currencies. For example, the marked 7.1 % appreciation against the renminbi made a further important contribution to the euro’s strength. Therefore, the price competitiveness of Germany and the euro area has worsened since the beginning of the year. Nevertheless, according to our calculations, the price competitiveness position of the euro area vis-à-vis a broad group of countries can currently be regarded as favourable. Based on this measure, however, Germany’s price competitiveness has fallen to a neutral level.

US sovereign bond yields declined markedly in the face of increasingly entrenched expectations of a slowdown in economic activity. Since the beginning of the year, signs of a slowdown in the US economy have increased, putting pressure on both US policy rate expectations and long-term US Treasury yields. For example, unexpectedly unfavourable sentiment indicators dampened the previously strong level of economic optimism. This deterioration in sentiment affected consumer confidence in particular, but also hit services and industry. One important reason for this was uncertainty about the US administration’s economic policy stance, particularly its tariff policy. At the beginning of April, this led to temporary disruptions in the long-term US Treasury market, with yields spiking higher at times amid reduced market liquidity. According to market observers, this abrupt rise in yields may have been self-reinforcing in some cases. For example, it may have forced investors who typically exploit small price differences between Treasuries and related futures contracts to sell their Treasury positions. 1 In addition, the simultaneous losses in US Treasury and equity prices, in some cases, may have led investors to offload US Treasuries as a way of generating liquidity in the face of heavy portfolio losses. 2 Another striking observation was that ten-year yields on US Treasuries rose more strongly than the rates of equivalent US interest rate swaps (OIS rates) as a result of the tariff announcements. Together with a significant decline in investors’ risk appetite and the effective depreciation of the US dollar, this suggests that market participants had their doubts about the safe haven status of Treasuries, at least temporarily. The subsequent announcement by the US administration to waive a large portion of the recently adopted country-specific tariffs for the next 90 days then helped to calm the market and to bring US Treasury yields back down somewhat. In addition, the aforementioned agreement between the US and Chinese governments helped to de-escalate the trade dispute. Nevertheless, uncertainty about the US’s future economic policy remained high and continued to weigh on the economic outlook. Towards the end of the reporting period, the rating downgrade of US Treasuries from AAA to AA1 by the rating agency Moody’s gave US yields somewhat of a boost. On balance, however, nominal yields on ten-year US Treasuries sank by 12 basis points to 4.5 % as this report went to press.

Long-term government bond yields in the euro area rose despite declining US yields and stronger expectations of policy rate cuts. The Eurosystem cut key interest rates by 25 basis points in January, and again in March and April. In view of progress made in the disinflation process and concerns about a global slowdown, the path for policy rates also declined somewhat in the short and medium term. For example, calculated on the basis of money market rates, the expected deposit facility rate for the period up to end-2025 most recently stood at 1.7 %, which is around 55 basis points lower than its current level. The fact that government bond yields nevertheless rose slightly on balance is largely due to the expansionary fiscal measures planned by the new German Federal Government. Market participants interpreted these measures primarily as a positive medium-term growth impulse and accordingly priced in a higher longer-term real interest rate level. They expected that the anticipated fiscal effects would not remain confined to Germany but would support activity in the euro area as a whole. These effects on long-term interest rates overshadowed both the expectation of larger policy rate cuts and the yield-dampening effects from the US, meaning that the GDP-weighted yield on ten-year euro area bonds rose by 15 basis points to 3.0 %.

Yields on ten-year Bunds and government bonds issued by other euro area countries rose similarly sharply. On 5 March, the day after the fiscal measures were announced, ten-year Bunds recorded their highest daily increase since 1990, with a yield increase of 29 basis points. The growth stimulus that market participants expected these measures to deliver was reflected in both long-term expected real interest rates and real term premia, while the impact on inflation expectations remained limited. The rise in yields also exceeded the increase in the interest rate swap rate (OIS rate) for the same maturity. This reflects a higher expected free float that investors would have to absorb (see the supplementary information entitled “Higher free float of government bonds ”). From the perspective of market participants, the planned fiscal measures will not weigh on Germany’s triple A credit rating or the benchmark status of Bunds. This was also evident after the US tariff announcements of 2 April, when investors’ risk appetite slumped and the increased demand for safe Bunds dampened their yields again (safe haven flows). In addition, global growth concerns associated with the tariff announcements have recently put pressure on yields. On balance, yields on ten-year Bunds nevertheless rose by 22 basis points during the period under review, closing at 2.6 %.

GDP-weighted yield spreads of ten-year euro area government bonds over Bunds with the same maturity narrowed slightly. The decline in risk appetite triggered by the tariff announcements was not reflected visibly in the yield spreads on euro area government bonds. It is worth noting that the yield spreads of French government bonds over Bunds narrowed by a total of 165 basis points. At the turn of the year, they had reached a relatively high level in the face of great political uncertainty. 

Yields on ten-year UK and Japanese government bonds rose. After the Bank of Japan raised its policy rates to 0.5 % in January, speculation about further interest rate hikes boosted Japanese government bond yields. In addition, supported by rising wages and relatively high inflation rates by historical standards, yields rose to 1.6 % at end-March, a level last reached in 2008. They declined again as a result of the US tariff announcements in April and the resulting economic concerns and safe haven flows. Nevertheless, at 1.5 %, they are currently 38 basis points higher than at the turn of the year. The Bank of England lowered its policy rate by 25 basis points in February and then again in May. With regard to further interest rate cuts, it stressed that a gradual and cautious approach was appropriate. As in the euro area, interest rates in the United Kingdom responded strongly to the latest events in the tariff dispute. On balance, ten-year British gilts yielded 10 basis points above their levels at the beginning of January.

Market-based inflation indicators barely changed overall in the period under review. For 2025, market-based inflation expectations derived from euro area inflation swaps stand at 2.0 %, meaning they are still in line with the price stability objective. Market-based inflation expectations for 2026 and 2027 remained virtually unchanged on balance. They signalled downside risks and remained entrenched at the lower end of the inflation target. According to surveys conducted by Consensus Economics, inflation expectations stood at 1.9 % for 2026 and 2.0 % for 2027. While the Federal Government’s fiscal package had barely any effect on market-based inflation compensation in the euro area, the tightening of US tariff and trade policies and changing commodity prices had a major impact on short to medium-term inflation expectations in the period under review. Market participants in the euro area saw in these measures primarily the threat of a deteriorating growth outlook, which was also reflected in the significant fall in oil prices following the tariff announcements. In addition, the significant appreciation of the euro against the US dollar had a dampening effect on inflation expectations in the euro area. The countermovement in financial markets also led to a certain increase in market-based inflation expectations towards the price stability objective. 

Market prices and surveys point to inflation expectations remaining firmly anchored at the level of the stability objective. The five-year forward inflation rate five years ahead has risen by 7 basis points since the beginning of the year, remaining in line with the target at 2.1 %. Longer-term survey-based inflation expectations for the euro area calculated on a quarterly basis by Consensus Economics also remained at the 2 % inflation target level in April.

Yields on European corporate bonds rose initially as market participants’ risk appetite fell sharply, but declined again recently as the market broadly recovered. Yields on BBB-rated corporate bonds with residual maturities of between seven and ten years rose on balance for both financial and non-financial corporations. As yields on matched-maturity federal securities rose in a similar manner, yield spreads barely changed on balance. Overall, the financing costs of European firms, as measured by yield spreads, were recently below their corresponding five-year averages irrespective of their credit quality ratings.

Amid considerable fluctuations, equity prices saw slight gains in the United States and strong gains in the euro area. The S&P 500 index first rose to a new record high in February before suffering significant price declines. Ultimately, however, it recovered and was, at the end of the period under review, 1.4 % higher on balance than at the beginning of the year. The EuroStoxx rose sharply during the same period, gaining a total of 12.6 %. In the United States, prices were buoyed mainly by a good reporting season at the beginning of the year. However, the US technology sector dropped off significantly when a Chinese company unveiled a surprisingly efficient AI-based language model. As a result, the overall market also developed much more weakly, as consumer confidence, which is very relevant for the US economy, deteriorated sharply. One key reason for this is likely to have been the prospect of restrictive US tariff and trade policy, the potential consequences of which led to high uncertainty among consumers. In the euro area, by contrast, prices rose in the review period on the back of somewhat better-than-expected economic signals, which was also reflected in firms’ higher medium-term earnings expectations. The fiscal package adopted in Germany provided a key impulse here, as reflected, amongst other things, in above-average equity price gains in the construction and armaments sectors. However, the surprisingly confrontational tariff announcements of 2 April caused temporarily strong price losses not only in the United States but also in the euro area, in addition to a slump in risk appetite and a sharp rise in uncertainty. For example, implied volatility in equity markets rose to multi-year highs on both sides of the Atlantic following the US tariff announcements. The aforementioned tariff deals that the US administration has negotiated in the meantime would later help calm the market. This led to a significant decline in uncertainty – at last count, it was once again below the respective five-year averages as measured by implied volatility for both the EuroStoxx and the S&P 500 index. Against this backdrop, German equity prices (CDAX) rose to a new record high, posting gains of 18.1 %, which was once again stronger than the European market as a whole. All in all, the divergent developments between the euro area and the United States seem to reflect the damage to confidence suffered in the US currency area. Equity prices in the UK, as measured by the FTSE 100 index, gained 6.4 % in value. By contrast, Japanese equities (Nikkei index) recorded a significant decline of 6.0 % during the period under review, mainly owing to the appreciation of the yen against the US dollar, close economic ties with the United States and the resulting uncertainty about future US trade policy.

Euro area bank shares recorded an exceptionally strong increase, while US banks also recorded price gains. Over the period under review, European banks’ equity prices significantly outperformed the EuroStoxx overall index (+38.2 %). One reason for this was the significantly higher earnings expectations in the banking sector over both the short and medium term. The impact of potential interest rate declines on interest income was largely limited and offset by the strong dynamics in fee receipts. Large systemic financial institutions in particular benefited from the high market volatility caused by US tariff policy. US banks recorded significantly lower price gains, but also outperformed the US market as a whole. Concerns about rising corporate insolvencies and weaker investment activity in the United States are likely to have had a dampening effect on US banks’ share prices. 

European and US equity valuations have declined since the turn of the year. Equity risk premia and the implied cost of equity, i.e. the sum of risk-free interest rates and risk premia, changed little or increased. These valuation measures, calculated using a dividend discount model, take into account both short and medium-term earnings expectations and risk-free interest rates. Medium-term earnings expectations increased for the euro area, while they weakened for the United States in line with the gloomier US economic outlook. Given the US administration’s economic policy stance, market participants thus corrected their previous assessment that medium-term earnings in the United States would continue to grow rapidly. Higher risk-free interest rates made a notable contribution to the higher implied cost of equity in the euro area. Measured in terms of the implied cost of equity, the valuation of European equities is close to its long-term average, while it is higher for US equities. 

 (This article reflects data up to 19 May 2025, 22:00.)

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