Following the victory of the centre-right CDU/CSU in Germany’s federal election on February 23, and with newly appointed Chancellor Friedrich Merz proposing aggressive fiscal policies aimed at boosting infrastructure and defence spending, business sentiment in Germany’s key manufacturing sector has improved notably. This uptick contrasts with a decline in confidence within the U.S. services sector, an essential pillar of the American economy.
Reflecting this shift, the spread between Germany’s Manufacturing PMI and the U.S. ISM Services PMI narrowed to -2.5 in March, from -7.0 in February, highlighting a relative improvement in German economic momentum (see Fig 1)
Meanwhile, consumer confidence in the U.S, a leading indicator of future retail spending—has continued to deteriorate. According to preliminary data from the University of Michigan, sentiment fell for the fourth consecutive month, dropping to 50.8 in April from 57 in March. This marks the lowest reading since June 2022.
Adding to concerns, inflation expectations among U.S. consumers have surged. One-year-ahead inflation expectations jumped to 6.7% in April, the highest since November 1981 from 5.0% in March. Long-term five-year expectations also climbed to 4.4%, the highest since June 1991, up from 4.1% in the previous month (see Fig 2)
This combination of slowing growth and persistent inflation—hallmarks of a stagflation environment, poses a significant challenge for the U.S. Federal Reserve, which may find it increasingly difficult to implement counter-cyclical monetary policies to support the economy.
As a result, global investors may begin to question the “U.S. exceptionalism” narrative that has underpinned markets over the past five years. A shift in sentiment could prompt a reallocation away from U.S. fixed income and risk assets, potentially triggering a sustained weakening trend in the U.S. dollar.
