Trump tariffs: Shock to prices, growth and confidence

“Liberation Day” finally provided details regarding President Trump’s “reciprocal” tariffs on US trading partners. But there remains little clarity on what it all means and how it may play out.  With such uncertainty, recession probabilities are rising.

The details announced in the White House Rose Garden were certainly more draconian than expected.

• Effective April 5, the administration will implement 10% baseline tariffs on all imports.
• Effective April 9, the administration will assess higher country-specific tariffs for the worst-offending trading partners.
• Canada and Mexico were notably excluded as United States-Mexico-Canada Agreement (USMCA) compliant goods remain exempt.
• Aluminum, steel, and autos are also exempt as they are already covered by targeted tariffs.
• Energy and minerals were excluded, along with copper, pharmaceuticals, semi-conductors, and lumber – as sector-specific tariffs are expected to be implemented.
• China announced retaliation measures on Friday: it will impose 34% tariffs on all goods from the US beginning April 10. This is the same amount Trump announced for China.

Tariff rate highest since early 1900s

Combining the new tariffs with those that have already been announced moves the average effective tariff rate up to about 23%.¹ To put it into perspective, this is above the notorious Smoot-Hawley Tariff Act of 1930, which added more strain to the global economic climate of the Great Depression, and back to the highest levels since the early 1900s. 

No wonder the market has done anything but take the announcement in stride. These tariffs represent a sizeable shock to both prices and growth. And as a result, recession probabilities are rising. Recession may not be the base case yet, but the buffers to a shock of this magnitude are thin and compressing by the day. Tariff uncertainty has been a sideshow to the real risk of slowing US growth, as labor market slack continues to organically build. That remains the case today, as housing remains in stasis, capital expenditure of corporations is likely frozen for the foreseeable future, and state and local government budgets compress. That leaves the consumer as the lone source of growth impulse. The fuel for that growth – incomes – which continues to slow.

Growth and inflation unknowns shake markets

It’s no easy task to estimate the effects of such an aggressive and wide-reaching trade policy proposal given the potential for second-order effects, including substitution, demand destruction, and retaliation, to name a few. But estimates suggest the tariffs, as announced, represent about a 1% drag on real GDP in 2025 and anywhere from 1.5% to north of 2% upward pressure on core Personal Consumption Expenditures (PCE) Price Index. Core PCE is a favored inflation measure of the Federal Reserve.¹

Markets have been understandably a sea of red with cyclical and growth stocks taking the brunt of the pain. Here are some market reactions to the tariff news on Thursday, April 3, that bear watching.

• The VIX (Cboe Volatility Index), pushed up into the 40s on Thursday, April 3. The VIX, which measures the expected volatility of the S&P 500^®, has averaged 19.5% since its launch in 1990.¹ 
• Treasuries rallied hard, with the US 10-year now trading firmly with a 3-handle. The 10-year Treasury yield fell to 4.05% on Thursday, April 3.¹
• Credit is finally beginning to move, as high yield spreads widened 131 basis points (bps) since February 18, with 53 bps of that coming on Thursday, April 3.¹
• Gold, the ultimate Texas hedge, gave up its immediate gains to close lower on April 3.¹ 
• Perhaps the most stunning move was the weakness in the US dollar, selling off as much as 2.50% on Thursday before rallying modestly into the weekend.¹

So much for the dollar smile

The dollar has long benefited from pro-cyclical flows – garnering a risk-on bid, thanks to stronger relative growth and a risk-off bid during flights to safety. The breakdown of that relationship is notable to say the least. Perhaps it’s a function of lower global trade and less demand for US dollars. Perhaps it’s a reflection of the market’s view that tariffs may damage US growth more than global growth. Or perhaps it’s an unwind of a massive, long-dollar asset trade that has steadily built up over years. Whatever the reason, we’ll be keeping a close eye on the greenback.
 

Are US trading partners willing to negotiate?

It’s one thing to estimate the first-order effects of tariffs and reduced trade on growth. But it’s another thing, entirely, to handicap a potential regime change in geopolitical and trade relationships. Despite the Trump administration’s claims that the tariff rates are a reflection of the tariff and non-tariff trade barriers utilized by US trading partners, they are simply a reflection of bilateral trade deficits. It appears to be the ratio of the US trade deficit with each country divided by their total exports to the US. That “methodology” leaves geopolitical adversaries with lower tariffs than close allies with standing free-trade agreements. Therefore, it’s worth questioning to what degree our trading partners will actually be willing to negotiate when there’s little evidence of the US acting in good faith. Perhaps we’ll see some de-escalation, but there’s a significant risk that we’re witnessing some irreparable damage. You can’t put the toothpaste back in the tube.
 

Who will bear the burden of these tariffs?

Traditional economic theory suggests that the country imposing tariffs generally sees currency strength, helping to offset a portion of the tariffs. That certainly hasn’t been the case here, as the dollar is now trading lower by almost 3% since the election in November.¹ That leaves either companies or consumers on the hook. With nominal incomes continuing to slow, that means either margin compression, demand destruction, or some combination of the two. Margins remain elevated so there’s room to stomach some compression, but either way, that’s not a great backdrop for the earnings outlook with downside risks for both margins and revenues. Not surprising, equities are pricing that earnings hit in. In short, recession risks are rising and markets are rightly reflecting that.
 

The beatings will continue until morale improves

Markets are officially in the panic phase – this is not the orderly de-risking we’ve seen over the past month. On the bright side, panic is a sign we’re getting closer to an overshoot. The bad news is we can remain in the panic phase for a while and continue doing damage. Markets tend to stop panicking when policy makers start panicking.

Fortunately, corporate balance sheets are entering this shock from a point of strength, which increases the resilience of the economy to handle the shock. Unfortunately, there’s not a whole lot the Fed can do to backstop confidence this time. The ball is entirely in the Trump administration’s court to short circuit the negative feedback loop. And should the administration fail to back off, then the burden falls to Congress. But there is a risk we may not be able to put all the toothpaste back in the tube. It’s all about confidence – confidence of consumers, businesses, and investors in the administration and future policy. That may take time to rebuild.