Trade Winds

A global trade war is brewing as the United States imposes sweeping new tariffs on a host of countries, heightening concerns about economic growth and roiling stock, bond, and currency markets around the world.  Policy details continue to shift, amplifying financial market instability and undermining investor confidence.

Some assert that this tariff barrage is a negotiating tactic to gain leverage and extract more favorable trade terms.  But that view overlooks President Trump’s long-standing support for tariffs.  He has consistently touted them as a vehicle to restore America’s “hollowed out” manufacturing base.  Furthermore, the tax revenues generated by sizable tariffs could help fund the administration’s broader policy initiatives.

Hoover’s vacuum

On April 2, President Trump announced an aggressive new tariff regime, targeting nearly every nation, from major trading partners to remote, sparsely populated island nations.  Effective April 5, the program applied a minimum, near-universal tariff of 10% on all goods imported to the United States.

The administration appears to embrace the idea that all of our bilateral trade deficits stem from unfair practices by foreign powers.  As such, higher tariffs will be imposed on “bad actors” — friends and foes alike — that run large trade surpluses with the U.S.  For instance, imports from the European Union will be subject to a 20% duty; Japan, 24%.  Imports from major trading partners in southeast Asia will face among the highest levies:  Vietnam 46%, China 34% (subsequently increased), Taiwan 32%, South Korea 25%.

By some estimates, the average effective tariff on U.S. imports could surge to 25% this year — a stark rise from the prevailing 2% average duty.  The last comparable hike occurred in 1930 when President Herbert Hoover signed the infamous Smoot-Hawley Tariff Act, sparking retaliatory tariffs from other nations and crippling global trade.

Dazed and confused

Though tariffs were a central pillar of Trump’s 2024 campaign, the speed and scale of the policy shift caught markets off guard.  Indeed, on April 3, the Dow shed 2,800 points.  The trade shock also led to a 10.5% plunge by the S&P 500 stock index, the largest one-day drop since March 2020 when a different existential threat reared its head.

The bond market convulsed as well.  The yield on the 10-year Treasury jumped half a percentage point to 4.49%, its sharpest weekly rise since markets reeled in the aftermath of the 9/11 terrorist attacks.  Investors dumped U.S. assets amid growing fears over the trade war and perhaps a loss of confidence in U.S. policy.

In response to the market turmoil, the administration has partially retreated.  While the 10% base tariff generally remains in effect, most of the harsher, country-specific levies have been paused for 90 days to allow time for negotiations.  Many U.S. trading partners appear open to making concessions, but progress may be hindered by the administration’s inconsistent messaging and lack of clearly articulated objectives.

China, however, has declined to bend the knee.  As the U.S.’s second-largest trading partner — and the source of one-quarter of America’s $1.2 trillion merchandise trade deficit — it has matched U.S. tariffs tit-for-tat.  At the moment, both countries seem to have settled on 125% levies on the other’s goods.  The standoff would seem almost comical if the potential economic consequences were not so serious for the global economy.

Taxation without representation

The U.S. economy was already losing momentum before the trade war escalated.  Many consumers have started to appear tapped out, with spending slowing and incomes stagnating.  Delinquency rates on credit card and automobile loans have climbed to their highest levels in over a decade.  Job openings continue to decline, pushing up measures of unemployment.  Surveys of both consumers and small businesses reveal growing pessimism about the economic outlook.

Recessions often start when a major shock hits an already vulnerable economy.  A broad-based trade war could serve as that trigger.  Tariffs are taxes paid by importers, not foreign producers — meaning they raise domestic prices, stoking domestic inflation.  The impact cascades through supply chains, raising input costs for businesses, much of which is passed onto consumers.  Companies’ profit margins narrow while higher prices erode consumer purchasing power and hurt demand.

Retaliatory tariffs abroad would jeopardize U.S. exporters, threatening their revenues as well as their jobs.  American companies could also lose market share as other countries forge trade agreements, giving preferential treatment to non-U.S. firms.  Meanwhile, foreign consumers could certainly turn away from U.S. brands.  And the administration’s trade math ignores services, a major American export.  In 2024, the U.S. had a $300 billion trade surplus in services.  Countries cannot easily impose tariffs on services, but they can tax, fine, or even ban U.S. companies.

While tariffs are inflationary and will weigh on growth, the ambiguity around U.S. trade policy will compound the harm to the economy.  Businesses need predictability to make long-term investment decisions.  Policy uncertainty paralyzes their decision-making, leading CEOs to pause or cancel hiring, capital spending, and expansion plans.  Such hesitation can ripple quickly through the broader economy.

Batten down the hatches

A recession is not inevitable — yet.  If negotiations proceed or financial markets force a change in policy direction, the administration may scale back the size and scope of the tariffs.  Failing that, a shift into a period of stagflation, an environment of weak economic growth and rising joblessness alongside rising inflation, may become more likely.  Such a backdrop would require the Federal Reserve to tread carefully.  Higher inflation would curb the central bank’s ability to cut rates aggressively in support of a slowing economy.

Corporate earnings could also take a hit.  While S&P 500 companies are expected to report 7% earnings growth for the first quarter, Wall Street’s forecast for 10% full-year growth seems increasingly optimistic.  An uncertain operating environment will likely lead many firms to suspend 2025 guidance and analysts to lower profit expectations.

Markets will remain highly sensitive to the headlines of the day, particularly as they relate to the trade situation.  Stocks will be volatile until investors gain more clarity on the path for economic and corporate profit growth.  In turbulent times like these, the instinct to sell stocks and flee to cash is strong.  But history indicates that abandoning stocks often locks in losses while missing the sharp gains that tend to occur at the start of a recovery.  The broad stock market has always rebounded from downturns to attain new highs — but that knowledge doesn’t make it any easier to sit tight in the middle of a storm.

— Christopher J. Singleton, CFA, Managing Director
April 16, 2025