How much uncertainty can markets stomach?

Anthony Willis

Senior Economist

Key Takeaways

President Trump announced reciprocal tariffs, including a 10% levy on almost all US imports and higher tariffs on goods from countries like China, Japan, and India as well as the European Union.
The tariffs are expected to significantly impact the global economy, potentially raising US inflation and reducing growth. Markets around the world have sold off sharply.
The global trade landscape may shift, with countries considering various responses to the US tariffs. China’s retaliation with a 34% tariff on US imports has further unsettled the mood – other nations are looking to negotiate.
A lot of bad news is starting to be priced in, both in terms of economic slowdown and the hit to earnings. We do think some buying opportunities will emerge but with volatility so high we will ‘wait and see’ and consider our positions each day.

Transcript

The news agenda is completely dominated by the build up to and fallout from President Trump’s long-awaited speech on reciprocal tariffs. Trump duly announced tough measures to ‘liberate’ the US economy via a 10% levy to be applied on almost all US imports from 5 April. In addition, the President announced a wide range of ‘reciprocal’ tariffs on goods from the ‘worst offenders’ of the US’s trading partners, taking aim at a system he claimed had ‘ripped off’ the US for decades. Reciprocal tariffs take effect on 9 April. As a result, tariffs on China will climb to over 54% after a 34% duty was imposed on top of the 20% levy put in place earlier this year. The EU will face a 20% tariff while Japan will face tariffs of 24% and India 26%. Mexico and Canada were spared from the tariffs with goods complying with the USMCA trade agreement exempted. The UK will ‘only’ face the 10% global levy. The US Administration has declared a national emergency ‘due to national security and economic security concerns arising from the conditions reflected in large and persistent annual US goods trade deficits’.

The tariffs are set to have a significant impact on the global economy and will take US tariffs on imports above levels last seen in the 1930s around the Great Depression, a time when global trade volumes were a fraction of what we see today, and global supply chains were far less integrated. The effective tariff rate (a weighted average of the tariffs applied to all US goods imports, reflecting the various tariffs applied to different products and countries) is at the higher end of expectations and could well eclipse the level seen in the 1930s if tariffs are implemented at the levels set out on Wednesday.

The consensus before this week was an effective tariff rate level of around 12-14% but 20-24% level now seems plausible as things stand, albeit with a lot of variables at play, and further sectoral tariffs yet to be announced as we have seen for the auto sector. Bear in mind the effective tariff rate was just 2.5% last year. Initial estimates suggest this could take 1-1.5 percentage points off US growth this year and raise inflation by 1-1.5 percentage points. This would not suggest a US recession, but would create a soft patch of US growth, along with higher inflation, a reduction in corporate earnings and a significant further dent to consumer and corporate confidence, which in itself could further negatively impact growth. In other countries, particularly in Asia, economies that have thrived through becoming manufacturing hubs for export to the US face significant difficulties. The downside risks to global growth are clear.

President Trump said the tariffs would raise money to pay for tax cuts and spark a resurgence in domestic manufacturing. Assuming trade continues as before, it is estimated that these tariff measures could raise as much as $600billion. That would be 2.2% of GDP, twice the size of the largest tax increase in modern US history. The Peterson Institute for International Economics estimated that these tariffs collectively are the ‘largest tax increase in at least a generation’ and would cost the typical US household more than $1,200 a year.

Tariffs are fundamentally stagflationary in that they slow economic growth and increase inflationary pressures. Companies and consumers are likely to remain in a ‘wait and see’ mode as they digest the news flow and contemplate how much of an impact these tariffs will have. Companies will also face the choice of either absorbing the tariff costs with a corresponding negative impact on their earnings or trying to pass these on to end consumers. There is also a policy challenge for the Federal Reserve (Fed) given the likely negative impact on growth and upwards pressure on inflation. The Fed will be very keen that high inflation expectations which have already risen, do not become entrenched.

So, is a global trade war now inevitable? The omens right now do not look great, but this will not be a ‘global’ trade war, more like the US vs everyone else. The US is a relatively closed economy anyway, making up about 15% of final demand for imports globally – the US does not dominate trade as it does global finance or military spending. Other countries can carry on trading without the US – for example the EU, the 12 members of the Asian CPTPP, South Korea and other open economies make up 34% of global demand for imports. We’ve also seen unlikely alliances being touted – China, South Korea and Japan have been considering a “unified response” to the US tariffs. The US’s trading partners will need to choose their responses carefully given the US has made clear any retaliation will be met with further tariffs.

The reciprocal tariffs are based on a very simplistic calculation around the US trade deficit with each respective nation. This calculation of the reciprocal tariffs to be implemented leaves scope for clarification and negotiation for those able to access and influence the US administration, likely a fairly short list of countries. Some countries may choose a fiscal response via domestic stimulus to offset the impact and avoid further tariff escalation; while others will choose a more aggressive response. US Treasury Secretary Scott Bessent said ‘If you retaliate, there will be escalation. If you don’t retaliate, this is the high-water mark.’ The road map for affected nations appears to be negotiate first and retaliate later but it is not clear if the US will be minded to water down the tariff levels announced. During the first Trump presidency tariffs appeared to be a means to move towards trade deals whereas this time round there appears to be a wider political doctrine at work with President Trump willing to accept a more difficult transition as the US encourages manufacturing to be brought home and to operate a more closed economy. If the US is truly withdrawing from global trade, then the consequences will be both significant and unpleasant. If we are to see negotiations, then they need to be swift in order to avoid an impact to economic growth.

There are still a huge amount of moving parts and unknowns, and ‘uncertainty’ is becoming an over-used word, but the reality is we remain in something of an information void, albeit we can now rule out the US taking a lenient view in terms of the tariff numbers. Markets have moved lower, but there still seems to be a prevailing view that these initial tariff levels still may not be the eventual landing point.

The retaliation by China on Friday with a 34% tariff on US imports has further unsettled the mood. But this remains a US vs Rest of the World issue rather than a global trade war. The most pain will still be felt in the US economy and I think these moves increase the chances of China and Europe making more use of economic stimulus to offset the damage caused by tariffs. The market moves at the back end of last week suggest we are seeing a real clear out in markets. The next few days, when we will see if and how much countries wish to negotiate with the US will help guide how much worse things can get. In the absence of more definitive information, and the US government taking a policy stance based more on ideology than economic strategy, the unknowns will likely continue to weigh on risk appetite until a more definitive outcome on the size, scope and duration of these tariffs can be identified.

A lot of bad news is starting to be priced in, both in terms of economic slowdown and the hit to earnings. We do think some buying opportunities will emerge but with volatility so high we will ‘wait and see’ and consider our positions each day.

How much uncertainty can markets stomach?

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