
Key Takeaways
- As tariff uncertainty continues, equity and currency markets remain volatile. We have, however, heard some positive noises around trade deals between the US and the UK, Europe and Japan.
- US exceptionalism is being challenged and President Trump’s rhetoric around Federal Reserve Chair, Jay Powell, add further uncertainty to the backdrop.
- Although economic risks have increased, we don’t foresee a recession in the US. More likely is the prospect of stagflation as growth weakens, inflation picks up and unemployment rises.
- Survey data has raised concerns over the strength of the consumer, but we will wait and see if this translates into economic growth. Any deterioration would cause us to reconsider our view and could lead to further downside in markets.
The tariff uncertainty continues, and equity, bond and currency markets remain volatile. We have heard some slightly positive noises around potential trade deals – or at least negotiations – for the UK, Europe and Japan but nothing concrete. Even China has suggested they are open to talks should the US show a little more ‘respect’.
This week we ask whether the US is embarking on an act of economic self-harm? It would certainly appear to be the case. Recession risks have clearly risen, but for now it’s not our base case. Indeed, investor positioning and survey data is extremely weak, meaning there are some upside risks if we do see any positive surprises from trade talks – if they take place.
The backdrop remains that the US exceptionalism theme is challenged – consumers have spent their pandemic savings, government spending and the budget deficit is in the spotlight, and business confidence is weak meaning we will likely see a lack of investment. All of this is happening against a backdrop of huge uncertainty with the waters further muddied by President Trump challenging the authority of Federal Reserve Chair, Jay Powell, and openly seeking ways to dismiss him. This would be a legal minefield and would only remove one voting member of 12 so would not necessarily change rates policy.
So, if we don’t see a US recession (yet) what do we expect? We see stagflation as the more likely outcome for now. That means very sluggish US economic growth of around 0.5% and inflation between 3.5% and 4%, with unemployment picking up from the current 4.2% to more like 4.7%. In such a scenario, the Fed is likely to be far more worried about inflation (and keeping inflation expectations anchored) than slowing growth or unemployment picking up to a level that would still be well below the 30-year average.
We do expect to see a significant hit to corporate earnings if these tariffs are maintained for an extended period – something that has not yet been reflected in a notable reduction in expectations. While the sell-side banks have reduced year-end forecasts for the S&P500 (but still see 15% gains from here to year-end) there has not yet been any shift lower in consensus earnings. It is hard for companies to provide concrete guidance as they are in the dark around tariffs as much as the rest of us.
We also harbour some concerns over the engine of the US economy – the consumer. Survey data suggests a challenging backdrop to this weak sentiment could at some point translate into hard data.
Consumer sentiment data is very soft across all income levels. The Conference Board numbers are weak and closing in on pandemic levels, and the University of Michigan survey is close to all-time lows. Worries over employment stand at levels normally seen only in recessions.
We will have to wait and see whether soft data translates into economic weakness – it’s not always the case. It is also important to acknowledge the impact of negative newsflow and the fact that stock market falls reinforce negative sentiment. We anticipate a choppy period for economic releases and will be watch releases closely.
The volatility is unlikely to be over, with headline risks persisting and markets remaining unsettled. We have the two world’s economic superpowers initiating policies that put an effective halt to trade between them, and the rest of the world faces uncertainty and the prospect of trying to soften the tariff impacts via negotiation.
This is undoubtedly an act of economic self-harm by the US, but based around an ideology that wants to boost domestic manufacturing and inflict pain on the other economic powers like the EU and China.
Will it cause a recession? It’s possible and we are watching for any signs of weak survey numbers filtering into the hard data. That would cause a change in our view and likely trigger further downside in markets that are yet to fully price in the prospect of recession.