US President Donald Trump announced a substantial escalation to his increasingly adversarial approach to global trade on Wednesday (2 April) evening, with a universal 10% tariff on imports and reciprocal duties levied on most of its largest trade partners. The new measures come at the more stringent end of market expectations and there has been a clear reaction with stock markets and the US dollar falling while government bonds have rallied.
It is important to keep market moves in context. While the stock market weakness is making headlines, the negative reaction is contained for now, given the lack of clarity around how long tariffs may be in place for before being diluted down by negotiations and exemptions. It is also important to maintain a long-term view to investing, with UK and European stocks still higher year-to-date and although US equities have fallen, that is coming off the back of two years of sizable returns in the region of 20% per annum.
Tariffs:
- All US imports will be subject to a 10% tariff, effective 5 April
- Targeted nations will receive a higher “reciprocal” tariff rate, effective 9 April. For example, a 34% duty will apply to China, 20% for Europe and 24% for Japan.
- Tariffs will be stacked, meaning that effective tariffs will be higher — the base rate on China will be 54% (new 34% tariff plus current 20% tariff)
- 25% tariff on cars made outside the US, effective 3 April
Economic impact
The direct impact of tariffs on company earnings varies by sector and region. Country equity market indices have varying degrees of exposure to their underlying economies, but the potentially wider reaching implications are around overall impacts for economic growth and second order impacts of a growth slowdown should all tariffs remain in place (which seems unlikely given Trump's comments of being open for negotiation).
We see the latest developments as negative for US and global growth and therefore detrimental to future equity returns, everything else being equal, hence the risk-off market reaction. There remains some confusion regarding the implementation and exemptions of tariffs, which has led to varied estimates as to the weighted average tariff rate of the forthcoming measures, ranging from 20%-25%. This would put tariffs even higher than the level seen in 1930 after the Smoot-Hawley act ushered in a wave of protectionism.
What is clear is that this marks a substantial increase on prior levels and will serve as a headwind to growth while increasing price pressures. The measures are expected to raise revenue (early estimates of around US$400bn, approximately 1.3% of GDP) but this tax increase could be offset by other tax cuts later on this year.
There are many potential knock-on effects regarding growth, making accurate forecasts difficult. Having said that, if the stated tariffs remain in place throughout the year then real US GDP growth could be around 1.0%-1.5% lower for 2025. The start of year estimate for real GDP growth was 2.2%. Regarding inflation, the initial estimates among economists are for a similar magnitude increase in inflation, with 1.0%-1.5% higher readings expected.
Uncertainty rises
The situation is obviously fluid and subject to change — we have already seen how Trump has used tariff threats to extract political concessions from Canada and Mexico. Rather than “liberation day” providing clarity for investors, it has in effect increased uncertainty. It appears that Trump is seeking to negotiate and draw concessions with the factsheet containing a line stating: “These additional ad valorem duties shall apply until such time as I determine that the underlying conditions described above are satisfied, resolved or mitigated.”
Market reaction
Equities move lower
Although Trump’s latest comments are making plenty of headlines, they have been coming, and equity markets have been trying to anticipate this announcement for some time.
Asian markets closed lower but not drastically on 3 April with Japanese equities -2.8%, Hong Kong -1.5% and China -0.6%. The relatively small size of the decline in China is perhaps surprising, although it may be explained to some extent for increased hopes of further stimulus measures in response.
US stock benchmarks opened 3% lower at similar levels to last week’s low. The sell-off overnight has essentially erased the last couple of day’s gains, when markets were potentially seeking to recover in hope of a less stringent tariff announcement. European markets also declined, but again not in a dramatic fashion (-2% at time of writing) and they remain comfortably higher year-to-date.
The current outcome is worse for some sectors (athleisure, luxury, capital goods) but actually better than it could have been for others (alcoholic beverages, autos, pharmaceuticals). This highlights the benefits of portfolio diversification and why active management can provide more favourable opportunities than a blanket passive approach.
The US dollar has fallen to a six-month low in response, with sterling rising to US$1.32 and the euro to US$1.11, up 5% and 8% year-to-date, respectively. This has presented a headwind for sterling- and euro-based investors holding dollar-denominated investments.
Fixed income remains safe haven asset
Global bond markets, in particular US Treasuries, have risen sharply in recent sessions, as investors take flight and look for safe-haven assets. Gilts are up 1.5% over the last week, demonstrating the diversification benefits bonds can provide during bouts of equity weakness. Should stocks fall further, then we would expect further upside in bonds.
The moves imply that the Federal Reserve will need to put additional rate cuts on the table to look to safeguard against the economy tipping into recession. But, at the same time, policymakers now face inflation rising too, putting them in somewhat of a bind. Growing signs of stagflation put the post-pandemic soft landing in doubt and we will be following economic releases closely.
Employment data is going to be key, with the non-farm payrolls figure on Friday 4 April expected to reveal how employers have been responding to Trump’s moves so far. While the figures won’t yet reflect any of the latest tariff moves, they will give an indication of how robust the jobs market is and whether it can withstand a downturn in growth.
Escalate to de-escalate?
Taking a glass half full approach, there is some hope that this could signal a high-water mark and that negotiations row back tariffs over time. This view is supported by comments from Treasury secretary Scott Bessent who referred to the levels as a “cap”, although there have been questions over his degree of control in this regard.
On the other hand, there is scope for things to get worse before they get better, and the additional tariffs could trigger retaliatory measures from other countries. It’s hard to predict how other leaders will react and although it would be in everyone’s interest to de-escalate the situation there is the possibility that we see further escalation.
Conclusion
In the meantime, we remain steadfast in our belief that our long-term approach to constructing multi-asset portfolios is optimal. The strong performance of bonds in recent sessions shows their diversification benefits during times of market uncertainty while the positive returns from European equities year-to-date speak to what can be gained from geographic diversification.
We believe in the importance of maintaining an analytical approach and avoiding emotional, knee-jerk reactions that have proven to lead to worse investment outcomes over time. Volatility has clearly increased as sentiment has soured, but we remain committed to cutting through the noise and focusing on market fundamentals. We will be continually monitoring developments as and when they occur and continue to provide timely updates where possible. If you have any specific questions, please don’t hesitate to contact your investment manager to discuss further.
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