Tariffs

While the market welcomed the pause in Liberation Day tariffs, we believe investors are overly optimistic about the relief from this Trump-driven uncertainty. Even with the pause, current tariff levels remain higher than they were in January. Elevated tariff levels are likely to be inflationary, which could explain the recent spikes in US Treasury yields. Currently, Congress does not have a veto-proof majority to rein in President Trump’s tariff policies, meaning the trade war with China will persist.

China’s aggressive retaliation against U.S. tariffs will enable President Trump to shift from punishing allies and redirect the trade war toward China. If Beijing does not react to the latest tariffs by doubling its fiscal stimulus, it indicates they are planning something different, as China will encounter economic destabilization. The likelihood of a hybrid military pressure on Taiwan will rise.

We believe Beijing views these US trade actions as nothing short of a declaration of economic war, not just a trade dispute. The US-China confrontation is set to escalate from here. Chinese authorities will allow the yuan to depreciate materially. Go short CNH against the US dollar. For EM and Asian equity portfolios, we are downgrading Chinese investable/offshore stocks from neutral to underweight.

The world is focused entirely on the trade war between the US and… well everyone. This is fair given that there has been no greater market catalyst than Liberation Day since the pandemic. However, we continue to stress that the BIG PICTURE for macro investors is the rotation out of the US. A rotation that started well before April 2, despite the understanding of the investment community that some tariff action would be afoot. 
 

President Trump imposed tariffs on the world in his first 100 days, as we expected. Tariffs may have catalyzed a recession in the US, given the weakness in consumer sentiment and demand. Trump will soon backpedal and grant exemptions to countries that are negotiating, which he will showcase as proofs of his successful trade policy. While he may backpedal on his tariffs on other countries, China is not likely to receive the same treatment due to the US-China strategic competition. 

Equities will find a bottom when the full effects of tariffs on earnings and economic growth are priced in. The bottom of the market appears a long way away, and the S&P 500 may end up as low as 4,300, barring any reversals in trade policy that could undo the damage.

This report looks at the FX implications of the Trump tariffs, and the review of our Q1 trades.

The March employment report showed strong job growth, but the labor market remains in a fragile state and the demand shock from tariffs could be the catalyst that tips it over the edge into recession. 

On the one hand, US tariffs are much more deflationary for the rest of the world than for the US, so interest rate differentials might move in favor of the US dollar in the near term. On the other hand, portfolio outflows from the US will weigh on the greenback over a cyclical horizon. We recommend buying Mexican and Central European domestic bonds.