SUMMARY
Investors were taken aback by the extent of new US tariffs. With a rapid fiscal or monetary rescue for markets, we remain cautious
KEY TAKEAWAYS:
New US tariffs are larger than expected
Markets have understandably taken fright
Negotiations and implementation are next up
Even quality equities may suffer near term
Credit could feel the strain
The Trump administration’s April 2 tariff announcements surprised the market with their scale and their breadth. Our best estimate is that full delivery of these tariffs would increase 2024’s effective tariff rate by 10X, to nearly 25% - meaningfully higher than the 10-15% range being discussed by the investment community before the announcement.
Our best estimate is that these policies would generate a $750 billion increase in US taxes in the year ahead, amounting to a fiscal tightening of 2.5% of GDP. The effects from such a large spike in import taxes, if not negotiated away, has the potential to wipe out US GDP growth in 2025. Even still, the extent of trade retaliation, additional tariffs, and legal challenges is yet to be seen.
Market reactions: the first 24 hours
Global equities plummeted in the overnight trading session as investors reduced risk and the selling followed through the trading day on Thursday.
The large-cap S&P 500 closed down 4.6% on the day and the small-cap Russell 2000 fell more than 6.5%. Bond yields fell across the world with investors flocking to safe havens amid rising fears of recession. Credit spreads continued to widen, though have only returned to late 2023 levels.
Perhaps most notable is the move in FX markets. The US dollar has traded sharply weaker versus other major currencies, a striking reversal of the “American exceptionalism” narrative that dominated most post-election analysis. We view these extreme market reactions as a rational response to policies that will present significant headwinds to growth and confidence in the near term.
Tariff next steps
The April 2 announcements were only the beginning of a critical phase of tariff negotiation and implementation. As of today, broad-based 10% tariffs will be imposed on April 5, and more targeted measures will take effect on April 9.
In theory this opens up a window for major trading partners to negotiate with the US. However, we are skeptical that global leaders will immediately rush to offer aggressive concessions. The administration has also promised further tariff announcements covering semiconductors and pharmaceuticals, which could further ratchet tariff rates for countries like India, Ireland, Switzerland, and key chipmaking nations in Asia.
Earnings on our radar even if the tariff-induced volatility calms, the near-term calendar is packed with equity catalysts as 1Q25 reporting season kicks off on Friday, April 11. While the earnings releases may be history, companies will have an opportunity to update the analyst community on their forward guidance and tariff mitigation strategies.
We believe the tone and content of earnings calls will be infinitely more important than the results from the first three months of this year. We are particularly worried that some firms will pull guidance completely amid the uncertainty, leaving analysts in the dark about the trajectory for sales and profits over coming quarters.
It is hard for us to imagine how companies will be able to reassure investors while the policy environment and growth backdrop are evolving so quickly. Without a meaningful amendment to April 2nd’s tariff plan, profits could be wiped out for this year.
Bottom line
Even at significantly lower prices than we first delivered the message to wait to add to risk, we are reiterating that same advice.
Given the heightened uncertainty on growth, policy, and earnings, we expect that even high-quality equities will remain under pressure in the near term. Investors who are holding on to hope of a swift rescue from monetary or fiscal policy support will likely be disappointed.
In fixed income, we are increasingly concerned about a deterioration in credit and prefer short duration bonds and cash to long duration Treasuries.
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