Traversing Trump tariffs

Financial and currency markets were left in turmoil following President Donald Trump’s announcement at the White House Rose Garden to sharply raise US trade tariffs on the 2 April, the date he dubbed as “Liberation Day”. If sustained, these new tariffs will have a broad and significant impact on countries, industries and products, as well as risk assets. Close allies and even the Australian owned, uninhabited Heard and McDonald Islands in the Southern Indian Ocean have been slapped with tariffs! 

For investors, this abrupt policy change and the uncertainty it has created, led to some of the biggest moves in financial asset prices since the pandemic. There are many ways markets could behave in the coming months—much will depend on Trump. 

For instance, tariff increases could be negotiated lower, creating grounds for a relief rally in stocks. Alternatively, trade wars could intensify globally, with increased uncertainty feeding into the real economy and markets. 

It is worth looking at what we know and what we don’t know. 

First, Trump's tariff plan raises taxes on imported goods. It starts with a 10% flat tariff for all countries (effective 5 April) except Canada and Mexico, who are already subject to tariffs from illegal immigration and fentanyl trafficking across the border. Then, countries with a goods trade deficit with the U.S. face extra charges (a “reciprocal” tariff) starting 9 April. Some imports, like steel, aluminium, energy, and cars, are exempt from these tariffs, as duties have already been charged.

At face value, the average tariff rate is 18% when weighted by imports, but product exclusions lower the effective increase to 13%, which would still be the highest rate since World War Two.  The exclusions apply to goods already subject to sectoral tariffs, including those not yet announced.

On Friday 4 April, China responded with a 34% tariff on US imported goods (effective 10 April)1 and plans to impose export controls on rare earth materials, a crucial input for the US high-tech industry. China has also filed a complaint with the World Trade Organisation, accusing the U.S. of violating international trade rules. These moves are likely to escalate trade tensions between the US and China.

Second, there have been big moves in financial markets since Liberation Day. Global equities have corrected sharply, with sterling returns on the MSCI All Country World Index (ACWI) benchmark down 5% since the 1 April. Ironically, US stocks have fared worse than the rest of the world.¹

In the bond market, US Treasury yields declined, dragging government yields down in other markets. The crude oil price has fallen nearly 10% on concerns of slower trade and economic growth, as well as a strangely timed oil production increase by the OPEC+ group of major oil-producing nations. In currency markets, the US dollar has depreciated, as foreign investors’ appetite for US assets takes a hit.

Third, despite the sell off, equity valuations remain above the long-term average. The MSCI ACWI forward price-to-earnings (PE) ratio trading on 17.7 times, above the low points of 13 times during both the pandemic and interest-rate corrections in 2020 and 2022, respectively.¹ This suggests there could be room for equity downside should US economic activity begin to slow over the coming months.

What is Trump’s objective?  Trump’s announcements on Liberation Day throws up a lot of questions. These include:

1. Does Trump truly believe that US trade tariffs are a way to raise revenue from the rest of the world and correct bilateral trade deficits?;
2. Or is it an attempt to squeeze out favourable terms from trading partners that could undermine China’s influence in the global economy, the US’s main rival for superpower status?;
3. Or does he hope to protect the US manufacturing sector from foreign competition to boost the US working class? 

Whilst we can’t answer these questions today, we can look at his previous actions and policies to get an idea of what to expect. First, he has shown a preference to use economic coercion to secure favourable trade deals for the US. Second, he likes to dominate the media and use the publicity to project an image of strength. And third, part of his approach also includes making outlandish demands (e.g. suggesting that the US will annex Greenland). Much of Trump’s approach can be likened to President Richard Nixon’s “Madman Theory” on foreign policy in the 1970s. 

Trump knows that consumers in the European Union and Chinese economies probably don’t have enough disposable income to support demand for US goods and services in order to correct wide US trade deficits. Trump needs to be careful that he does not overplay his hand. If higher import tariffs cause inflation, then it will reduce his popularity. Trump will have an eye on the November 2026 midterm elections, where he needs the Republican Party to retain their majority control in Congress or he risks becoming a lame duck president in his remaining two years in office. 

Arguably, the best Trump can gain from trade tariffs is to use them as a bargaining chip to benefit the US economy through favourable terms on trade and investments to show visible wins to his supporters. For instance, Trump could offer to lower trade tariffs if China agrees to buy more US Treasuries. This will help keep yields down to make it easier to finance a wide US budget deficit.

Recessions are typically driven by deteriorating labour markets. As firms layoff workers, consumption falls, leading to further job losses and a downward spiral. The data we have today suggests the labour market currently remains solid, with real take-home pay expanding by nearly 2% a year.¹ This should provide the consumer the financial wherewithal to shop. Meanwhile, US corporate finances are in reasonable health, with plenty of cash on the balance sheet. Small business sentiment has also improved on the expectation of less government regulation, while the Fed has been cutting interest rates since last summer.

However, the longer this trade war continues, the greater its impact on consumer and business confidence. If confidence does collapse, it could tip the US into recession. That could lead to further downward pressure on stocks should analysts revise down company earnings expectations. The second-round impact of a recession (i.e. mortgage debt defaults) would also affect the financial system, leading to lower equity valuations.

In times of market uncertainty, diversification is essential for investors. We invest across geographies, sectors, and asset classes to reduce downside risk and improve risk-adjusted returns for clients. Our allocations to bonds and gold have proven valuable in managing current risks, with both asset classes performing well amidst escalating global trade tensions. 

Investors should avoid panicked decisions. As we’ve seen previously, Trump has shown a willingness to change his mind at short notice, which could prompt a positive reaction from risk assets. We have also seen policy stimulus from the EU and China in recent months, highlighting investment opportunities beyond US equities.

Despite current challenges, falling bond yields, lower oil prices, and a weaker dollar could pave the way for a rebound in the equity market once US trade policies stabilise. In his Liberation Day speech, Trump suggested that he will pass tax cuts later in the year along with significant deregulation, both of which should benefit the equity market. 

As investors traverse Trump tariffs, our portfolios remain diversified. We are avoiding knee-jerk reactions and will be looking for opportunities to take advantage of current dislocations.  

1. LSEG Datastream/Evelyn Partners