Written by Steve Andrews
The second week of April brought the tariff discussions to a boiling point after broad global tariffs were instituted on Tuesday, April 8. This in turn pulled the S&P 500 stock index down over 18.5% from its recent high on February 19th. The next day the markets made an abrupt about-face from their tariff-induced panic after President Trump issued a 90-day moratorium on the new reciprocal tariffs for all countries except for China. Why the change in policy?
Shifting Signals from the Bond Market
Slumping stock prices have had little impact on the Trump administration’s tariff policies over the past few weeks, however the recent sharp rise in long-term US interest rates seems to have caught the administration’s attention. After the April 8 tariffs were implemented, the yield on the 10-year Treasury Note climbed a half-point, rising above 4.50%. The spike in long-term interest rates came even as the US inflation picture brightened in March.
Bond traders appear to be concerned that global investors may be poised to reduce their holdings of US Treasuries. This could increase supply in the market, driving prices down and boosting yields (interest rates), just as the federal deficit continues to climb. Treasury Secretary Scott Bessent has said for some time that the administration's focus has been on reducing long-term rates, so the spike in long-term rates was eye-opening for those in the White House.
Concerns Despite Cooling Inflation
Rates rose even as the inflation picture continues to brighten. Consumer Prices (CPI) fell for the first time since 2020. Excluding housing, overall CPI was up 1.8% from March 2024. Not to be outdone, Producer Prices (PPI) for goods and services used in the production process declined to 2.7% (year-over-year) from February’s 3.2% increase, and Core PPI fell to 3.3% - an improvement from the 3.4% annual increase in February.
While the twin inflation reports were heartening for investors, they didn't do much to reduce anxiety over future inflation. While I believe that the current consumers’ outlook vastly overstates the potential for higher inflation, let’s assume that inflation did rebound to, say, 4%. That would suggest that the 10-year Treasury rate could rise above 5.50%, since Treasury yields have historically been set at a spread that runs between 1.50% and 2.00% above the expected rate of inflation. This explains part of the run-up in long-term Treasury rates.
Investor Reactions and Global Markets
The rise in long-term interest rates, resulting from the transition away from US Treasuries as a haven for worried investors, has benefited gold prices, which reached a new record high. How the US economy will weather the tariff changes has global investors hedging their bets, as seen by the outperformance by foreign stocks versus the US this year, and there doesn't appear to be an end to all the uncertainty on the horizon.
Global Trade Strategy
Despite the angst of the past few weeks, there is hope that the uncertainty over trade may be resolved soon. Whether it was the sharp reaction from the bond market, which drove interest rates higher, or the fact that scores of countries facing reciprocal tariffs have approached the US to see if they can reach an agreement, a temporary truce was called and the markets rejoiced in seeing some de-escalation of the tariff talks. While there may be a few outliers once the dust settles, I still believe that the intention of the broad tariffs was not the beginning of a global trade war - rather it was an attempt to corral China which has been pretty much “all take and no give” when it comes to global trade. The administration believes that the time has come to hold China accountable. China is much more reliant on US markets than we are on theirs and will feel the pain from the tariffs deeply. This raises concerns of some type of military response – perhaps Taiwan – which adds to geopolitical risks.
Economic Outlook
As to the effect from the tariffs on the US economy, it comes down to three things: which countries would get tariffs imposed on them; the magnitude of the tariffs; and for how long. The administration has settled two out of those three variables. Now we wait to see how long they last. While China was quick to impose retaliatory tariffs, other countries have already decided it more prudent to come to the bargaining table. Vietnam, Vietnam, facing 46% tariffs from the Trump administration, immediately offered to lower their tariffs to 0% as they quickly realized what's at stake, since they manufacture many of the clothes we wear, as well as the bulk of Nike sneakers, and other products.
The tariff tradeoffs will continue to roil the markets for a while longer. While the economy will likely continue to struggle in the months ahead, as companies and consumers readjust supply chains and weather some temporary price increases, I think the odds are better than 50 / 50 that we will avoid a recession. The US economy entered this rough patch from a position of relative strength. The yield curve, which didn't usher in a recession when it inverted two years ago, is currently positive. There is abundant liquidity in the financial system. Credit spreads, while widening of late as market angst increased, remain low by historical standards, as do new weekly claims for unemployment benefits, while the housing and manufacturing sectors continue to heal. The job market remains healthy, which is supporting consumer spending, and Bloomberg just reported that credit card spending on retail transactions was up 3.1% in March from a year ago.
People (and economies) who are otherwise healthy can suffer a panic attack which raises anxiety, blood pressure, and the heart rate, and makes them feel like the end is near. But, once the stress that triggered the attack fades away, so do the symptoms. As was the case during most of the longest economic expansion in our history (2010-20), the economy is holding up well in the here and now, but many worry that the next recession is just 6 months away. Until the economy shows real signs of a decline in economic health, try to remain calm and not let the anxiety get to you.
