Announcement effect

To reiterate the opening line from the past two weeks, “global equities retreated further last week due to ongoing US tariff concerns.” Markets rebounded on Friday, largely as a result of a quieter day from President Trump.

Last week’s major global highlight was US President Donald Trump’s confirmation that he would move forward with steel and aluminium tariffs. The tariffs have no exceptions, meaning Australia will also be impacted. In response to Europe’s 50% tax on US whisky, Trump has threatened to impose a 200% tariff on European wine, champagne and other alcoholic beverages. Trump has also confirmed a round of “reciprocal tariffs” is also in the works.

So where do investors go from here? Until now, my view has been that Trump would not persist with policies that threatened a major equity market fallout and/or a US recession. However, the US equity market is already down 10% and his resolve to pursue big tariff increases seems undiminished. He’s also conceded that the US economy may face a period of ‘transition’ and refused to rule out a recession.

Some see method in the madness. Trump wants a recession to force the Federal Reserve into cutting interest rates and lowering bond yields, to make the budget deficit easier to finance. But that simply makes no sense. A recession would make the deficit even larger. Further, tariffs also involve price increases which the Fed and/or the bond market might not take as a signal to lower interest rates. It’s akin to cutting off one’s nose to spite one’s face.

The harsh truth may be that Trump genuinely believes large tariff increases will strengthen the economy and boost government revenues, despite the prevailing economic evidence suggesting otherwise.

If this is so, investors will be left with a new situation. First, markets will need to navigate the flurry of announcements. Some stability may return once Trump has finished all of his tariff declarations.

The next key point to watch is whether he shifts focus to more market-supportive policies, such as tax cuts. Less market-supportive policies could include significant spending cuts and/or large reductions in immigration, which may have a depressive effect on demand.

By then, markets will have passed through the eye of the storm. Now, investors will have to wait for the ultimate impact of these tariffs on the economy. These would likely start with increases in wholesale and retail prices as well as some downgrades to corporate earnings expectations.

This could lead to further equity market wobbles, and perhaps an extension of the equity market correction to 20%. However, the ultimate question is whether a 20-25% across-the-board increase in US tariffs causes a recession and a much deeper equity market decline.

At this stage, my judgement is that tariffs will not cause a recession. I believe the underlying economic fundamentals (such as household and corporate balance sheets) remain sound, and the Fed could ultimately pivot and cut interest rates if need be. Trump could also announce tax cuts to further support corporate America.

However, a lot remains uncertain and we are just ‘war gaming’ potential scenarios at this point. Early signs of an unduly negative reaction from corporates or consumers could come from weekly jobless claims, consumer sentiment and/or spending data.

This uncertainty is all the more disappointing given the good news we saw in US inflation last week. Lower-than-expected gains were seen in both consumer and producer prices for February. Were it not for the tariff chaos, markets would likely be celebrating the continuation of the US ‘soft landing/Goldilocks’ scenario.

In other key global news last week, China’s Two Sessions series of key policy meetings concluded with a pledge to pursue similar growth this year as last year. There are, as yet, no obvious signs of a new ‘fiscal bazooka’.

In Japan, major firms agreed to union demands for hefty wage increases. While this should help support consumer spending, it will increase the likelihood of rate hikes from the Bank of Japan in coming months.

In Europe, Germany’s main political parties agreed to exempt spending on defence, infrastructure and climate change from rules limiting budget deficits. This, along with hopes for a peace deal in Ukraine, is helping sustain sentiment in European equity markets despite the escalating trade war with the United States.

Finally, with inflation close to its 2% target and new threats on the trade front, the Bank of Canada cut interest rates by 0.25% to 2.75%.