Trump tariffs vs Market expectation

What is the announcement, and how does it compare to market expectations?
President Trump announced that he would apply a minimum 10% tariff on all exporters to the U.S., and multiple countries will face an additional tariff that equals half the ratio of the U.S. bilateral trade deficit with the country divided by U.S. imports from that country. The list of countries is extensive, with some countries facing tariffs of over 40%.

Of the major global economies, China will face a 54% tariff (a 34% “reciprocal” tariff on top of the already announced 20%), Europe will face a tariff of 20%, and Japan 24%. Several countries, including the UK and Australia, will have the minimum 10% applied to them. Canada and Mexico were excluded from the list, suggesting they will continue to face 25% tariffs for non-USMCA-compliant goods, but no additional levies. Exemptions have been given to energy products, sectors that are already facing additional tariffs (such as aluminium and steel), and other sectors that are subject to investigations— reducing the overall impact. However, many of these exemptions are likely only temporary as additional sectoral tariffs are likely to be applied. Regarding timing, 10% tariffs come into effect this weekend and the higher tariffs will be introduced next week.

Previously announced measures had increased the U.S. average tariff rate to 11%, the highest since the 1940s. Yesterday’s announcement raised the tariff rate even further to around 24%, the highest since 1908, and was meaningfully more aggressive than the broad market had expected.

Unpacking the immediate market reaction

With the initial announcement proving to be more aggressive than expected, the market responded overwhelmingly negatively, with stock futures trading lower and the U.S. dollar weakening further. U.S. Treasurys have rallied only slightly as the market tries to digest the conflicting growth and inflation impacts.

For the time being, market expectations for Fed rates have not shifted, with three cuts still expected this year. However, some forecasters have already taken out one Fed cut from their 2025 forecasts, so market pricing may begin to shift. Fed Chair Powell speaks tomorrow and may offer some insights as to how the central bank is viewing this very challenging policy predicament.

Next steps

While “Liberation Day” helped reduce some tariff uncertainty, it hasn’t resolved it entirely. Markets are still waiting to see whether additional sector-specific tariffs will be announced and whether countries will choose to negotiate or retaliate.

Negotiation could lower some of the higher individual tariff rates, while retaliation risks triggering an escalatory cycle. Early reports from Europe and China are suggestive of retaliation, though both are likely to respond cautiously as they weigh the least damaging path forward. For some countries, negotiations will be particularly difficult. In the EU’s case, for example, VAT is viewed as a fair, non-discriminatory tax since it applies equally to domestic and imported goods.

Ultimately, whether through negotiation or retaliation, the U.S. announcement points to a renewed stretch of uncertainty over the final scope, level and timing of tariffs.

How does this impact the macro outlook for the U.S.?

The size and scope of the tariff announcement pale in comparison to punitive trade actions seen during the 2018 Trade War and underscore the heightened economic disruption that is likely to emerge. The overall impact is likely to be severe to the consumer, with the tariff increase representing the largest tax-hike seen in the U.S. in modern history.

While the administration’s stated goal of the tariffs—reshoring manufacturing and the resulting capex boost to the economy—is certainly possibly, the reality is that the process will likely take years, if it happens at all. In the meantime, the steep tariffs on imports are likely to be an immediate drag on the economy, with limited short-term benefit.

One item that market participants will be waiting to learn more about is pro-growth economic tailwinds. An optimistic scenario would be for new fiscal measures to be announced, potentially funded by the $600-700bn in annual tariff revenue in the near-term. Uses for the tariff revenues could include helping to reduce the deficit thereby driving down bond yields, or financing tax cuts. For example, corporate tax cuts would stimulate on-shoring, while income tax cuts could provide important support for lower-income households, limiting the tariff impact on the U.S. consumer. To date, nothing has been formally proposed, but it would provide an important support to both the U.S. economy and markets if this begins to take shape.

Ahead of the announcement, most analysts had revised their U.S. growth forecasts lower but still did not expect a recession. With the size and scope of what was announced, however, there are now likely to be further downward revisions as economists recalculate the increase in the average tariff rate.

Our initial estimates suggest that U.S. GDP growth is likely to see an initial hit of around 2.5%, with the fallout potentially larger if some trade partners retaliate. (This is an increase from our prior estimate of about a 1.5% hit to growth, following the trade actions announced before April 2.)

We will review our GDP forecast (which had been initially lowered in early March to show GDP growth falling meaningfully below trend but skirting recession) but early calculations suggest that a U.S. recession could materialise unless:

1. At least some tariff rates are reduced in the coming months; and,
2. The Fed resumes policy rate cuts; and,
3. Growth-friendly measures are introduced later this year, such as tax cuts and deregulation

Impact on inflation

The most meaningful impact of the tariffs is likely to fall on U.S. consumers. With the most significant tariff increases targeting countries central to the U.S. supply chain for consumer goods—China, Vietnam, Taiwan, and Cambodia—households should expect higher prices across a wide range of everyday items. The introduction of the 10% blanket tariffs on other trading partners further limits the potential for substitution, leaving importers—and ultimately consumers—with little choice but to absorb the full cost of rising prices in the near term.

As a result, inflation pressures are set to intensify. Current forecasts likely underestimate the upside risk, with estimates suggesting that tariffs alone could add as much as 1.4% to inflation. With roughly 6% of personal goods consumption tied to imports, core CPI could easily trend back toward 4% by year-end, reversing much of the recent inflation progress and weighing on real purchasing power.

The combination of slowing growth and rising inflation creates an increasingly uneasy macro environment—one that bears some resemblance to stagflationary conditions, even if it doesn't fully meet the definition. This mix adds complexity to the policy outlook.

How might the Fed’s policy outlook be impacted?

From the Fed’s perspective, the recent inflation pickup makes their policy decision making even more uncomfortable. With price stability still not fully achieved, and tariffs threatening to push prices higher, policymakers may not be able to provide as much monetary support as the growth picture requires, and could even bind them from cutting rates at all.

If the Fed believes that softer growth will exert downward pressure on inflation in the medium-term (provided long-term inflation expectations remain anchored), the path to policy easing is still plausible. We continue to expect two to three rate cuts this year, but the path to easing has become narrower and more uncertain.

What do the tariffs mean for Europe and China?

Europe

We initially lowered our 2025 Euro area GDP growth forecast from 0.9% to 0.7%, assuming a 10% targeted tariff on European exports. A 20% blanket tariff now points to a 0.9 percentage point direct drag on growth—with further downside risk if Europe retaliates. As a result, another downgrade to the European growth outlook is likely.

The inflation impact remains uncertain, but the downside risks to growth suggest the ECB’s policy path is relatively straightforward. While recent weeks have seen some hesitation around the need for additional rate cuts, the combination of weaker growth prospects and a stronger euro makes a rate cut at the ECB’s April meeting highly likely. If a recession becomes more probable, multiple additional cuts could follow.

Note that Germany’s historic fiscal policy shift should at least provide a positive offset over the medium term, helping Europe to contend with the tariff headwinds. In addition, it is possible that Europe introduces new targeted measures to support deeply impacted sectors.

China

China’s 54% tariff is close to the original 60% tariff that President Trump had initially threatened. The 54% is also still larger than most forecasters were expecting. With tariff rates on several other Asian economies rising to levels that will likely tip them into recession (for example, Vietnam has been hit with a nearly 50% tariff), it will be challenging for China to re-route their exports.

Additional stimulus from policymakers, both monetary and fiscal, is likely to be announced to offset the tariff impact. At the recent March NPC meeting, the announced fiscal package was modestly expansive, but policymakers noted that they were committed to increasing the policy response if necessary. The next watchpoint will be later this month, when the politburo holds its quarterly meeting on the economy.

The early read is that export headwinds will intensify, weighing more heavily on growth. However, additional stimulus measures are likely to cushion the blow by lifting domestic consumption. Even so, we expect to revise down our 2025 GDP growth forecast for China—shifting from a strong 4.5% to a more modest 4.2-4.3%, depending on the size and speed of policy support.

Risk asset outlook

Unfortunately, yesterday’s announcement left tariff uncertainty firmly in place and was not the clearing event many had hoped for. The stagflationary nature of the shock implies that markets are likely to remain risk-off for the time being. With over 41% of S&P 500 revenues generated outside the U.S., markets will be focused on how countries respond to the announcement and if they begin to consider ways to strengthen their economies against these headwinds.

Notably, yesterday’s announcement potentially paved the way for the Trump administration to turn their attention to some growth-friendly measures, such as tax policy and deregulation. A constructive announcement on these policies could steady market sentiment and enable investors to look beyond the destructive trade headlines that have dominated markets for the past two months. 

Principal Asset Management