04.04.2025 -
- US President Donald Trump announced a wave of new tariffs on 2 April, which he labelled ‘Liberation Day’.
- The market reaction has seen equity markets fall while bond yields have moved lower as economic growth expectation are cut.
- Globally, bonds should outperform risk assets; and in credit markets better quality credit is likely to be preferred.
US President Donald Trump announced a wave of new tariffs on 2 April, which he branded ‘Liberation Day’, arguing they would help boost the US economy. Trump introduced a new baseline 10% US tax on goods from all countries and higher reciprocal tariffs for nations which the US government believe have high barriers to US imports.
The US government is expected to impose the reciprocal tariffs on around 60 of the "worst offenders" from 9 April.
Market impact
The US tariff announcement is widely expected to worsen the global growth and inflation outlook. The sweeping tariff package came in at the high end of expectations and, according to analysts, will increase the effective tariff on imports to the US to between 20% and 25%.
Some analysts suggest that US economic growth could be reduced by 1% to 2% while inflation will move higher. This will be seen as a stagflation for the US economy. Tariffs on goods from the rest of the world should reduce export growth and will be a negative growth shock, with Asia and Europe most affected given the size of the proposed tariff rates.
On the back of the news equity markets moved lower, and bond yields have fallen. Markets are also now pricing in a much higher risk of a US recession and elsewhere with some banks now changing their view to officially call for a US recession in their forecasts.
As well as the direct impact on economic activity, business confidence is likely to continue to be severely impacted by the ongoing uncertainty over the outlook. Some of this could be reflected in company earnings statements in the US and elsewhere over the coming weeks as first quarter numbers begin to be reported. It is hard to see why equity markets would reverse recent moves when the global trading system has just been upended - further equity losses seem to be likely.
For European markets there is a time horizon problem. Increased spending on defence and infrastructure should eventually be a tailwind for European growth and equity returns. However, in the short-term European companies will be hit by tariffs across several sectors. As in the US, guidance from company CEOs will be critical for equity investors in the months ahead.
A new monetary policy outlook
While bond yields are moving lower, as expectations for growth are cut, for central banks, however, it is not clear how this plays out in the short-term. The US Federal Reserve is now faced with the prospect of lower growth and higher inflation. The market is suggesting growth fears will dominate and is pricing in almost four interest rate cuts this year. For the Fed to validate that, we need to see weaker numbers, especially in the labour market. However, the rate outlook is supportive for bonds. With recession risks increased, real yields could move lower. For now, the tariff impact on growth could be more important than the medium-term fiscal outlook but that will impact on longer-term bond yields in time. In general, government bond yield curves are likely to be steeper going forward.
Generally, central banks may be called upon to offset the trade war’s negative growth impact. Market expectations are for further European Central Bank rate cuts. We also expect more pricing for Bank of England cuts and given the size of tariffs imposed on Japan, additional Bank of Japan monetary tightening would be questioned.
Investment implications
The US dollar has fallen on the back of the trade news. The US’s more aggressive stance on trade and other matters appears to be turning global investor sentiment away from the world’s largest economy. This could exacerbate downward moves in US equities and complicates matters for US bonds. However, so-called ‘safe haven’ inflows – even domestically in the US – would tend to favour bonds over equities while the world digests this news.
Indeed, globally, bonds should outperform, with better quality credit (i.e. more rate like fixed income) likely to do better than more equity like credit, where there is a meaningful correlation between credit spreads and equity market moves. In addition, short-duration fixed income strategies in credit and in inflation linked bonds could be beneficiaries of more defensive allocations by global investors.