Effects of tariff increases

• Enguerrand Artaz
  Strategist
  La Financière de l'Echiquier (LFDE)

The reaction of the equity markets to these announcements was, logically, very negative. While futures had rallied on a Wall Street Journal rumour of a generalized increase of only 10% (which turned out to be partly true, as it was the minimum rate, but very incomplete), they then fell sharply: -3.5% in a straight line for the S&P 500 future: -3.5% in a straight line for the S&P 500 future, and the decline is continuing this morning.

At the same time, the dollar has weakened sharply against the euro and the yen, and interest rates have eased significantly. This last point is noteworthy: the markets are in “risk-off” mode. And it is the negative impact of these rates on growth that is at the center of fears, much more than the short-term bullish effect on prices.

What are the prospects?

Is there any negotiating room for these rates? The answer seems positive. But these negotiations will take place with tariffs in place. And the longer they take, the greater the negative impact of the tariffs. Moreover, it seems unlikely that many countries will escape the minimum threshold of +10%. What’s more, the risk of escalation is significant. Some countries might be tempted to implement retaliatory measures. Trump has warned that, in this case, tariffs would be further increased. This seems to have been anticipated. Astonishing as it may seem, the tariffs imposed on each country are described as “discounted tariffs” (i.e. lower than the tariffs supposed to be applied by the various countries, according to the nebulous calculations of the White House); this leaves room for further increases in the event of escalation.

In short, these initial announcements may ease the situation, but this will take time. Developments will certainly be on a country-by-country basis, and there is a notable risk of escalation. As we suspected, this “Liberation Day” is a step forward, but the uncertainty remains.

Market strategies?

Every day spent with these tariffs will have a negative impact on US growth, primarily through consumption. Given the fragility of the average American consumer and his or her aversion to price rises after the inflationary phase of recent years, passing on tariff increases in consumer prices is bound to have a heavy impact on demand. And if rate hikes are not passed on to consumers, it is companies’ margins that will suffer. In any case, the impact will be very negative, and the risk of recession in the United States is now becoming very real. This situation will also weigh on the growth of our trading partners.

At this stage, the markets do not yet appear to be positioned for this scenario. The S&P 500 is only -10% off its all-time highs, while valuation and positioning remain high. The potential for further de-risking appears significant, especially as one of the first victims of this Liberation Day, the US individual, was also the main support for the markets over the last two years. Adopting a cautious stance, both in terms of equity exposure and style – with an emphasis on defensives – seems appropriate

Can European equities outperform in this context? Certainly, with less potential for deleveraging given the still weak positioning in the asset class, lower valuations and downward pressure on the dollar that could continue, making US equities even less attractive to euro investors. In absolute terms, however, we should not expect a decoupling: in such a negative scenario, the trend will be downward for all markets.

Where to turn? Beyond cash and possibly gold, bonds – avoiding High Yield and US credit – remain the saving grace. The downside risk to global growth from these rates should continue to push yields lower. What’s more, on European IG credit, the risk of a sharp spread widening is relatively moderate.

Disclaimers: This information, data and opinions of LFDE are provided for information purposes only and, as such, do not constitute an offer to buy or sell a security, nor do they constitute investment advice or financial analysis. Past performance is no guarantee of future results.