Key Takeaways
- US equities have now recovered from the losses experienced post early April’s tariff announcements. The S&P500 is now only 3% off its all-time highs.
- Despite the recovery in equities, the US dollar is weaker and US Treasury yields have increased.
- We have seen some agreements over new tariffs – most notably between the US and China – but sector specific announcements are looming.
- Despite the pause and agreements the US tariff regime is now significantly higher than last year.
- Markets have recovered but much uncertainty remains. It will be some weeks before reliable economic data emerges, and businesses and consumers need clarity.
- We are adopting a cautious approach to asset allocation with a modest emphasis on equities and small overweights to the US and Europe.
If you had the luxury of being on a desert island since the end of March, looking at the S&P 500 index you would wonder if much had been going on. US equities have completed the round trip and have now recovered all their ‘Liberation Day’ losses in the aftermath of a surprisingly encouraging outcome from talks between the US and China, which have seen a reversal in the post ‘Liberation Day’ escalations in tariffs to levels which amounted to an effective ‘blockade’ in trade.
We start the week with the S&P500 index only about 3% off its all-time high. But that doesn’t tell the whole story – the dollar has weakened notably, down 3% since ‘Liberation Day’ and US Treasury yields have jumped. Interest rate expectations have also been on a rollercoaster ride – at the market lows in the week after the tariff announcements, markets were pricing five rate cuts for the year. Now we are down to just two.
It still feels like the story of this trade war has several chapters to be written. The end of the 90-day window before reciprocal tariffs are theoretically reinstated is just over seven weeks away. Before July, we should also have news on tariffs for specific sectors, such as semiconductors and pharmaceuticals, mirroring what we have already seen for the auto industry. But financial markets are very much taking the ‘glass half full’ view that we will see continued easing of tariffs from the initial levels that caused such distress in early April. Policy uncertainty is now easing, and there seems to be consensus that we are very much on the path of de-escalation.
The landing zone for tariffs under the template set by the UK and China may feel like a good outcome, but we are still in a far worse position than before. The upper and lower boundary for tariffs is becoming clearer, and it would appear the baseline 10% tariff is ‘as good as it gets’. We should be mindful that with a baseline 10% and other tariffs set to stay in place, the overall US tariff regime is now estimated to be around 14-17%. This is way higher than anything we have seen since the 1930s and a huge leap from 2.5% last year. While the trade war may well be on a de-escalating path already, there will be impact for some countries and companies. It is impossible for the US to carry out negotiations with everyone in the 90-day window, hence the comments over the weekend that some countries will be reminded of their tariff levels in a letter due to arrive in the next 2-3 weeks.
The strong recovery in markets despite continued uncertainty is tempering our asset allocation views and we are not minded to add additional risk to our already slightly positive views on equities, and mild biases to the US and Europe. The strong rally in equity markets suggests ‘Liberation Day’ was just a bad dream, but the heightened tariff regime, and persistent uncertainty will still have a negative impact on the economic outlook, albeit ‘less bad’ than was feared a few weeks ago.
Thankfully, given the extremely high tariff levels between the US and China have been in place for a limited time, the economic damage should only be relatively superficial. The front running of trade before the tariffs kicked in and the drop off in shipments from China to the US in the past few weeks, however, still has the scope to cause plenty of confusion in the economic data before it settles down. As a result, we are going to have a period where the economic data carries little weight given the confusing policy backdrop. A little patience is needed before we have ‘clean’ economic data, and a more measured analysis of the economic backdrop can take place.
The key point to limit the economic fallout is to ensure we have certainty sooner rather than later; and there is still much to be done in this respect. Business and consumer spending decisions are driven by confidence, and this could take some time to restore, particularly in the US.
