News & Insights

The Tariff Endgame

While there is much fury and posturing in trade news, with our focus on making quality investment decisions, we are trying to decipher what administration officials are saying in detail on tariffs and perhaps infer intent. What’s emerging from initial negotiations already underway with Japan and the EU are several end goals:

• Revitalizing domestic U.S. production of certain key or strategic industries, including semiconductors, pharmaceuticals, small vehicle manufacturing and industrial metals that have been largely off-shored
• “Leveling the playing field” through a likely higher permanent baseline of tariffs to address both tariff and non-tariff barriers, such as tax policy, port fees, subsidies, and currency manipulation, that inhibit U.S. exports or the ability of U.S. companies to compete in some markets
• Fundamentally resetting the U.S.-China economic relationship, which is likely to be the most challenging negotiation of all

The administration will likely focus on forging agreements with long-term partners of the U.S. Japan, the UK, South Korea, Canada, Australia and the EU could play a big role by joining onto deals that are more balanced in terms of U.S. interests. Treasury Secretary Bessent has been advocating for rapid and successful negotiations with the allies to isolate China away from the developed world.

China has a greater risk of enduring high tariffs imposed for longer. Recently, the administration announced more restrictions on the export of NVIDIA and AMD chips to China. The Trump administration is also floating delisting Chinese companies traded on U.S. stock exchanges. The administration demands are expected to include ending subsidies for its industries, currency manipulation, intellectual property theft, arbitrary property rights (including instilling courts that codify clear rights to foreign ownership), aggressive military action toward the U.S. and our allies, and implementing standardized accounting for Chinese stocks listed on U.S. exchanges. While this list gives China options for negotiation, President Xi’s current intransigence, retaliation, and seeming unwillingness to come to the table will likely make negotiations difficult and drawn out. Even then, these issues, if resolved, will still result in a large trade deficit with China. Given that the monumental trade deficit is a primary issue for the Trump administration and many of the contributing factors are fundamental to the Chinese economy, they will find it painful to concede too many of the U.S.’s demands.

There are a lot of apparent noble goals of employment, national security, and leveling of the economic playing field within the administration’s targets. While progress can be made on agreements in the shorter term, this is a huge undertaking with no guarantees of success and will take many years to implement.

United States Effective Tariff Rate

Source: Oxford Economics/Haver Analytics

U.S. Economic Policy Uncertainty Index

Source: Bloomberg

Analysis Paralysis at the Fed

Several Federal Reserve members, including Powell have recently indicated that the Fed is putting monetary policy on hold amid concern over market volatility and uncertainty around administration policies, especially tariffs. Since the presidential election, Fed comments have speculated on the potential effect of disruptive changes in administration policies, including tariffs, fiscal policy, immigration and budget cuts, in marked contrast with the Fed’s prior adherence to being “data driven.” By making no change to its rate path in its March meeting despite increasing inflation expectations, and forecasting lower employment and GDP growth, the FOMC may be sending a troubling signal that it doesn’t know what to do in the face of uncertainty. Despite the market selloff since that meeting, Powell has stuck to a similar tone, even as the latest CPI inflation data surprised to the downside. He is adamant about a “wait and see” approach and not changing policy until there is more clarity on President Trump’s tariffs. What will give him more clarity when the tariffs can change day to day is not clear.

Powell’s views seem puzzling. In a talk at the Economic Club of Chicago, he warned of the risks of stagflation and supply disruptions similar to those during the pandemic. Yet he and Fed Governor Waller resurrected the infamous “transitory” characterization to describe inflation due to the tariff’s supposed one-time hit to inflation.

Powell also firmly stated that they are going to prioritize the inflation part of their mandate, meaning additional rate cuts are unlikely to come soon. Minneapolis Fed President Neel Kashkari and Governor Adriana Kugler have stated a similar view. Fed funds rate futures traders have taken note. There has been hardly any change in rate cut expectations over the last month, despite the disruption to markets and expectations. The upside to this is that amid continued inflation fears, rising interest rates, and a falling dollar, a seemingly hawkish Fed adds an additional layer of confidence to the treasury market and the world’s reserve currency.

This stubbornness on the Fed’s part to ease policy has created a growing rift between Powell and the President. While President Trump has openly advocated for his “termination”, Powell, in maybe the only thing he has said clearly and with conviction, insists he will not be pushed out by the president. Nonetheless, his term expires in May of 2026 and speculation as to who will replace him has already begun. As accusations of the Fed being politically biased grow, the calls for Powell’s resignation will too. With other central banks cutting, as the ECB just did, amid massive trade uncertainty, a lack of adjustment in the Fed’s policy will only increase the calls for a change in leadership at the Fed.

Economic Projections from Federal Reserve Members and Federal Reserve Bank Presidents

Source: The Federal Reserve

Market Expected Fed Funds Rate by End of 2025

Source: Bloomberg

Soft Data Softens but Real Economy Still Okay 

A downturn in consumer and business survey data has diverged from actual reported economic activity, which remains stable. While this may seem obvious given the fears surrounding tariffs, it highlights the strength of the economy as we go into these unsettling changes in policy. Persistent speculation about the potential inflationary effect of the new administration’s tariff announcements has weakened consumer sentiment, raising expectations of a recession and inflation.

The Bloomberg U.S. Economic Surprise Index, which measures deviation of actual economic data from consensus expectations, is currently coming in line with expectations. Again, the soft data of the manufacturing purchasing manager indices and University of Michigan consumer confidence survey have been weak but other categories, the hard data, are running ahead of expectations. Some of it, including retail sales, has been coming in strong as people and businesses pull forward purchases to get ahead of the tariffs, but it still shows that they are able to make these purchases and are not struggling coming into this new tariff regime. More high frequency data like Johnson RedBook’s weekly retail sales are still strong as well.

Other current indicators remain generally stable and in positive territory. As an example, the Dallas Fed’s Weekly Economic Index, which is dominated by hard data, continues to report growth. There’s been a spike in initial unemployment claims for federal workers amid government downsizing, but overall jobless claims remain assuredly low and consistent with a stable labor market. Despite the recent selloff in equities, the Goldman Sachs U.S. Financial Conditions Index still sees overall financial conditions as a slight net contributor to GDP growth. This assessment does not attempt to negate the probability of a slowdown, but to show that the economy is in a good place to better absorb the anticipated disruptions.

Economic U.S. Surprise Index

Source: Bloomberg

Federal Reserve Bank of Dallas Weekly Economic Index

Source: Bloomberg

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