Market Update – Market Reaction to Tariffs

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This article is by Justin Rourke – Head of Advice at Armstrong Watson Financial Planning & Wealth Management and Richard Cole, Fund Manager at Future Money Ltd. We aim to provide you with our commentary on the latest economic and investment developments which are likely to be affecting your investment and pension portfolios.

We also provide regular webinars called “Making Sense of Markets” where they discuss the factors affecting economies and markets. Our latest webinar was on 14th May. Please click here to watch.

In this latest update we continue to discuss the fallout from Donald Trump’s tariffs. The trade war may have softened, but its impacts remain significant.

While the scale of his actions has perhaps been surprising, the fact that Donald Trump has led to a volatile period in investment markets is no shock. His first term in office taught us to expect the unconventional, to put it mildly.

The period from his election in November 2024 until his inauguration in late January saw markets rally, particularly US equities and the US dollar. Investors were enthused with his promise to cut taxes and to deliver deregulation for businesses. While he also promised tariffs, this threat was not taken as seriously as it should have been.

However, from his days back in office, market sentiment shifted dramatically. Trump's approach, which can be characterised by the usually Silicon Valley-related mantra "move fast and break things" led to a significant loss of confidence in US assets. His early actions, such as softening on Russia while hardening on Ukraine, threatening to take control of Gaza and evict its population, and making threats of tariffs on Canada and Mexico, contributed to this shift.

With the US no longer as trustworthy as it once was, the dollar fell in value, and so did large American technology stocks. While Trump’s actions didn’t directly affect the tech stocks, the turn in sentiment the president created was the catalyst for investors to lose faith in the stretched valuations in this part of the market. Consequently, in February, and especially March, US assets fell by more than international peers.

Then came his ‘liberation day’ tariffs on April 2. Following his announced import taxes and his subsequent posturing, panic set in, causing all major equity markets to decline. Initially, Trump appeared unfazed by the market turmoil, dismissing the losses as a normal reaction, but the situation changed once US treasuries started to sell off, meaning the cost of borrowing for the US government had increased. In a similar way to Liz Truss’ pounding by the ‘bond vigilantes,’ Trump’s belligerence met its match and he was forced to U-turn, with the 90-day pause announced on April 9.

Economic Impact

There remains considerable uncertainty about what level tariffs will ultimately be set at. However, it seems very unlikely that Trump will fully remove the import taxes he created and therefore global trade will be impacted. This will lead to both slower economic growth and higher inflation.

In their April world economic outlook report, the International Monetary Fund (IMF) forecast that the US will face the largest economic shock as a result of the tariffs, with it having reduced its prediction for this year’s US GDP by 0.9% relative to its previous estimate, which was calculated in January. For context, the IMF had downgraded its predictions for the UK’s growth by 0.5% and China’s by 0.6%.

While other factors besides Trump’s tariffs have contributed to these changing forecasts, it appears that rather than making America great again, Trump has driven a downturn in its fortunes, dragging the rest of the world with it to slower growth.

International Response

Trump’s second term in the White House is still in its infancy, but it has already led to major adjustments in global politics and monetary policy.

In response to the threat of US military support in Europe being withdrawn, the German government has broken with post-reunification rules to approve huge increases in borrowing to fund both infrastructure and defence investment. Meanwhile, in response to Trump’s erratic behaviour and falling approval ratings, Canada’s Mark Carney and Australia’s Anthony Albanese overturned huge polling deficits to beat their previously high-riding MAGA-style opponents in their recent elections.

Turning attention to central banks, the stagflationary impact of the trade war has made decisions on interest rates all the more challenging. On the one hand, the higher inflation forecast would mean higher interest rates are needed, while on the other the slowing growth would suggest rate cuts were in order. This uncertainty is leading to divergent policy. In recent weeks, both the European Central Bank and the Bank of England (BoE) lowered their official interest rates, while the US’ Federal Reserve decided not to cut.

To further highlight the uncertainty currently present, the BoE’s vote was split three ways, with 2 votes to maintain rates, 5 to cut by 0.25%, and 2 to cut by 0.5%. For the UK, a cut was decided upon given concerns over the UK’s growth rate, especially in the face of greater tariffs on exports to the US, yet with services inflation and wage growth still well above target, maintaining higher interest rates could have easily been justified.

For completeness, data out since the Bank’s decision shows that the UK economy grew by a larger than expected 0.7% in the first quarter of this year, which might suggest the Bank’s decision to cut was a mistake, but it is important to remember that this reading applied to the economy prior to Trump’s tariff announcements, and the knock to confidence they are expected to create.

Negotiations

In the early days following ‘liberation day’, markets were panicked as a complete reworking of global trade seemed inbound. However, since that point, a series of concessions and softer language have emerged, which has led to a recovery in sentiment. The recent negotiations between China and the US agreed an interim deal reducing tariffs to 30% on Chinese imports to the US and to 10% on US imports to China. Such easing of restrictions was greater than expected.

While trade taxes at these levels still impact trade, they do not sever it altogether. The pause is for just 90 days, which means a re-escalation of hostilities could emerge. Yet, with US Treasury Secretary Scott Bessent stating "neither side wants a decoupling" this indicates a much more constructive tone than existed throughout the early weeks of this matter.

In addition, a limited UK-US deal was also struck, removing the 25% tariffs on steel and reducing tariffs to 10% for cars. This is well short of the full trade deal President Trump described it as, and it also means the UK is still subject to America’s standard 10% tariff for most other goods. Agreeing these concessions is therefore positive compared to recent conditions, but cannot be celebrated too wildly, with US/UK trade still more challenging than it was just a few months ago and therefore the UK economy is likely to suffer.

Market Outlook

While it has been a volatile time with both heavy losses and large gains over recent weeks, US assets have underperformed overall. This does not mean that equities listed in the US are now cheap, however. The price differential between US and international markets has declined slightly, yet it is still very elevated relative to historical levels.

Europe remains reasonably cheap relative to the US, while the UK, Emerging Markets, and China remain near historical lows when compared to America. In the short-term, valuations are a poor predictor of future returns, and instead the direction of markets is at Trump’s whim.

Looking further out than that, conditions appear more promising. Should economies slow as a result of Trump’s policies, then interest rates could be reduced, supporting markets broadly, meanwhile the areas with the lowest valuations will likely present the best opportunities for long-term investors.

Our Philosophy

Volatility is a part of investing, which is why we always take time to understand how much risk any client is prepared to take before investing. We also generally believe in the benefit of diversification of assets to help manage some of the extremes of the markets. Taking a diversified multi-asset approach means that some assets can fare better in different market conditions as they are more defensive assets, such as bonds, whereas during periods of growth, equities tend to fare better.

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Important Information

Please note that the contents are based on the author’s opinion and are not intended as investment advice. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.