Tariff tension turning point?

“Anyone who isn’t confused doesn’t understand the situation”

– Edward R Murrow

With all the bewildering news about tariffs, geopolitics, inflation, deflation, recessions, and interest rates, I thought I would try to clarify things by providing regular updates on the latest twists and turns in this ongoing and fast-moving global saga.

It may be worth saying again that I still find myself at odds with the consensual view that Trump’s tariffs will catapult the US economy into recession and the world economy into something similar but slightly less bad. As troubling and disruptive as his initial proposals were, I still believe that they were a worst-case scenario which will be ameliorated through negotiation, and that significant offsets and substitution effects will insulate the global economy from their worst effects. This slightly more optimistic perspective has recently gained a bit more currency in financial markets recently. However, investors are still understandably very nervous, especially in the US.

It is hard to condense all of the potentially conflicting news into one coherent view, so I thought that it might help if I  focused my comments on the US (because it is the economy most likely to be affected by the tariffs), China (because it is in eye of the storm for the same reason), and the UK as a proxy for other developed economies (and because of its importance to the majority of Woodford Views subscribers). I will also include a couple of comments on the EU, not least because the ECB cut rates again last week as I expected it to.

US

So, first to the US, where understandably, investor concerns about the Trump tariffs are most acute and probably accentuated by his latest criticism of FED Chair, Jerome Powell, for not cutting interest rates. Apart from breaking the unwritten rule that political leaders don’t criticise the heads of independent central banks, this latest tirade has got the media once again writing that US financial markets and the dollar risk losing their safe-haven status. This building consensus adds to the already gloomy mood that suggests Trump’s tariffs will pitch the US economy into a recession with potentially higher inflation. For some high-profile investment banks, a recession is now almost guaranteed, with JP Morgan, for example, seeing a 60% chance of one starting before the end of 2025 and Goldman Sachs not far behind at close to 50%.

I remain much more optimistic despite these headwinds. Total goods imports are about 16% of US GDP, which in effect means that about 85% of US GDP should be unaffected by Trump’s tariffs. In addition, lower energy prices are clearly a benefit for the broader economy. Despite the hectoring, the FED will deliver lower interest rates to the economy, probably starting in May. Other substitution effects, which may take longer to play out, will also help to offset the more immediate headwinds. So, although the tariffs are an unwelcome new development that will clearly create some major problems for some businesses, many others will be completely unaffected by them.

My view is that the economy will slow in 2025, but a recession is a very low probability outcome. Looking longer term, and I appreciate that this is once again a minority view, I expect China and the US to start talking to each other about how to defuse what is currently a mutually damaging escalation of their ongoing trade war.

Update: Based on the news last night and today since I wrote this article, this is exactly what seems to be happening:

It’s also important to remember that many global businesses are already announcing significant new US investment plans in the wake of Trump’s tariff tirade. Last week, I highlighted Nvidia’s announcement of a $500bn investment in AI infrastructure, but there are many others in the automotive and now in the pharmaceutical industries. For example, Roche has today announced that it will be investing $50bn in US research, manufacturing and distribution infrastructure over the next five years, hot on the heels of Novartis’s announcement that it would invest $23bn in similar projects. Roche now claims that after this investment, it will export more medicines from the US than it imports. I think these kinds of announcements from globally significant businesses completely contradict the financial market hysteria that casts the US economy as permanently fractured by tariffs and trade disputes.

Having said that, and in the interests of keeping it simple, I think at this stage of this period of extreme volatility, four months into Trump’s presidency, a couple of important things are now clear:

1. Through lower energy prices and a lower US dollar, the US will be exporting deflation to the world economy. (See below)
2. The US will import inflation through higher cost of goods imports (via tariffs) and a lower dollar.
3. This will not be sufficient to fully offset the lower inflationary impetus from lower energy prices, substitution effects and lower interest rates.
4. The US economy will slow in 2025 but will not fall into a recession. I expect it to continue to outperform many developed economy peers.
5. The US equity market remains overvalued, in my opinion. I suspect, albeit that it is impossible to prove, that it is this valuation problem which lies behind the more significant fall in this market relative to others so far in 2025.
6. US ten-year bond yields have fallen below 4.4%, and I expect them to fall further through the remainder of 2025 as official rates are cut from their current effective level of 4.33% (target range 4.25-4.5%). Trump has criticised the FED Chair for not cutting rates, but I don’t expect this political pressure to change the thinking of the twelve members of the rate-setting committee. Ten-year yields in the US started the year close to 4.8%.

China

It is becoming increasingly clear that President Trump’s tariff policy focuses on China. Although the trade surplus it enjoys with the US is clearly a central concern of the administration, the broader issue seems to be the geopolitical confrontation between these two superpowers. My guess is that this escalating confrontation will never deliver a winner but is almost guaranteed to harm both economies. That’s why I remain of the view that in time the leaders of both countries will sit down and start talking rather than engaging in the current tit-for-tat tariff exchange. I would not expect this engagement to solve all of the challenges these two superpowers confront, but it should at least help partially defuse what has become a drag on the health and well-being of both economies. Right on cue, yesterday, the US Treasury Secretary, Scott Bessent, said in a private briefing that the tariff standoff with China is unsustainable and that he expects the situation to de-escalate. He added that negotiations haven’t started yet, but said a deal is possible.

In the meantime, China’s exports to the US will clearly fall, and given their importance to the economy, this will be a headwind for the immediate future. This is why the domestic fiscal policy stimulus is so important. Right now, most of the large US investment banks and large global organisations like the IMF believe that China’s growth rate will fall significantly from the targeted 5%. Indeed, in its latest global growth outlook, the IMF now thinks growth in China will only reach 4% in 2025.

I continue to believe that the Chinese leadership will be eager to demonstrate the resilience of the domestic economy in the face of the tariff challenge. That’s why I expect we will see more targeted fiscal stimulus measures designed specifically to address higher household consumption (and less saving) and the well-rehearsed problems in the residential property market. Ultimately, though, I still believe that the situation right now is a worst-case outcome and will improve significantly from here, especially if the two sides start talking.

UK

Last week, I updated my recent comments on the UK economy and, in summary, the news continues to improve. Of particular importance and something that the mainstream financial media hasn’t spoken about, is how far the oil price has fallen in £ terms. I mentioned last week that the oil price was down 20% in US$ terms since the start of 2025. In sterling terms, however, given the appreciation of the £ against the $, the price is down 25%. Over a year, it is down nearly 30%. That is very meaningful and again reflects what I mentioned earlier in this piece, which is that a lower dollar is helpfully exporting deflation to the rest of the global economy. (See below)

As I said last week, I expect this significant impact on inflation to not only highlight how wrong both the MPC and OBR are about inflation but also to focus the rate-setting committee’s minds on how inappropriately high UK interest rates are currently. By way of example, we have a similar inflation rate (2.6%) as that in the EU (2.5%), and yet base rates are at 4.5% whilst the ECB cut its equivalent rate (deposit facility) to 2.25% last week.  Quite how the MPC could explain this discrepancy is beyond me.

Of some interest to this debate were comments today from Megan Greene, one of the MPC committee members, who said in an interview with Bloomberg News yesterday that US tariffs pose disinflationary rather than inflationary risks for the UK economy. My sense from all this has for some time been that the MPC need to get on with delivering lower and more appropriate interest rates for the UK economy and that their meeting in early May offers an opportunity to get on with that process. If the MPC starts this process in a few weeks, I expect this to provide further support to UK financial asset markets, especially to listed domestic economy-focused businesses.