Bracing for tariff “Liberation Day”

Posted 21 March 2025

Capital markets were calmer for most of the week, with a little turbulence into the end. Up until Thursday close, stock prices moved higher and measures of intraday volatility fell somewhat, largely thanks to fewer signs of policy upheaval from the US government. The week’s biggest policy event – a meeting of the US Federal Reserve – gave little information that we did not already know or expect. American investors took this as a decent sign and, for the first time in a few weeks, the US was one of the better performers.

Meanwhile, China ended the week with a bout of profit-taking. Of course, the profit comes about because the region has been the best performer of recent weeks. We discuss China in an article below.

Overall, though, it feels like markets are bracing for the next major policy event: the imposition of Donald Trump’s tariffs on 2 April.

US markets bounce – tentatively.
We wrote last week that US investor sentiment had probably swung too far down and was ripe for a bounce back, provided the news calmed down. So it proved this week. This was helped by the Federal Reserve’s decision to hold interest rates steady and leave its rate cut projections virtually unchanged. Investors saw the Fed meeting as relatively dovish (preferring lower rates), most likely because of Powell’s assertion that tariff inflation may well be “transitory” – and hence might not prompt tighter monetary policy. We talk more about the Fed’s thinking in a separate article.

One point worth mentioning here is the Fed’s reduction in its quantitative tightening programme (QT – the amount by which it sells government bonds each month). One of the big questions last week was whether investors were merely worried about slowing growth, or whether there was a liquidity problem in markets. The Fed’s QT reduction should partially help avoid the latter, at least in the US treasury market. It is not so much that the Fed is reacting to liquidity conditions, but just that it is stabilising bond markets more assiduously than it might have done in the past. That is a positive for markets going forward.

US bond yields subsequently fell and, all else being equal, you would expect this to result in a weaker dollar. But in the event, the dollar actually strengthened – though it is hard to pinpoint exactly why. It could just be part of the general reprieve for US assets, or it could be down to the fact that the world’s other central banks (most notably the European Central Bank) are expected to be more dovish than the Fed. In any case, the dollar’s strength meant that US equities came out as one of the best performers in sterling terms – in stark contrast to the trend of the last month.

Shocks, for once, not coming from Trump.
Perhaps the biggest help for markets this week was a quieter White House. That meant investors could take a breath, and intraday trading volatility fell. In particular, we had no new spending cuts from Elon Musk’s Department of Government Efficiency (DOGE). DOGE’s seemingly indiscriminate layoffs have been a concern for the US economy so, for now, no news is good news. Trump’s social media criticism of the Fed for not cutting rates might be seen as unwelcome threat to central bank independence but, in truth, the president’s comments were tame by his standards. He called for rate cuts – as usual – but avoided directly threatening chairman Powell’s job.

As we have argued before, however, simply stopping the disruption will not be enough to get markets back on Trump’s side; the president needs to make good on his market-friendly promises. For now, the negative impacts of DOGE cuts and tariffs might not be so great as to spur the administration into economic support, but it is worth remembering that many government layoffs have not yet shown up in the jobless claims data. When they do, Trump could push ahead with tax cuts and deregulation.

The biggest geopolitical threats to markets were outside of the US this week. Turkish police arrested Istanbul mayor and popular opposition leader Ekrem Imamoglu on Thursday – an incredible antidemocratic crackdown from president Erdogan. Aside from impacting emerging market sentiment, Erdogan’s authoritarian flex could be a major problem for European nations. Europe relies heavily on Türkiye for military equipment, and hence will want a stable Türkiye now more than ever.

Back into brace position.
The calm in markets this week could just be down to end-of-financial-year rebalancing, but there is also a feeling that investors are bracing for the imposition of Trump’s tariffs on 2 April – “Liberation Day”, as the president calls it. This is the great known unknown for markets: not only do we not know the full economic implications, we do not know whether the tariffs will actually come into force. They could just as well be delayed or avoided through last-minute trade deals.

The US will struggle to get the deals it wants with many major trading partners – because it has an entirely different framework for thinking about tariff costs to other nations. Trump’s European tariffs, for example, are apparently a response to the difference in effective VAT costs for US and European producers (European companies can often claim these back while importers cannot). But European leaders do not consider these tariffs at all – and see Trump’s demand they be reduced as effectively a request to exempt American companies from regular taxation.

Underlying the White House’s framework is the idea of ‘reciprocal’ tariffs – where Washington comes up with an estimate of what it thinks are the unfair levies its companies pay to other nations and then charge that nation’s companies the same amount. The problem is that different regulatory environments mean governments are unlikely to come up with the same ‘fair’ estimate. If the US insists on its own ‘reciprocal’ amount anyway, it will inevitably lead to a tit-for-tat tariff rate spiral.

Markets await to see how these issues will play out on 2 April. Before then, we will get a better idea of the economic impacts Trump has already had, when US business sentiment surveys come out next week. These will be key to watch. If businesses signal they are seriously worried, we could get another delay to “Liberation Day”.

Lastly, we will also see the UK Spring Statement on Wednesday 26th March – though the market impacts will probably be small, given the policy announcements already made recently.