Monday Digest
Posted 28 April 2025
Improving mood versus slowing growth
Capital markets bounced last week, supposedly because of Trump backing down on Chinese tariffs and Federal Reserve independence.
We should be careful about these rationalisations. Greater liquidity led to a better mood in stocks and bonds, and a ‘buy the dip’ mentality from US retail investors. Trump suggesting Chinese tariffs could be lower – and that Fed chair Powell could keep his job – certainly helped, but this isn’t crisis averted. Institutional investors are still nervous, and tariff uncertainty has all but halted business investment.
The mood benefitted from the public appearances of US treasury secretary Scott Bessent, who sounded much more constructive on trade, tariffs and the Fed. Unfortunately, we don’t know how long Bessent’s time in the sun will last. Trump likes his cabinet to fight for policy influence – exemplified by last week’s shouting match between Bessent and Elon Musk. China also called Trump’s claims of dialogue “fake news”. Beijing might be bluffing when it says they have more stomach for trade war, but the suggestion will anger Trump’s inner circle. Bessent’s ‘adult in the room’ style won out last week, but it might not next time.
The fact US businesses can’t plan ahead – and hence can’t invest – is a growth negative for the world’s largest economy. US stocks are still more expensive than others in price-to-earnings valuations. That has been sustained for decades by exceptional profits, but the latest earnings reports show that exceptionalism is fading.
Other regions could pick up some of the investment slack – most notably Europe, which is being forced to invest in its own capacity. And it’s worth noting that calls of a global recession aren’t backed up by the economic data. But the rest of world can’t fully make up for the reduction in US business investment. The growth outlook is therefore weaker than at the start of the year. We shouldn’t be surprised if last week’s positivity is soon tested.
Tariff recap: what’s here and what’s near?
Trump tariffs are always in the news, but it’s surprisingly difficult to find out which tariffs are actually in place. The table below shows US tariffs currently in effect and those soon expected.
US imports from Mexico and Canada face a 25% import tax – except those covered by the USMCA trade deal Trump signed in 2019. The White House says that USMCA compliant goods account for 50% of Canadian imports and 38% of Mexican imports. Non-USMCA compliant energy and potash imports face a lower 10% tariff.
Trump suspended his “reciprocal” tariffs until 9 July, but the baseline 10% on most countries – and 25% on cars, steel and aluminium – is still in place. China faces a higher 145% rate, despite the president’s softer rhetoric last week. Chinese electronics are currently exempt but probably won’t remain so, and the de minimis rule excluding small orders up to $800 will end on 2 May.
Looking ahead, the most likely outcome is a patchwork of bilateral trade deals. Despite White House antagonism towards Europe, many expect lower tariffs eventually. China is more complicated, as it’s unclear whether Trump is tactically or ideologically opposed. But trade deals take longer to sign than Trump’s 90 days, so even in the best case scenario we will probably see last-minute unilateral declarations from Washington.
More tariffs are on the way, like 25% for pharmaceuticals and semiconductors. It’s also possible the US will threaten to tariff China’s trading partners – similar to their plan for Venezuela. Then there is the USMCA renegotiation between the US, Canada and Mexico looming next year. In the meantime, trade experts’ best guess for average US tariffs by the year end is 15-20%. That wouldn’t mean a deep recession, but the fact nobody is sure what will happen doesn’t help.
Fed independence: it would have been a nice idea
Trump saying he has “no intention” of firing Federal Reserve chair Jerome Powell was a relief for markets, as central banks’ operational independence is a cornerstone of the global financial system.
The central bank independence movement started in the 1920s, but was put on hold during WWII and the Keynesian macroeconomic consensus that followed. When the consensus collapsed during the 1970s inflation crisis, the role of central banking had shifted from emergency lending to ongoing economic management – which led to banks gaining legal independence from the 1980s. Economists generally think independence has succeeded in giving central banks credibility and taming inflation.
But independence has always been more an aspiration than a reality. Governments scrutinise central banks, and successful economic policy requires fiscal and monetary coordination. Trump adviser Stephen Miran has argued this coordination means Fed independence isn’t realistic or desirable – but you could argue it means the opposite. Monetary policymakers need to think about the implications of public spending on interest rates, which requires thinking on longer timeframes than short-term election cycles. Fed independence is reminiscent of Gandhi’s famous line, when asked about Western civilisation: “I think it would be a good idea.”
Markets certainly don’t like Trump’s attempts to squash this aspiration. The longer-term impact of Fed’s independence removal would be on bonds. Interestingly, this might actually reduce our preferred measure of government ‘credit risk’ (the difference between government bond yields and Fed-guaranteed interbank swap rates) because it would mean the treasury can directly print money to pay off its debts. The real risk is that the money would become worthless – meaning higher yields. This puts the Fed in a bind. Arguably, Powell should cut interest rates because of weaker US growth, but the uncertain impacts of Trump’s policies on inflation is stopping the Fed from doing so. Hopefully, the White House won’t stop Powell from acting altogether.