Trump’s Liberation Day turns into market clear out

Posted 4 April 2025

Donald Trump’s tariffs upset markets, which were unprepared for their magnitude. The US imposed a 10% tariff on most imports, and additional “reciprocal” tariffs on major trading partners. Unsurprisingly, this was followed by China’s 34% retaliatory tariff this morning. Global stocks sold off, as investors digest the prospect of a full-blown global trade war. Sharply lower bond yields reflect markets’ downgraded global growth expectations. Just like past growth scares, these are trying times for investors, but we must stay level-headed. Markets often overcorrect to shocks and, as a result, the ensuing recovery is often swift. If you sell risk assets in fear, you can often miss that recovery.

Trade war prospect leads to markets falling to capitulation levels
The sheer levels of Washington’s “reciprocal” tariffs surprised markets. Trump’s announcement had calculations of bilateral trade disadvantages and called them “Tariffs charged to the U.S.A”. They are nothing of the sort. They are equal to a simple measure of regional US trade deficits, in the hope that proportional import taxes will reduce those deficits proportionally. Economists overwhelmingly disagree with this policy. Incidentally, social media sleuths noticed that it is the exact method described by popular AI models when you ask them to come up with a simple tariff plan.

In the end, markets sold off because the individual tariffs averaged out at 18.5% for all US imports, versus an expected 15%. That may seem low compared to the rates on Trump’s board, but 1/3 of all imports are exempt for one reason or other (pharmaceuticals, steel, aluminium, certain fossil fuels, etc) while Mexico and Canada are currently excluded altogether.

Thursday’s sell-off was focussed on the US. The prevailing narrative was that tariffs will hurt global growth, but could be contained through negotiations and counter-policies. Other regions (Europe and China) can boost demand through fiscal expansion and are already doing so, which might compensate for some of the lost US demand.

Friday morning continued what Trump started. China, with an extra 34% “reciprocal” tariff (taking total tariffs above 50%), responded with a 34% tariff of its own. European stocks plummeted and US markets opened notably lower again, after futures overnight suggested they had found a bottom. Beijing showed restraint during Trump’s first term tariffs, knowing that counter-tariffs would hurt China’s economy. The fact Beijing is now reciprocating shows this is not about economic logic but a show of force. In this situation, everyone loses.

After liberation, retaliation?
The biggest investment banks have all downgraded their 2025 US growth forecasts, and even the perma-bull Trump has talked about short-term pain. But no one is sure how a tariff-constrained economy will fare: analysts are evenly divided on predicting outright recession or simply slower growth. If the US and China follow through, it will inevitably scar the global economy. Trump declared that retaliatory tariffs would beget further retaliation, suggesting we are entering a damaging spiral. But, him following through is a big if – and it depends on how others respond. So far, European leaders seem more intent on entering negotiations and making concessions.

The less worrying take is that Trump’s tariffs are just an opening gambit in negotiations. US Treasury secretary Scott Bessent described them as a “high water mark”, and their proposed structure backs up that interpretation. The 10% baseline, unfortunately, looks here to stay – but the extra “reciprocals” seem up for debate.

This creates the fundamental question for investors: is Trump for real or for the deal? He goes back and forth between those positions, but they are incompatible over the long-term. On that front, it was very encouraging that Canada and Mexico were exempt from even the 10% baseline – though both still face other tariffs already introduced. America’s neighbours and largest trading partners started early on trade negotiations, and their experience suggests Europe could find a way through too.

Tariffs needed for US budget, complicating the bond outlook.
The other tariff rationale is that the US government needs money – which is why the 10% baseline looks set to remain. Funds are needed to reduce the budget deficit, especially if Trump goes ahead with tax cuts. Elon Musk’s “chainsaw for bureaucracy” has made a lot of noise this year, but not a lot of real savings, approximately $10bn out of a $6,750bn federal budget. The $600bn tariff revenue figure that has been floated would be far more significant.

If tariffs do allow for tax cuts, it would be the first market-friendly promise to come good during Trump’s second reign, but it probably would not live up to US investors’ excitement last year. The current view is that tax cuts would numb the pain, but the net growth improvement would be marginal at best. Although, we know from recent years that the US economy should not be underestimated.

US treasury yields fell sharply due to lower growth expectations. Taking a step back, though, US bond prices (the inverse of yields) look precarious. With talk of tax cuts, the president is gearing up for fiscal expansion, despite his acknowledgement of dire public finances. At the same time, he is cutting the economic and financial ties that provide perpetual overseas funding for the US bond market. Yields are low now, but we should not be surprised if they rise over the medium term. Higher US yields may be required to attract continued international bond demand.

Staying calm in a crisis.
There are risks in every direction, but risks often bring rewards. While the general economic outlook has worsened, we suggest avoiding any rash decisions. Until recently, US assets had a premium over the rest of the world, due to consistently higher earnings growth for 15 years. This premium has now been largely taken off and even most of the US tech mega cap market darlings have fallen to fairly average valuations.

Just like in the build up to the spring 2020 pandemic shutdown, markets have ricocheted from one extreme – ‘it’s all fine’ – to the other – ‘everything is going down hell-in-a-handcart and nobody will do anything about it’. We call these episodes capitulation, or market clearing events. What follows is usually a recognition that there are many mitigating factors or policies that can dampen the economic shock. With COVID19, the path and time frame to recovery was far less clear. And yet, once policymakers stepped up, markets staged a steep recovery, long before the economic slowdown troughed.

The current crisis is entirely man made, and has very clear mitigation levers. So, it is perhaps unsurprising to hear Donald Trump stating overnight that he is open to tariff negotiations. We also should not forget that the US Federal Reserve has plenty of rate-cutting firepower up its sleeve. The global economy has entered all of this in a fairly healthy state, showing remarkable resilience when interest rates rapidly rose from 0 to 5% a few years ago. Due to geopolitical factors, there have also been healthy demand-boosting policies initiated by the rest of the world.

Only after the fact can we know when markets’ turning point was. After this week’s apparent capitulation, we sense we are close, but we should not be surprised to see some more volatility ahead. Neither should we be surprised to see a recovery sooner rather than later. Once the dust settles and new policy direction becomes clearer, changes to medium-term trends will emerge. That will be the time to reposition investment portfolios, and decide whether beyond our tactical underweights of the moment there are long-term opportunities to change regional asset allocations.