Financial and economic fall out from Trump’s tariff policy continues

A week after the Trump administration announced a broad tariff policy change on April 2, financial, policy and economic uncertainty continues.

The financial market reaction to the introduction of tariffs was swift. The S&P 500 saw a two-day fall of 10.5% on April 3 and 4. This ranks as the 5th worst two-day decline in the market since 1962, worsted only by declines during the stock market crash of October 1987 (two times), the Great Financial Crisis of 2008, and the COVID pandemic.

A survey conducted by the American Association of Individual Investors saw an increase in the fraction of investors who are bearish on the market from 52% on March 27 to 62% on April 3.

In addition, investors withdrew capital from high-yield (or junk) bonds that represent lending to some of the economy’s riskiest borrowers, leading to a two-day 82 basis point increase in the ICE BofA U.S. High Yield Index - an increase that is larger than 99.7% of two-day periods recorded since 1997. This capital withdrawal from risky debt is attributed largely to a perceived increase in the risk of bankruptcy amongst indebted firms, a phenomenon common in recessions.

In foreign exchange markets, the dollar weakened by 1.3% on April 3, as measured against a trade-weighted basket of foreign currencies — regaining some of that loss on April 4 for a two-day decline of 0.44%. This despite the fact that tariffs typically increase a country’s currency value.

Yields on the 10-year U.S. treasury also dropped on April 3 as money flowed into these typically risk-free bonds, but then fell on April 4, despite continued decline in equity markets. In times of financial distress, dollar denominated assets are often in high demand which increases the value of the dollar. The traditional safety of treasury bonds makes them a haven for those fleeing the stock market. The tariff announcement, worryingly, seemed to drive investment out of dollar denominated assets and treasuries.

Since this initial reaction, markets have remained volatile, with Monday, April 7, seeing the largest intraday point swing in the history of the Dow Jones Industrial Average. This swing was due in part to a headline that suggested that the Trump administration was considering putting a 90-day pause on tariffs — a proposal that was later denied by administration officials.

Tuesday saw another large swing as investors began the day optimistic about the possibility of bilateral trade negotiations that could lead to a reduction in the original tariff rates. These hopes were counteracted by the administration’s announcement that it would increase total tariffs on China in response to their reciprocal tariffs.

This back and forth currently stands at a U.S. tariff rate of 125% on imported Chinese goods and an 84% Chinese tariff on American goods.

Perhaps most troublingly, Wednesday saw an increase in the sell-off in U.S. Treasuries with a further 0.12 percentage point increase in the 10-year treasury yield as of the Treasury’s auction at 1 p.m.

The administration’s stance on the objective of these tariffs has become less clear since the original announcement, due largely to mixed messaging from administration officials on the intent and nature of the emergency tariffs.

Peter Navarro, President Donald Trump’s senior counselor for trade and manufacturing, writes in the Financial Times that the tariff policy is “not a negotiation,” while Treasury Secretary Scott Bessent seems to be leading the charge to negotiate with trading partners, including initial talks with Japan, in order to bring about a reduction in tariff rates.

A tiff between Trump’s efficiency czar Elon Musk and Commerce secretary Howard Lutnick further complicated the message.

This uncertainty surrounding the goal and eventual implementation of these tariffs increases the economic uncertainty surrounding them. U.S. companies face a difficult investment decision as they try to guess at the place that tariff policy will land before making investment decisions and purchasing both finished goods and the raw and intermediate material needed for production in the U.S.

Hiring and growth also look uncertain. The flurry of on-again-off again tariffs of the last few months increase this uncertainty even further.

This policy uncertainty and the difficulty in economically rationalizing the dramatic shift in tariff policy has also raised concerns that the U.S. has weakened its position as an investment safe haven. For decades the U.S. has been the place investors fled when market outlooks worsened. World savings rushed into the U.S. in the Great Financial Crisis of 2007-2009 despite the genesis of that crisis being leveraged bets on U.S. assets like residential mortgages.

This flight to the U.S. in times of crisis is a luxury that has allowed the U.S. to borrow at low rates exactly when we would most like to stimulate the economy by lowering taxes or increasing government spending.

The recent uptick in treasury yields and decline in the dollar raises the likelihood that international investors will diversify their crisis portfolio strategy by tilting away from U.S.-based assets like treasuries. This potential shift in investor sentiment along with the continued policy uncertainty are headwinds for U.S. financial markets and the broader economy.

Also facing headwinds are the administration’s attempts to establish policy credibility amongst investors and corporate decision makers. A pattern of disconnect between what the administration, particularly President Trump, communicates and the policy actions that result has left companies, investors and households more likely to wait to make large investment decisions — further delaying the potential economic transition that the president seeks to enable and increasing the likelihood of a recession this year.

This afternoon, Trump placed a 90 day pause on the reciprocal tariffs for countries that did not retaliate against last week’s tariff announcement, leaving the 10% tariff on all countries in place. The current escalation of tariffs between the U.S. and China continues and, as of writing, it was not clear what the policy means for tariffs on European goods.

The pattern of communication from the administration suggests that rather than being a resolution of tariff uncertainty, this pause may be just the latest development in ongoing policy fluctuation. This leaves market observers’ antennae tuned to treasury markets, bankruptcies amongst highly leveraged firms, earnings from financial companies due later this week, and the social media account of President Trump.

While these questions get resolved American households and businesses watch, and wait, from the sidelines.