The financial market reaction to the Trump administration’s on-again-off-again tariff policy has calmed for now and businesses, investors and the administration are considering their next moves inside of a 90-day pause on many of the most aggressive tariffs.
With financial volatility still high, but lower than its most frenetic moments, financial and economic observers are looking for signs that evolving tariff policy or the related financial uncertainty will lead to a broader economic downturn. Economically speaking, we have shuffled out onto a frozen lake and heard the ice beneath us crack. Now we wait to see if we will fall through into the freezing water below.
There are several cracks to keep an eye on. The first is the direct impact of the tariffs on businesses. Tariffs on China currently stand at 145% (minus electronics), with tariffs for other countries at 10% along with industry specific tariffs on automobiles, steel, aluminum and some other goods. These other tariffs and the very large tariffs on China lead to estimates by the Yale Budget Lab that current average tariff rates stand at 28%. This is more than ten times larger than average tariff rates prior to April’s policy changes. This dramatic rise has companies evaluating the impact on their business and starting to formulate strategies on product offerings to cancel, alternative supply chain development, and pricing changes to implement.
I spoke this week with an executive at a consumer products company that produces goods in the U.S. as well as importing from China and other countries. These products are then sold to several national retail chains where households buy them.
“It became clear to us right away that this was going to be inflationary and recessionary,” he told me, describing the impact of the tariffs on both the cost of production for the company as well as the impact on the demand from households.
When asked how this would affect the experience of American shoppers, he predicted that, “If the China tariff doesn’t go away within 30 days we’ll see significant changes in the marketplace as inventories are drawn down.”
According to this executive, this will include a noticeable decrease in the choice available to consumers as companies supplying household products, clothing, furniture, sports equipment, and many other items cut product lines where the tariffs have destroyed operating margins. Everything from the family camping trip to furnishing a new freshman’s apartment is likely to cost more and provide less choice than in years past.
An increase in uncertainty and the lead time necessary to develop alternative product lines and business strategies has led to a decline in hiring. “We’ve canceled all hiring for the time being except for a very small number of roles,” said the executive. Economists are looking to hire announcements from large employers in the next fw weeks to measure the breadth of the impact of the tariffs on the labor market.
A recent survey by the University of Michigan reports that the share of respondents who expect unemployment to be higher next year is at its highest point since 2009.
These potential declines in hiring are going to stretch consumers’ budgets even more than they already are. This could lead to problems in the already tight consumer credit market. In its earnings call on Friday, JP Morgan reported that the portion of its credit card loans that would need to be written off was the highest it has been in 13 years.
There is concern that the added stress of higher prices, potential layoffs and decreased wealth through stock market declines will depress consumer spending and further slow the economy. A decline in consumer spending can often be recessionary as consumption makes up about two-thirds of the country’s output.
Another crack in the economy is in financial markets. In the last week the already troubling increase in U.S. Treasury yields has steadied, but the decline in the U.S. dollar has continued.
A decline in global demand for U.S.-issued bonds has at least two negative effects for the broader economy. The first, is that treasury bonds are an important tool for financial institutions to store short-term funds, for central banks to facilitate trade, and for traders like hedge funds to speculate.
The stable price of treasuries has for decades induced people to borrow and lend using them for derivatives transactions in a highly leveraged way. A large price swing in a highly leveraged market like treasuries can lead to the need for counterparties to unwind trades rapidly or post additional collateral.
This rapid need to unwind trades or post collateral can turn a small problem into a systemic one, as was the case during the financial crisis of 2007-2009 when AIG was forced to post additional collateral on masses of derivative contracts and was unable to do so in a falling market without a Federal Reserve bailout.
In the very long run, a continued decrease in the demand for treasuries decreases the importance of the U.S. in the world economy.
Although much has been written this week about the possibility of the dollar losing its place as the world’s reserve currency, “de-dollarization,” as it is sometimes called, is a phenomenon that would take decades.
The U.S. faces much more immediate problems today. Near the top of that list is the alienation of our most valued trading partners. The world may continue to use the dollar in many of its transactions, but the international resentment that is building over trading, both goods and assets, with a country that is actively trying to harm them is going to have security and economic consequences that take more than a 90-day pause to fix.
The increase in risk perceived by U.S. trading partners because of these policies is leading to them diversifying away from sales to, and collaboration with, the U.S. These kinds of trading relationships, which the U.S. has spent the last 40 years trying to cultivate and which have been an important part of the growth of that period, will not be rebuilt as quickly as they are being dismantled.
The administration has the chance to walk back the tariff rates if it feels compelled to do so. Walking back the loss of trust and the open display of animosity toward its trading partners and allies will be much harder.
The consequences of the first three months of the Trump administration’s tariff policy have been set in motion. Like walking on a frozen lake, the cracks are starting to show, and we are at greater risk of a short-run recession now than at any point since COVID.
More worryingly, the current policy stance and the volatile implementation of that stance risks U.S. growth for years to come. When asked when he expects his company to start hiring again, the executive I spoke with said “we won’t start hiring in earnest again until we’re convinced that tariff policy is stable.”
That could be years in the making.