International Trade Policy: Game of Chicken

Since their respective highs on February 19, the S&P 500 and Nasdaq Composite have fallen -13.7% and -19.3% through Friday, April 4. Based on the MSCI All Country World Index of developed and emerging markets, over $11 trillion in market wealth has vanished. For the moment, financial markets appear to be expecting more inflation, slower growth, and less international trade.

The equity selloff correlates with President Trump’s new tariff policies, the specifics of which began to slowly emerge in early February and the breadth and depth of which were revealed after the market close on Wednesday, April 2. The President announced a 10% baseline tariff for all exporters into the United States, and additional reciprocal tariffs on as many as 60 countries that the President believes are the worst offenders in maintaining high barriers against American exports.   

Of course, markets seemingly panicked last Thursday and Friday, as they discounted the economic implications as well as the possible retaliations from trading partners. China, for that matter, quickly announced 34% retaliatory tariffs on Friday morning. There are rumors that others, including the European Union, will also be instituting their own retaliatory measures. On the other hand, countries such as Taiwan and Vietnam, Indonesia and India, are pursuing constructive discussions to level trade levies and restrictions against the United States.

It remains to be seen if the White House will impose additional tariffs or punitive measures against the retaliating countries.

The following are some notable details from Yale’s Budget Lab about the April 2nd Trump tariffs and all other tariffs imposed by the Trump Administration year-to-date. (Source: Where We Stand: The Fiscal, Economic, and Distributional Effects of All U.S. Tariffs Enacted in 2025 Through April 2 | The Budget Lab at Yale)

• China will have a 54% tariff (34% reciprocal tariff, plus the 20% imposed earlier this year). If one adds tariffs imposed during Trump’s first term, China tariffs will be 76%.

• Japan, South Korea and India will face tariffs of 25%.

• European imports face 20% tariffs (but 25% on vehicles).

• Average effective US tariff rate will be 22.5%; the highest since 1909. The April 2nd plan raised it 11.5 percentage points.

• Due to all tariffs imposed this year, the price level in 2025 will increase 2.3% during the short run.

• Yale’s Budget Lab forecasts US real GDP growth will decline -0.9% in 2025 due to the April 2nd tariffs and all other U.S. tariffs imposed this year. During the long run, all recent tariffs are expected to reduce US real GDP growth by -0.6% annually.

So where do equity markets go from here? During the short-term, we expect broad market indices will react positively to compromises reached with countries that reduce trade barriers, and negatively to retaliations and other aggressive reactions.

Optimists will argue that the tariffs announced to date will be a high watermark and the starting point of negotiations that ultimately reduce barriers around the world. This would be a highly bullish scenario. Unfortunately, while we believe this will be true with certain trading partners, we don’t believe that it will be the case with all. Relations with China, for example, appear to be worsening as opposed to improving.

During the medium term, we expect earnings expectations to be revised lower, from already lofty expectations at relatively high stock valuations. And during the longer term, a recession, long-delayed and rooted in massive post-Covid government spending, is increasingly likely.

Key variables we’re watching for will be the degree to which compromises or retaliations occur, upcoming tax reform in Congress, and changes in Fed policy. Better pro-growth tax plans or a more aggressive rate-cutting Fed would be equity market positives.

Lost in most of the public discourse today is the question: where is pro-growth tax policy to ignite risk appetites? This is not just a question for Washington, but legislatures around the world.

We suspect financial markets will need to perform even worse to extract such surprises.

The “Trump put” and “Fed put” are seemingly off the table, for now.

On Sunday night, the President defended his recent trade actions: “I don’t want anything to go down, but sometimes you have to take medicine to fix something.”

As for the Fed, it typically pursues a sharp pivot to rate cuts in reaction to deflationary pressures and/or freezing credit conditions. Given that the new tariff policies are expected to be inflationary in nature, more pain in credit markets is probably necessary for the central bank to step in.

As a result, financial markets seem to be watching a game of chicken between the United States and the rest of the world with international trade policy. But it’s arguably a game of chicken among executive and legislative policymakers globally. Eventually, countries, national legislatures, or central banks will blink. The question of course is, how much will break in the meanwhile.