Trump flip-flop
Trump flip-flop
Summary
US policy announcements and changes are like blossom in a spring breeze… drifting and senseless scattering in the wind, alas without the beauty. President Trump has made a series of announcements on tariffs that have roiled markets. The economic impact is yet to be seen, but it is not good news. The increased level of tariffs is likely to result in higher inflation and slower economic growth.
The 2nd April announcement of tariffs (ranging from 10% on peopleless but penguin rich McDonald Islands through to the 104% on goods from China) caused turmoil on bonds and equities. After a few days, during which time US equities had fallen 15%, on April 9th the US government stated that it would delay some tariffs for 90 days but implement a universal 10% tariff while China would face a tariff rate of 145% after it deigned to retaliate with tariffs of its own. This easing of threatened tariffs resulted in US equities rallying close to 10% on 9th April. On 11th April, President Trump announced further relief through a ‘temporary’ exemption on consumer electronics.
Whilst there is relief that things could have been worse if the initial 2nd April announcement was fully implemented, the outcome is much worse for the US economy than pre-Trump trade arrangements. Boston Federal Reserve research suggests that inflation may rise by 1%, and US economic growth slows by 1%.
However, these estimates are not taking into account the damage to business confidence and delays on spending. It is possible that the US economy, that had been slowing could tip into a recession. Further acts of self-harm by President Trump on the US economy would likely deepen the slowdown into something more worrisome.
Equity and corporate bond valuations have eased back from highs, suggesting that some of the exuberance seen in asset prices in 2024 has been eroded. But in both high yield bonds and equities, valuations remain above long run averages suggesting that if the economy weakens further and profit estimates are cut, there is likely to be further volatility in markets until policy certainty emerges.
The US Dollar may become an asset to watch in the coming months. It is unclear what President Trump’s view is on the currency. Viewed in the light of the Trade Weighted measure and by the size of the Current Account Deficit, the US Dollar appears too high against its main trading partners.
Scenarios
Forecasting the future is always challenging. But there are times when it is more challenging. In such periods, the use of scenarios allows one to consider a range of potential paths that the economy may take.
Psychologically, the benefit from this process is that it is possible to think more freely without being emotionally tied to one outcome or shutting one’s thoughts to alternative paths. Given President Trump’s propensity to change his mind, alternative paths are very possible.
In brief the different scenarios are outlined below.
Whilst the so-called Goldilocks outcome of falling inflation and modest economic growth benefited investors in 2024, President Trump’s actions appear to make this less likely. Indeed, the longer the tariff turmoil continues (and flip-flopping extends uncertainty) the less likely that the economic conditions of falling inflation and stable economic growth will evolve.
Recession: The US economy was already slowing from a 3% growth rate in 2024 to an expected 2.25% in 2025. President Trump’s actions are likely to have destabilised the US (and global) economy leading to even slower growth. This may tip the US economy into shrinking (a recession) over the next few months. Against this backdrop inflation is likely to initially rise (as those goods with tariffs placed on them are likely to see the prices paid by the consumer increase). This inflation may restrict the Federal Reserve’s scope and willingness to cut interest rates to revive economic growth, but it is still likely that interest rates will be cut if the US economy falls into a recession. In time this will aid the US economy, but the economic news-flow may get worse before getting better.
Trade deals may alleviate the pain of the current tariff turmoil. Whether President Trump is a showman is debated elsewhere in the media. A path back to some sanity may be a series of ‘deals’ where the likes of the UK, Japan and South Korea pledge to reduce the trade deficit with the US. This would allow President Trump to claim “victory” in the rhetoric that emerges from the White House and supporting media. If deals can be delivered with the EU and China then the downside risk may be short lived, but there seems scant sign that such deals are close. In the meantime, the trade uncertainty will be having a chilling impact on economic activity.
The chart on the right reflects the forecasts for 2025 economic growth and inflation for the US over the past 2 years. Even ahead of the April tariff announcement estimates for economic growth in 2025 had started to be cut whilst at the same time inflation expectations had been increasing. In 2024, by contrast, the backdrop was stable inflation and rising economic growth forecasts.
In the current tariff policy proposal (as at the 15th April), inflation forecasts are likely to be revised higher and economic growth forecasts are likely to be cut in coming weeks and months.
Even ahead of the tariff tirade, forecasts for 2025 for US economic growth and inflation have moved apart in recent weeks
Source: Bloomberg, Artorius
What is priced in? High yields suggest some but not much bad news
Investors spend their time looking at the economy for clues as to how to invest. Part of the investment process is distilling what or how much of the good/bad news is already priced into asset prices.
Some of the economic slowdown / recession risk is starting to be factored into prices. Some but not all, in our view. An example of this is the difference in yield between high yield bonds and government bonds in the US. High yield bonds are those bonds whose credit rating lies below investment grade and are historically viewed as being less robust and riskier to lend to. This elevated level of risk brings with it higher borrowing costs (higher yields) when compared to ‘risk-free’ borrowing by government.
Since January 2000 the yield difference (spread) between high yield bonds and government bonds has averaged 4.97%. At the end of January 2025, the difference in bond yield reduced to 2.65%. This lower-than-average spread reflected the lower-than-average default risk that investors had priced into credit markets, justified to a degree by the backdrop of low but stable economic growth and inflation.
In recent days this spread has increased to 4%. This is still below the spread levels seen in periods of financial and economic distress in the past 25 years. Even in the economic growth scare of 2016, spread levels widened to over 8%. If economic conditions worsen due to the impact of President Trump’s tariffs, high yield bond spreads may increase further relative to government bond yields.
High yield bond spread over government bonds has increased slightly in recent weeks but remain far below those levels seen in periods of recession
Source: Bloomberg, Artorius
What of equities?
In recessions profits fall. We are nervous about the state of US profits given the risk of a recession arising from the Trump policy volatility. There is a strong likelihood that as companies begin to provide updates in coming weeks, they may lower earnings expectations for 2025 and 2026. This is challenging backdrop for US equities to rally sustainably.
Valuations vary across time. For a given level of earnings the valuation can be a swing factor in returns. For example, if the earnings of a company (or the index, which ‘just’ a basket of companies) is £100 and on 1st January the price to earnings ratio (PE) valuation is 20 times (20x) then that company would have a price of £2,000. Assuming nothing changed to profits (i.e. it remains at £100, and on the 1st February the PE fell to 15x then the price would have fallen to 1,500. The 20% fall in the price of the investment (company or index) would be due to valuation changes. Over the very long term 10 plus years valuations tend to matter less but in the short-term valuations are a significant part of the determinant of returns.
The chart below shows the valuation (PE) based on the earnings estimate for the US equity market represented by the S&P 500 (the largest 500 companies in the US). The valuation rose to 22.4x at the end of 2024. This has fallen to 18.5x in recent days, 17% lower than the valuation highs of 2024. So whilst some of the exuberance of 2024 has dissipated, when compared to the 16x average seen since 2000, valuations still feel slightly elevated and subject to some risk of further erosion.
US equity valuations have eased back since the start of the year, but remain higher than this century’s average
Source: Bloomberg, Artorius
US Dollar
The US dollar has fallen 10% since January 13th 2025. This erosion of the US Dollar value reflects a change in perception of the attractiveness in holding US assets. However, it is worth noting that the level of the US Dollar remains high when compared to the past 45 years. It is not clear what view the Trump administration has of the US Dollar. Looking at the chart below, it would be fair to conclude that the US Dollar is too strong.
A strong dollar makes trade rebalancing harder. However, a weak US Dollar will impact spending power of the US consumer as import prices will increase (as they will do so in any case with the imposition of tariffs) and inflationary pressures will be higher than they would be otherwise.
This conclusion could also be arrived at by looking at the US Current Account deficit, which has ballooned to $228bn or 3.9% of the economy in 2024. The US has run a deficit for a considerable period of time, suggesting that the US Dollar has been too strong for too long. Other economies have in effect benefitted from this deficit, as, in aggregate, they have sold more to the US than the US has bought from them.
US Dollar has eased back 10% in recent weeks, but remains towards the high level when viewed in the context of the past 45 years.
Source: Bloomberg, US Federal Reserve, Artorius
US Current Account Deficit as a percentage of economy: the large deficit suggests that the US Dollar is too strong
Source: Bloomberg, US Federal Reserve, Artorius
Conclusion
US policy announcements and changes are like blossom in a spring breeze… drifting and senseless scattering in the wind, alas without the beauty. President Trump has made a series of announcements on tariffs that have roiled markets. The economic impact is yet to be seen, but it is not good news. The increased level of tariffs is likely to result in higher inflation and slower economic growth.
Whilst there is relief that things could have been worse if the initial 2nd April announcement was fully implemented, the outcome is much worse for the US economy than pre-Trump trade arrangements. Initial calculations are that inflation may rise by 1%, according to research by the Boston Federal Reserve, and US economic growth slow by 1%.
However, these estimates are not taking into account the damage to business confidence and delays on spending. It is possible that the US economy, that had been slowing could tip into a recession. Further acts of self-harm by President Trump on the US economy would likely deepen the slowdown into something more worrisome.
Equity and corporate bond valuations have eased back from highs, suggesting that some of the exuberance seen in asset prices in 2024 has been eroded. But in both high yield bonds and equities, valuations remain above long run averages suggesting that if the economy weakens further and profit estimates are cut, there is likely to be further volatility in markets until policy certainty emerges.
The US Dollar may become an asset to watch in coming months. It is unclear what President Trump’s view is on the currency. Viewed in the light of the Trade Weighted measure and by the size of the Current Account Deficit, the US Dollar appears too high against its main trading partners.
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Important Information
Artorius provides this document in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 17th April 2025 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
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