How will the trade war end?

In our latest monthly market update video, our Chief Investment Officer Richard Flax shares his insights on what drove markets in April, with a spotlight on the ongoing US–China tariff tensions.

April was a really interesting month for financial markets and once again it was US trade policy that was the real driver. By early May, equity markets were more or less back where they started – which would probably have surprised most people on April 3rd. 

On April 2nd, President Trump announced a broad range of tariffs on trading partners around the world. The basic shape was a 10% flat tariff, combined with a range of reciprocal tariffs on trading partners. From what we can tell, the reciprocal tariffs were calibrated based on the size of the trade deficit between the US and the partner. In some cases, the announcement prompted retaliation, most notably from China. 

It’s fair to say that the tariff regime was higher than investors had expected, raising concerns that we’ll see a significant slowdown in growth, both in the US and around the world. 

In terms of market reaction, we saw equities sell off quite sharply in the few days after the announcement. But the moves in bonds were more interesting. On the fixed income side, initially we saw US government bond yields fall – presumably as investors looked for assets that were perceived as safe. But, we actually then saw treasury yields begin to rise – raising concerns about the credit worthiness of US government debt, generally regarded as among the safest financial assets in the world. 

A week after the initial announcement we saw signs of de-escalation. The President announced a 90-day pause from the US on countries that hadn’t retaliated. At the same time, the US and China continued to raise tariffs on each others products. But even here we began to see exemptions for certain products on both sides. Equity markets in particular have taken some comfort. At the start of May, the US equity market returned to the level it reached prior to April 2nd. 

So how should we think about all this? We think there are a few ways to look at this.

Data of the month

This months figure is 145% – the headline tariff rate the US imposed on Chinese goods. It’s a dramatic figure for one of the largest exporters to the US. Even if we start to see exemptions for certain categories and even a de-escalation, we’d still expect to see gaps on the shelves of US retailers in the coming months. 

Question of the month

“What is the US trying to achieve and how do you think the trade war will end?”

There are a few ways to think about this.

First, the US administration believes that the US has been treated unfairly by its trading partners and should equalise that relationship. It thinks tariffs are an effective way of achieving that. 

Second, the administration sees tariffs as a way to raise revenues to improve the government finances and help to finance a cut in tax rates

Third, the administration sees its tariff announcement as part of a negotiation with its partners.

Viewing tariffs as part of a negotiation makes life harder for investors and businesses. The goalposts move constantly, as new announcements supersede previous policies. Knee-jerk reactions to the latest news can cost investors even hours later.

As for how it will end up. It’s tough to know, of course. But we think that we’ll continue to see a de-escalation from the tariffs announced on April 2nd. There are lots of negotiations underway and they take time, but we think all sides will be keen to show at least some progress towards lower tariffs. But it won’t necessarily be a quick process and we don’t expect tariffs to return to their pre-April 2nd levels. So we’d expect to see an impact on growth and inflation over the coming quarters, but far less than might have feared in the days after April 2nd.

What does it mean for portfolio positioning? In general, we’d argue for a conservative stance, as higher tariffs slow down economic growth. But, as we saw in April, markets can reverse course really quickly and that should make us wary of trying to predict short-term moves.