The stream of announcements coming from the new US administration has kept investors on their toes this week. But as of today, equity ETFs remain largely unchanged for the week. What, if anything, should we learn from this?
In terms of policy announcements, last weekend the US government indicated that it would raise trade tariffs on Mexico, Canada and China. Those countries indicated that they would likely reciprocate with tariffs of their own.
The president also announced that tariffs against the European Union would also likely go up in the coming months. The conventional wisdom views tariffs as a tax on consumption – slowing growth and, possibly, raising prices. That can be a tricky combination for financial assets. But, by the end of Monday, we saw a change of tack, with tariffs delayed in exchange for various policy concessions and investors appeared to relax – at least a little bit.
What should we learn from this? First, the incoming US administration had flagged the likely increase in tariffs well in advance. So, investors shouldn’t have been taken by surprise. Second, while higher tariffs are likely in the coming quarters, it does seem that they will be used at least partly as a negotiating tool. That could limit their impact on the global economy as a whole.
Finally, on the policy impact, we continue to see higher tariffs as a constraint on growth. Their impact on long-term inflation is less clear. We could see tariffs get passed through to final prices or companies could choose to absorb the impact, potentially putting pressure on their margins. That has implications on the outlook for interest rates. Higher inflation would make it tougher for Central Banks to cut rates; slower growth and lower margins could hit corporate earnings. So, we’ll continue to follow trade policy closely, but also the likely impact on those policies for the broader economy.
Turning to interest rates, the Treasury Secretary, Scott Bessent, commented in an interview that the administration’s focus is really on the US ten-year yield than the policy rate. This is notable for a couple of reasons. First, it might insulate US central bankers a little bit from government criticism of their decisions. Central bankers can’t really control what happens to the ten-year yield. Second, it highlights the shift in the yield curve (the difference between short-term rates and longer-term rates).
Over the past few months, longer rates have moved higher, even as the Fed has cut rates. That’s a little unusual. There are a few reasons why that might be the case – expectations for stronger growth and higher inflation, for instance, or concern over the budget deficit.
Bessent’s comments do refocus attention on efforts to reduce government spending, which has been a long-term question from many investors. There have been a number of announcements and actions over the past couple of weeks on plans to cut the foreign aid budget, reduce the federal workforce or abolish the Department of Education. It’s too early to say how effective these attempts will be, or their long-term consequences. There’s a lot of the federal budget that isn’t really discretionary. But shrinking the federal budget could help assuage concerns over the long-term outlook for US government debt and help bring down the cost of borrowing.
Where does this leave us? There’s been a lot to digest this week. Some of the announcements will likely be enacted and many will fall by the wayside. Some, like tariffs, will probably elicit a response from other governments. We’ll continue to focus on their impact on key macroeconomic variables and financial markets – particularly on the outlook for growth, inflation and corporate profitability. But the last week has also been a valuable reminder that, while government policy can be an important driver for markets, we should be wary of changing portfolios too quickly in response to the latest headline. There are likely to be a lot of them.
Want to know more about our take on US policy shifts and market trends? Watch our latest market update for key insights.
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