No White Smoke on Tariff Relief
April shaped up to be one of the most remarkable months for markets in recent memory. For the beginning part of 2025, risk assets rallied on hopes of tax cuts and de-regulation. U.S. technology stocks, which had reached a record share of the U.S. market, then came under fire on the introduction of new AI competition from China, which weighed on the S&P. The narrative quickly shifted on April 2nd when the White House announced sweeping tariffs sparking fears of a trade war, rising inflation, and a global economic slowdown. Equity markets reacted with the sharpest decline since the pandemic, with the S&P 500 and Nasdaq retreating almost 19% and 24% respectively from their February highs: and the volatility index, or VIX, briefly crossed 60 on an intraday basis for only the second time since 2020.
Then, just as abruptly as markets had fallen, the announcement on April 9th of a 90-day reprieve on tariffs triggered a violent rally with the S&P 500 and Nasdaq gaining 9.5% and 12% respectively in a single day, one of the best days ever for the indices. Despite the significant swings throughout the month, major indices closed with only modest changes. The critical questions now facing market participants are: Is this rebound sustainable or not? Beyond U.S.-China, will there be additional tariff increases in other areas such as pharmaceuticals, movies, and semiconductors? Even if the tariffs are reversed quickly, what lasting economic damage has already been done?
The first round of talks with China is set to commence tomorrow in Switzerland, with Treasury Secretary Scott Bessent and Trade Representative Jamieson Greer representing the U.S. The talks signify an opportunity to de-escalate tensions, but it is unlikely that any meaningful relief on tariffs comes quickly or easily. Until there is more clarity on the trade front, price action in rates and risk assets will be driven by headlines and projections on how the changing tariff landscape will filter through to corporate earnings and macroeconomic data.
This environment puts the Fed in a tough position. The Federal Open Market Committee (FOMC) held rates steady as widely expected at their meeting this week, but the updated policy statement added concern about inflation expectations. Notably, the committee added a stagflationary outlook that they judge “the risks of higher unemployment and higher inflation have risen.” Fed Chair Jerome Powell noted in his opening remarks that “without price stability, we cannot achieve the long period of strong labor market conditions that benefits all Americans,” suggesting that given a stagflationary scenario, the Fed ultimately will prioritize the price-stability side of its dual mandate over full employment. Powell made clear he won’t be rushed into lowering rates until there’s more visibility on the direction of trade policy, which has to come from the White House. The FOMC will likely remain on hold until they have more conviction on whether the next prudent action is a cut based on a weakening economy, or whether it’s a move towards more restrictive policy due to inflation becoming unanchored. The cost of being late to cut rates is arguably small relative to the potential for a larger mistake if the Fed eased meaningfully and inflation expectations increased dramatically. At his news conference, Powell reiterated that the economy is “solid,” and that he doesn’t see any hard data that reflect the weakness seen in sentiment.
Broader economic weakness is likely given the Fed’s limited room to maneuver. The Fed has been unsuccessful in bringing inflation back to its 2% target and some measures of inflation expectations are rising meaningfully. If the tariffs stand for a long enough period of time, the drawdown in activity could be significant enough to tip the U.S. and global economies into a recession. Even if the trade situation is resolved quickly, the damage to business and consumer confidence could cause a consequential rise in unemployment. “Hard” economic data (data that measures objective metrics) has yet to soften due to lagged effects and accelerated imports to stockpile inventory ahead of tariffs. But, with the S&P 500 trading at 21x forward earnings and high yield spreads well off their recent highs, markets are far from pricing-in a recession.
This is a tricky time for investors. While the economy had been resilient, risk assets have already pulled forward a lot of optimism in a very uncertain backdrop. Financial markets are currently pricing in roughly three 25 basis-point cuts this year. That seems high given the current position the Federal reserve is in with regards to the stagflationary risks highlighted in the FOMC policy statement. Given the ambiguous outlook late in the cycle, we continue to favor up-the-quality-curve stocks with high cash flow and lower volatility of earnings. In fixed income, we continue to prefer Munis and Agency Mortgage-Backed Securities. The month of April was a perfect example of how counterproductive market-timing can be. Many of the largest declines during the month were followed by significant rebounds. This highlights the importance of staying invested and being tactical around perceived inflection points.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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