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The last month was a rollercoaster for markets. It is still all about the trade war, but the focus has moved very much towards de-escalation, with multiple meetings and offers, a trade deal with the UK and most importantly, meetings with China. In the wake of the pause of the “Liberation Day” reciprocal tariffs, the post-escalation 145% tariff on Chinese goods remained, effectively placing a trade embargo between the two countries. The outcome of the talks was a 90-day suspension of the reciprocal tariffs (back to the 10% base line), with the additional 20% Fentanyl related tariff also remaining in place. There was some pressure on the administration to de-escalate, with numerous statistics on shipping freight stats (collapsing) and low inventory levels (Retailers held about 34 days of stock in February) raising the spectre of empty shelves and a Covid-type supply shock. It is likely that the rapid de-escalation has prevented this.

The impact of tariffs can be seen in the expectation element of survey data, which has weakened precipitously. No evidence can yet be seen in hard data, which will take much longer. The 90-day pause opens a pathway for ongoing discussions and we may even end up in situation where the policy uncertainty falls dramatically. The bottom line for policy makers though is that the economic tea leaves they rely on for policy setting will be severely clouded for many months to come. The debate rages on about the inflationary impact of tariffs, the most commonly seen take being “stagflation”. This word raises the spectre of the 1970’s era of persistently high inflation and weak growth – but even if tariffs do push prices higher, they do not push inflation higher, as their impact on price changes drops out after a year. There is no doubt though that global trade has delivered a significant boost to global growth over the last several decades, and tariffs, which curtail global trade, will lead to weaker global growth. The true impact will be determined by their final level and what parts of the global trade system is exempt.

US

GDP data for the first quarter gives an indication of the difficulty in analysing economic data over the next several months. The economy contracted at a headline level, but domestic demand remained reasonably robust. The surge in imports ahead of tariffs meant that net exports subtracted ~5% from headline GDP. But imports are either consumed, invested, or end up in inventories – and indeed the surge in inventories added much of this back, but not all – it may be that bonded warehouses, where imports are stuck in limbo, are further skewing the data. Another positive element from the Q1 GDP data was the surge in investment spending, driven by a 22.5% surge in equipment spending (mostly IT) – enormous investment spending on AI, data centres and grid capacity continues.

Inflation data continues to moderate, though the inevitable questioning of the tariff impact simply not showing up yet remains. But only ~10% of the U.S. Consumer Price Index basket being attributed to imported goods (both direct imports and indirect imports, such as intermediate goods used in domestic production). Including all current exemptions, exclusions and pauses, the effective US tariff rate has increased from ~1.5% to ~22%. Therefore, if the current status quo remains, and there was zero substitution, and 100% pass through, it adds 2.2% to CPI. Which drops off after a year (and likely goes into reverse as the administration does trade deals). And the oil price has fallen 15% year-to-date. Hardly stagflation.

The labour market also showed no signs of strain – strong jobs growth, a steady unemployment rate, earnings growth broadly consistent with the Federal Reserve’s mandate. The Fed is taking a wait-and-see approach, but the lack of inflationary pressures combined with risks to the downside from trade policy uncertainty suggest some insurance cuts are warranted.

Europe

European data, particularly soft data, has been weak. The ECB rate cut this month however was made more notable by the dovish commentary that accompanied it, President Lagarde acknowledging that US tariffs may be more disinflationary than inflationary for Europe, the net impact is uncertain, and even the more hawkish members over the last month warning of the dangers to growth and that rates may fall below neutral if trade uncertainty proves more damaging for growth. Given the outlook, this is good news, and suggests that the ECB could be more proactive than the Fed. Previously, the ECB had estimated a near term inflation uplift of 0.5% due to retaliation and weaker foreign exchange (which fades over time), but private sector economists estimate that you would need a 25% tariff retaliation and a 10% foreign exchange decline to reach that – neither has happened. There is a larger growth shock, oil and gas prices are down, there has been no retaliation, there remains the risk of dumping of Chinese goods in Europe. Germany’s fiscal spending package helps, but trade uncertainty and the appreciation of the euro more than offset any positive from a growth perspective – and the initial growth outlook was already weak

China

The enormous tariffs effectively led to a trade embargo between the US and China, but it only lasted a month, and there is a three-month window now to reach some compromise. Soft data held up well even throughout the last month, and lead indicators continue to rise, indicating that the policy announcements over the last 6-9 months, none of which alone were very large, are combining to at least draw a line under the cyclical weakness of the last few years.

But the economic picture remains murky given the ongoing trade concerns.