Trump Has The Stock Market and Fed Cornered
The stock market selloff continues amid the escalation of the trade wars between the U.S. and 180 other countries, and it’s left investors asking the questions:
Where is the bottom?
Are we headed for a recession?
Unfortunately, the answers are largely rooted in the decisions that President Trump makes in the coming days and weeks. There have been talks about the Fed decreasing rates, tax reform getting passed sooner, and negotiations beginning with 50 of the 180 countries that we placed tariffs on. In this article, we are going to explain why all of these solutions may be too little too late when it comes to the overall negative impact that tariffs are currently having on the U.S economy.
Trump Holds All of the Cards
In our opinion, the only way out of this market selloff is a policy pivot by the Trump administration on the latest round of tariffs - which could be announced ant any moment. Markets would likely respond very positively to any sign of relief. This could come in the form of a “pause” in the assessments of the tariffs for a specific number of days to provide time for negotiations to take place, or the Trump administration could reverse course, either walking back or reducing the tariff amounts that are currently being assessed.
Notice that I didn’t add to the list that “tariffs are either eliminated or reduced by successfully negotiating with 180 countries on which tariffs have been placed.” While this would typically be an option, we do not believe that the Trump administration has the manpower to successfully negotiate with 180 countries simultaneously in a way that would reduce or eliminate the tariffs before they negatively impact the global economy.
The magnitude of the tariff is a real problem, and we believe this to be one of the big missteps by the Trump administration in trade negotiations. The reciprocal tariffs are not based on the tariffs that are being levied against U.S. goods being imported by other countries, but rather a formula by the Trump administration that’s based on the trade deficit between the U.S. and these various countries, which is not prudently resolved through the assessment of tariffs.
For example, let's say that Japan assesses a 5% tariff against U.S. imports. Since the U.S. imports more from Japan than Japan imports from the U.S., this results in a trade deficit between the two countries. The Trump administration has decided not to levy a reciprocal tariff based on the 5% actual tariff levied against U.S. goods but rather is assessing a much larger tariff based on the amount of the trading deficit between the U.S. and Japan. However, this might not be the root cause of the trade imbalance. Another example: let's say the U.S. consumer prefers buying Japanese electronics, but there aren’t naturally many things that Japan buys or needs from the U.S. This would cause exports from Japan to exceed imports from the U.S., which is being driven largely by consumer demand, not tariffs. However, the Trump administration is now assessing sizable tariffs against Japan to try to reduce the trade deficit. In effect, this approach either forces Japan to buy more goods from the U.S. or for the U.S. consumer to buy less goods imported from Japan - even those products are preferred for their quality over alternatives from other countries.
In a way, the Trump administration is trying to use a hammer to fix a problem that requires a screwdriver. In addition, it was recently pointed out on an analyst call that since the United States spends more than it makes, we are naturally going to run deficits with other countries because we're purchasing more than we produce as a country. If we are concerned with the U.S. trade deficits, and although tariffs may be a contributing factor, the lion’s share of the problem may be the U.S. just outspending what we produce each year.
Tariffs are Paralyzing the Global Economy
While we have seen the tariffs being implemented this week, just the threat of tariffs has a paralyzing impact on both the U.S. and global economy. Since there is so much at stake in the negotiation of these tariffs, it causes companies to put off purchasing decisions, hiring decisions, new construction, and encourages companies to sit on their cash, not knowing which direction the economy will go from here.
Not only do we need a pause, delay, or elimination of the tariff to stave off a recession, but it needs to happen within a reasonable period of time, because the reduction in spending by consumers and businesses during this wait-and-see approach is already reducing the GDP in Q2, which could push the QDP negative in Q2 and potentially Q3. Two consecutive quarters of negative GDP is a recession.
Delay In Building New Factories
While the Trump administration's main goal with the trade negotiations is to bring more manufacturing back to the United States, these are multibillion-dollar decisions for these publicly traded companies. For example, it’s estimated that if Apple were to move forward with building a new multi-billion facility in the U.S., it might take them 10 years to build it. The catalyst for building it in the first place would be to avoid having to pay the tariffs on iPhones that are being imported from China. But if you're Apple, do you commit to spending billions to build a new factory in the US when in 4 years there could be a change in the administration in Washington and then the tariffs could be removed, making it no longer prudent to produce hardware in the United States? These are the decisions that these big multinational companies face before pulling the trigger on bringing manufacturing back to the United States.
Labor Shortage
Another reasonable question to ask is if all these manufacturing jobs come back to the United States, do we have enough workers to hire in the U.S. to run those factories? The unemployment rate in the U.S. is 4.2%, which is well below the 6% historical trend. With the Trump administration greatly limiting immigration into the U.S., it’s difficult to pinpoint where all these additional workers would come from within the U.S.
The Fed is Stuck
The Fed is stuck between a rock and a hard place. Normally, when there is weakness in the U.S. economy, the Fed will step in and begin lowering interest rates. However, tariffs are inflationary, so if the Fed begins reducing rates to help the economy while prices are moving higher because of the tariffs, it could result in another round of hyperinflation like we saw coming out of COVID. This may cause the Fed to stay on pause, meaning the markets may not receive any immediate help from the Fed in the near future.
Tax Reform
There is also the argument to be made that weakening the U.S. economy may allow larger tax cuts to be passed with the anticipation of the Trump tax cuts that are currently working their way through Congress. While this may very well be true, again, it’s a timing issue. Tax reform is a slow-moving animal, and even in the best-case scenario, we may not see the tax reform passed until August 2025 or later, but by then the U.S. economy could already be in a recession if the tariff issues are not resolved.
Waiting For the Recovery
The economy is truly balancing on the edge of a knife right now. An announcement at any moment from the Trump administration indicating a pause or reduction of the tariff could make the last few weeks just a bad dream. But it’s not just that relief happens, but that the U.S. economy likely needs to receive that relief soon to avoid too much damage from happening due to the economic paralysis in the interim. There are very few moments in history where so much is riding on policy coming out of Washington that it becomes difficult to predict which path the U.S. economy will follow in coming weeks and months. This is truly a situation where investors will have to assess the data each day and what the developing trends in the economic data are to determine whether or not changes should be made to their asset allocation.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
