On Wednesday, April 2, U.S. President Donald J. Trump introduced his much-anticipated tariff regime. All imports would be subject to a 10% tariff, while Trump would impose higher rates on nations that the administration views as “bad actors” on trade.
We wanted to share our perspective on the tariff news and the implications for fixed income investments.
Macro and Rates
- If the tariffs are fully implemented by Wednesday, April 9, as announced, we would expect a U.S. GDP growth rate of below 1% and core inflation of around 3.5% this year. This would represent a substantial deterioration in both GDP and inflation outcomes relative to general expectations. In our view, a recession (if defined as negative growth rates) would be a real possibility.
- We have expected the Federal Reserve to ease two to three times this year as growth (without any tariff news) is already slowing, something that should continue. In our view, the Fed will be balancing the tariffs’ impact on inflation and inflation expectations with any growth deterioration. Inflation expectations appear well anchored, which creates scope for the Fed to respond to the growth changes if needed. We believe that the market is priced for 100 basis points of easing over the next 12 months.
- We expect a similar response from other central banks like the European Central Bank and Bank of England that will balance the inflation impacts with the growth impacts.
Credit Implications
- Regarding credit markets, we generally have maintained reduced exposures and an up-in-quality bias so far this year. Despite the widening of credit spreads year-to-date, we are generally maintaining this strategic positioning. We continue to think credit spreads should have a wider equilibrium level to better price in the probability of a recession. In our view, for example, U.S. high yield spreads of around 425 basis points would better reflect this risk than the current 370 basis points.
- Yesterday, we saw pricing pressure in credit markets, but it was generally modest. Businesses with supply chains in Asia were the most affected, but overall, we would characterize the widening in spreads as orderly. That said, there was some evidence of forced liquidation of positions in derivatives markets.
- In emerging markets, we generally have been underweight Asia and overweight Latin America, and are maintaining this exposure. We are seeing opportunities to slightly reduce emerging markets corporate risk given the strong performance this year.
Looking Ahead
In the near term, we think it is more likely than not that we see negotiation and some watering down of the announced tariffs, but the directional impulse of these policies is unlikely to change. Interestingly, the relatively favorable treatment of Canada, Mexico and Latin America suggests a deliberate policy of favoring the U.S. “sphere of influence” in a multipolar world.
Longer term, we believe that a world with more U.S. trade barriers will also be a world where the U.S. likely sees fewer capital inflows and a higher equilibrium cost of capital. Implications of this could be higher U.S. rates than perhaps expected and steeper yield curves and a weaker dollar, as well as an increased risk premium in credit markets. Tax cuts, deregulation and pro-growth policies may partially offset this impulse, but global capital flows will likely change over the coming years and could result in new equilibrium levels.
Similarly, markets outside the U.S. will likely be viewed more favorably. Outperformance of European credit markets and emerging markets, compared to the U.S. markets, could continue.
