Keep Calm and Carry On

After Liberation Day, US tariffs have been multiplied by 10 relative to the “pre-Trump” level. If they were to stay at their new level – i.e. if still elusive negotiations do not start and resolve quickly – the impact on consumers’ purchasing power, corporate margins and hence investment could push the US economy into a brush with recession in the second half of this year. Beyond that point, a lot will depend on the Fed’s appetite to accommodate the shock. While we have little doubt that, once clear signs of labour market deterioration appear, the Fed will resume cutting, we do not think it will necessarily go very far into accommodative territory. Long-term credibility matters to central bankers, and they will take the risk of over-reacting very seriously. This could trigger a more direct conflict between the White House and the central bank. 

Europe will be hard hit as well. Even if the shock is smaller than in the US, the Euro area economy was already soft before Liberation Day and the additional hit on exports and confidence may also trigger a brush with recession later this year – with more space in our view for the ECB to accommodate though, as disinflation should continue. The key questions for Europe now revolve around retaliation. We think there is good argument for “readying” the retaliation measures without implementing them straightaway. If we are right and the US economy slows down quickly, this could change the political balance in the US, and if it is obvious that Europe bears no effective responsibility in this state of affairs, the “European case” could be stronger if/when negotiations start in earnest. 

The US move on 2 April naturally draws attention to scary historical precedents, such as the Smoot-Hawley tariff of 1930 which prolonged the great depression and impaired global trade. However, the protectionist spiral of the 1930s was largely explained by the constraints of the Gold Standard. Governments today have more choice. If they keep their composure, there is still a space for the old, rule-based trade framework.