Shares on Wall Street slumped on Monday to record one of the worst trading days since 2022, driven by concerns about the impact of President Donald Trump’s trade policies on the US economy. Investors are now worried that a trade war could push the world’s biggest economy into a possible recession, with Trump appearing not to rule out that possibility. Speaking to Fox News on Sunday, Trump parried a question on whether the US is headed into a recession with an uncharacteristically ambivalent response: “I hate to predict things like that. There is a period of transition, because what we’re doing is very big. We’re bringing wealth back to America, that’s a big thing. And there are always periods (where) it takes a little time.” This came days after Trump said his measures could lead to some pain in the “short term”.
This seems to be a markedly different outlook from Trump in his first term, where he was much more responsive to stock market patterns. Incidentally, in Monday’s selloff, while the tech-heavy NASDAQ was down over 4 per cent, Elon Musk-promoted Tesla was one of the stocks that fell the most, down more than 10 per cent and sharply lower than its peak back in December.
Recession talk
There are three issues that analysts are pointing to amid the renewed “recession” talk. One, that Wall Street is perhaps now overreacting to the fact that it did not really believe Trump would follow through on this threat of tariffs that he made throughout his election campaign. So, when last week, the tariffs came into effect on Canada, Mexico and China, and more tariffs are likely on steel and aluminum products, the stock markets are perhaps responding to the fact that Trump is now walking his talk. There is also the broader uncertainty that this rapid back-and-forth on tariffs by his administration has triggered.
Secondly, bond yields – or the return a bond investor expects to receive each year over its term to maturity – are perhaps a better indicator of whether a recession is in the making. The American 10-year bond yield eased by 11 basis points Monday as demand for safe-haven assets increased after Trump declined to rule out a recession as a result of his tariff policies. When bond yields are going down, it means that the return an investor can expect from holding a bond is decreasing, which is typically caused by the price of the bond rising in the market (yields and prices of bonds have an inverse relationship). Lower yields potentially indicates a shift towards a more risk-averse sentiment among investors, often associated with economic uncertainty.
Thirdly, though the broader economic data at this time is not indicating an impending American recession, there are some clear pointers to a growth slowdown. Job market data is holding up so far based on the February jobs report that came out Friday, but consumer confidence is down, and business surveys cite uncertainty as a reason for being cautious about capital investment. Fourth-quarter US gross domestic (GDP) growth for 2024 came in at a strong 2.3 per cent, driven primarily by consumer spending. However, the early data for this year suggest a slowdown could be on the cards.
The various Federal Reserve Bank surveys have shown more caution among businesses, with the Philadelphia Federal Reserve’s Manufacturing Business Outlook Survey results showing that new orders and hiring are down, while prices are up. Comments from businesses across the country focus on the uncertainty surrounding tariffs and the potential negative impact on orders, adding to the pessimism. But Trump has, so far, shown that his administration is willing to tolerate this to achieve his broader ambitions, including rebalancing trade, his plans for deregulation, including promised tax cuts later in the year.
And while Trump appears to be equivocal on the recession prospects, his commerce secretary Howard Lutnick, and the main cheerleader of reciprocal tariffs within the new administration, was a lot less ambivalent at a press briefing. “There’s going to be no recession in America. What there’s going to be is global tariffs are going to come down because President Trump has said, you want to charge us 100 per cent, we’re going to charge you 100 per cent! You know what they say? They say, No, no… don’t charge us 100 per cent, we’ll bring ours down… We’ll unleash America out to the world, grow our economy in a way we’ve never grown before. You are going to see, over the next two years, the greatest set of growth coming from America… I would never bet on recession. No chance.”
Problems with Washington’s high tariffs plan
Lutnick’s bluster aside, there is a reason why the high tariff threats by the US are not likely to sustain. The structural issues with the American economy is one key reason. The US economy relies heavily on trade, and that’s part of its structural construct in the post-World War-II era. This is because the American economy consumes more goods than it produces domestically at full employment. As a result, its imports are almost always higher than its exports, resulting in a trade deficit.
This trade deficit is a point of contention for Trump, which he’s used as the trigger for the imposition of tariffs on countries around the world. But what this simplistic assumption glosses over is the fact that till the time America consumes more than it produces, it will have a deficit with a lot of countries. This is also triggered by the fact that the labour costs in America are high, and so it does not merit economic logic for US workers to be producing this efficiently in the country, like say garments or low-end consumer goods. So, other countries that have relative efficiencies in these sectors, primarily due to labour or raw material advantages, are more effective at producing these goods and shipping them to the US. The evolving labour productivity issue, and a shift of comparative advantage to developing nations explain the loss in manufacturing jobs in the US, and tariffs are unlikely to fix that fundamental issue.
Also, Trump has consistently insisted that tariffs are paid for by foreign countries. This hardsell, has resonated within his base, but is blatantly false. It is, in fact, US importers — American companies or representatives of foreign companies in the US — that end up paying tariffs when these goods come in, and this money goes to the American Treasury. These companies, in turn, generally pass their higher costs on to their customers in the form of higher retail prices.
A study by economists at the Massachusetts Institute of Technology, Harvard University, the University of Zurich and the World Bank concluded that Trump’s tariffs in his last term neither raised or lowered US employment. Despite Trump’s 2018 taxes on imported steel, for instance, the number of jobs at American steel plants was barely impacted. On the other hand, the retaliatory taxes imposed by China and other nations on US goods had “negative employment impacts,’’ especially for farmers, the study found. These retaliatory tariffs were only partly offset by government aid that Trump was forced to dole out to farmers, partly funded by the incremental revenues raised by the tariffs.
Macroeconomic impact and a likely Fed pivot
The radical economic outlook presented by Trump prior to the elections includes plans to impose a 20 per cent tariff on all imports and more than 200 per cent duty on cars; a proposal to deport millions of irregular immigrants; and to extend tax cuts at a time when the US budget deficit is at record high. Trump, however, realises that he came to power on account of unrest among a section of American consumers about high inflation and their standard of living not having gone up as per expectations. His tariff war could only fuel this fire. In quantum terms, a 10-20 per cent tariff is really high for a country that has a weighted average tariff of only about 2.2 per cent.
Higher tariffs and a trade war would most certainly lead to higher inflation in the US. This, combined with runaway deficits are likely to force the US Federal Reserve — the American central bank — to end its rate-cutting cycle prematurely.
That could have implications for the monetary easing plans of other countries, including India.
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