Avoiding the thorns

President Trump announced his reciprocal tariffs Wednesday in the Rose Garden, but they are unlikely to come up roses for the US and global economies. At a base of 10%, with much higher rates on many other countries, the tariffs are far more sweeping than expected. While most of the world is scrambling to understand them, and perhaps panicking, we think the bond market is responding rationally, with rates declining and credit spreads widening. How far the market runs with this theme will be determined by if the administration softens its position or negotiates with individual trade partners. Also, we are skeptical of the simplistic calculation formula determining the target value for each country.

In general, our views are consistent with the conventional view that tariffs increase inflation-albeit typically in a "transitory" manner-and they slow growth and degrade employment. This means Trump's stance has the potential to lead to stagflation, at least in the short term.

In the long term, if the administration continues to pursue protectionist policies, it could remove one of the major pillars of disinflation that the bond market has enjoyed over the past four-plus decades. All other things being equal, this could very well result in higher levels of inflation and interest rates. Also, in our opinion, the biggest economic challenge the US faces is not the trade deficit itself but rather financing it with a large budget deficit.

We entered into this period positioned for volatility and it certainly has been bumpy. Ultimately, we think it is best to continue to evaluate the situation as it is bound to change, and then change again.