Key takeaways:
- Equity markets sold off sharply Monday after President Donald Trump confirmed that the U.S. would impose 25% tariffs on Canadian and Mexican imports beginning March 4.
- We estimate that these tariffs could boost consumer prices by 75 basis points. However, we don’t expect that they will be enough to tip the U.S. economy into a recession.
- We still think the Fed could cut interest rates two or three times this year.
- Our measure of market sentiment is now at its most pessimistic level since 2023. Still, we believe long-term investors will benefit from staying disciplined and sticking to their strategic plan.
Equity markets sold off on Monday with the ongoing momentum unwind in U.S. tech exacerbated by President Trump’s comment that new tariffs against Canada, Mexico, and China will all move forward on March 4. The risk-off tone was felt across asset classes.
- The S&P 500 traded down 1.8% and is off around 4.5% from its mid-February high
- The 10-year U.S. Treasury yield fell 7 basis points, a decline of over 60 bps from mid-January
- The Japanese yen strengthened while the Canadian dollar and Mexican peso sold off
The steps against Canada and Mexico, in particular, were surprising as many investors thought a last second deal or delay was possible. Suffice to say: trade policy uncertainty remains extremely high. We don’t know if these new tariffs are sustainable and how long they will last.
Stunted Growth?
Tariffs are simply a tax on imported products—a tax which should directionally slow economic growth and provide a one-time boost to the price of those goods.
Canada, Mexico and China are the United States’ three largest trading partners. Our calculations suggest that sustaining tariffs at these levels would hit U.S. real GDP growth by around 75 basis points and boost core PCE (personal consumption expenditures) inflation by a similar degree. But these import exposures are unlikely to be felt uniformly across the economy. We estimate that the consumer discretionary (think automobiles), industrials and materials (lumber, for example) sectors are most exposed to the new trade actions while other sectors like financials are likely to be more insulated.
In short, we don’t think the tariffs are enough to knock the U.S. economy over into a recession but they could meaningfully dent the macro outlook.
Doing the Math
Tariffs complicate the calculus for central bankers given cross-cutting impacts onto growth (dovish) and inflation (hawkish, particularly if inflation expectations rise). Although some measures of inflation expectations have risen, market expectations for medium-term inflation still look well-anchored for now. We expected gradual Fed rate cuts in 2025 as underlying inflation moved closer to target. We still see gradual cuts even with a mix shift of drivers from trade policy—weaker growth and stickier inflation. Indeed, the Fed cut rates in 2019 in response to the trade war with China and weaker global growth.
What's Next?
Our strategies have broadly been focused on diversification, risk management, and security selection into high policy uncertainty. For bonds, our assessment of Treasury valuation has downshifted from attractive in mid-January to fairly priced today. For example, our estimate of fair value on the 10-year Treasury is 4.1% and we expect two or three Fed rate cuts in 2025—both of which are on top of current market pricing.
For stocks, the mega-cap selloff and trade tensions have pushed our proprietary measure of market psychology to its most pessimistic level since 2023. To be clear, we are not yet at an unsustainable extreme of investor panic that would warrant a more risk-on posture in our portfolios.
But, even at these levels, long-term investors are usually rewarded for being in the market and sticking to their strategic plan. Our active managers continue to find opportunities in sectors like financials which offer better relative value and could benefit from some of the Trump administration's policy changes.
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.