Many investors went into 2025 assuming Donald Trump would use tariffs as a negotiating tool, but this belief has been shaken in recent weeks, generating significant market angst. But Mr Trump's fiscal strategy may yet lead to a benign outcome for the global economy.
The Trump administration is clearly intent on targeting the US's twin deficits. The White House is seeking to address the fiscal deficit -- which has risen to around 6% of GDP -- by slashing government payrolls via the Department of Government Efficiency (Doge). And it's currently trying to reduce the trade deficit through tariffs.
While Doge's actions may initially be contractionary -- potentially leading to a temporary 0.3% rise in the unemployment rate, according to my calculations -- the pain should be short-lived. If the Trump administration is correct that US government spending is rife with inefficiencies, fraud and abuse, then an operation like Doge, if properly executed, ought to boost productivity over the long term, which markets should welcome.
Tariffs are a different story. Concerns about a broadening, deepening trade war have helped push down the S&P 500 by around 10% from its peak.
US financial markets are struggling to digest the open-ended trajectory of today's escalating tariff threats, and for good reason. As a reminder, tariffs implemented through the Smoot-Hawley Tariff Act of 1930 exacerbated the Great Depression.
High import tariffs might not lead to a crisis of that magnitude this time around, but they could cause a mild adverse supply-chain shock. And remember what Covid-19 did to the global supply chain, and in turn, what supply-chain disruptions did to inflation and financial markets?
I count myself among those who thought tariffs would simply be a negotiating tool for Mr Trump, not a desirable end in themselves -- particularly not to raise revenue. Imports are only 11% of US GDP, so tariff revenue is unlikely to ever fully substitute for income taxes or other duties.
But even if the Trump administration is more willing to implement higher tariffs than previously thought, that doesn't mean long-term tariff hikes are inevitable. There's still a path that could lead to lower tariffs and, ultimately, a fairly healthy global outlook for the rest of the year.
KEEP NEGOTIATING
When assessing the potential danger of the tariff threats, it's helpful to look at what Mr Trump is actually doing. If the administration were seeking to push through tariffs for their own sake, why would Mr Trump be planning to meet Chinese President Xi Jinping in April, and why has the US been negotiating with Canada, Mexico and the European Union?
And why should we dismiss the possibility that US trading partners will be willing to reduce their tariffs on US goods? Might they not be more inclined to do so now that Mr Trump has shown he's serious? And if they do, the US could respond by scrapping further hikes or even reducing some of its tariffs.
In any case, Mr Trump's strategy appears to be front-loading risk and back-loading possible rewards. The "Sharpe ratio," or risk-adjusted return, of his trade policy, thus, should be very low at first, as the denominator explodes, before rising sharply later, as the denominator shrinks and the numerator rises. "Risk now, reward later" is a sequential feature that could very well be by design.
'MAR-A-LAGO ACCORD'
Another way out of the escalating tariff war is for the US to pivot and focus instead on some type of "Mar-a-Lago Accord" -- an organised plan among multiple countries to drive down the dollar, akin to the Plaza Accord of 1985.
The dollar has been overvalued for nearly a decade, and the size of the overvaluation is significant across a wide range of currencies. This has contributed to the erosion of US manufacturing competitiveness and stoked support for protectionist measures in the US. Consider that the average hourly manufacturing wage is $53 in the US, compared to $32 in Germany and $10 in China.
Of course, the dollar has already weakened 6% this year, potentially because markets are pricing in a benign soft landing -- or moderate economic slowdown -- in the US.
But if the Trump administration were to abandon tariffs in exchange for a plan to systematically weaken the dollar, markets would likely welcome this more organised approach, meaning US equities could reverse course even if the dollar continues to slide. Some may currently be underestimating the willingness of US trading partners to agree to a Mar-a-Lago Accord.
SOFT LANDING
What does all this mean for the economic outlook? Backward-looking data points to a global economy that could achieve 3.2-3.3% growth in 2025, similar to 2024 and 2023, though some of the Trump administration's forward-looking policies pose serious risks.
What current data indicate is that 2025 might see the US experience a soft landing, while Europe and China accelerate, propelled by fiscal consolidation in Washington and fiscal expansion in Berlin and Beijing.
This prospective economic convergence may help explain why, despite the significant correction in US equities since late February, emerging market currencies have so far exhibited few signs of angst and US Treasuries have failed to rally by an amount commensurate with the acute decline in US equities.
In short, a benign global outcome still remains my base case, though further escalations in trade tensions could lead to a more sinister scenario. Much will depend on whether Mr Trump's tariff threats prove to be a beneficial tool or a self-defeating end in themselves.
Stephen Jen is CEO and co-CIO of Eurizon SLJ asset management. All chart data is from Datastream.