Insights
The Price of Protectionism
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Global Multi-Asset Macro Musings
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April 10, 2025
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The Price of Protectionism
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April 10, 2025
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The Price of Protectionism
The Price of Protectionism |
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Bottom Line
Markets stop panicking when policymakers start to panic – Trump and his advisors do not appear to be panicking and Congress, the courts or the Fed are not stepping in as circuit breakers – given the market damage is foretelling the economic damage, a policy shift is likely but, until then, the base case is for a recession and a full-blown equity bear market of -30 to -35% total, which we were halfway through as of April 4.
The tariffs announced on Wednesday, April 2 represent one of the largest tax increases in U.S. history. Here we share our analysis of the tariffs’ likely impact on the economy and markets. All data is as of Friday, April 4th close.
If maintained for even 4-5 months, the current tariffs will lead to a recession as consumer incomes are hit and uncertainty freezes investment, hiring and spending. If the tariffs were in place for only 1-2 months, or were reduced significantly within a few days (see Off Ramps and Offsets below), the U.S. economy would still suffer a severe hit, but avoid recession. We expect a prolonged period of elevated tariffs as the off ramps would take time and real economic pain is likely to be realized in the meantime.
Base Case: U.S. recession (70% probability)
- Assuming announced tariffs are in place through 2025, this would represent a -220 basis point (bps) hit to U.S. GDP1, and a +200 bps boost to inflation, implying +0.1% growth in 2025, with growth strongly negative in Q3-Q4 (-0.9% average seasonally-adjusted annual rate (SAAR)).
- No Fed put: the Fed, stuck between slumping growth (with unemployment rate rising to 5.2% from 4.2%) and inflation rising to 4.4%, to ease 250 bps, but slower and later.
- Market Impact: total U.S. stock market decline of -30 to -35% (S&P 4,000 - 4,300) and bond rally of 50-75 bps down to 3.25-3.50%.
Bull Case (see Off Ramps and Offsets): severe growth hit but no recession (25% probability)
- Tariff hike roughly halved to a 13 percentage point increase from Inauguration levels within 1-2 months => GDP hit -150 bps.
- GDP grows 0.8% in 2025, but Q2 and Q3 see slightly negative growth (-0.1% average SAAR).
- Market Impact: stock market decline of -23% to 4,750 and bond rally of 25 bps to 3.75%.
100% Tariff Roll Back Case: temporary growth hit due to uncertainty (5% probability)
- If tariffs were to be eliminated entirely, GDP would grow +1.7% in 2025, but see a deep air pocket in Q2 (+0.5% growth) before rebounding in Q3.
- Market Impact: stocks stage a rebound from current levels back to 5,500 and bonds sell off 25-50 bps to 4.25-4.50%.
Off Ramps and Offsets: How can a U.S. recession be avoided?
Off Ramps: potential paths to lower the tariff increase to 13% (vs. 22%)
- Stock market damage and intense political pressure cause a policy reversal.
- Legal challenges (e.g. against use of International Emergency Economic Powers Act (IEEPA)) succeed.
- Successful negotiations with trade partners.
- Congress takes back tariff power (constitutionally its prerogative), bringing overall tariff increases down, though leaving many sector tariffs intact.
Offsets:
- Fed cuts: Policy easing will be reactive and initially slow after 5 years of overshooting the inflation target. Though the tariff-driven inflation spike to 4.4% is mostly a one-time price increase, core inflation is at a high starting point (February at +2.75%) and tariffs could modestly boost long-term inflation expectations, lessening typical recessionary disinflation. Thus, we expect quarterly Fed cuts (of 250+ bps total) to start in June as the data confirms recession. In 2026, the Fed is more likely to cut at consecutive meetings once inflation starts to decline. Helpful for 2026 growth, but too late to prevent recession.
- Modest tariff revenue recycled into economy: the Executive has the power to tariff (under certain circumstances) but not to spend the receipts. Congress is biased to cut spending and selecting industries to bailout will be divisive.
- Tax cuts: Tax cuts likely to provide only +10-20 bps of stimulus in 2025. Most cuts are already in place and the extension is effective starting only Oct 1, 2025.
Net-net: significant offsets unlikely but some form of off-ramp possible, leading to a tariff reduction to 13% increase and only -150 bps hit to GDP (see Bull Case above).
Stock Market Impact
Our base case is for a US stock market decline of -30 to -35%, modestly greater than the historical median bear market decline of -28%, given the 2nd-highest-ever starting valuations for a bear market (only 2000 was higher) and a reactive, not preemptive Fed, but a smaller expected profits decline compared to past recessions. Down -17%, US stocks were halfway there as of April 4:
- Earnings will likely fall -7% in 2025 (vs. consensus of +11% as of March 31).
- Forward equity multiples to contract to 15x from 22.4x at the peak, as the risk premium increase offsets lower bond yields.
- At the bottom of the bear market, we would expect at least $200 billion of mutual fund and ETF outflows (cumulatively) as a sign of capitulation. As of April 2, we had seen $25 billion of outflows following $1.4 trillion of inflows since 2020. Though hedge funds and CTAs have dramatically reduced positions since the beginning of the correction on February 19th, most institutions and retail investors only started selling in late March.
In our more benign Bull Case, the total market decline would be a more modest -23%. As the earnings and multiple hit would be more modest, we would expect stocks to bottom out at 17-18x , though the rebound is unlikely to be V-shaped given the nature of the policy shock.
We expect global growth to also be severely impacted by U.S. tariffs. However, the global growth hit should be relatively smaller as the U.S. is tariffing all its trading partners, but the U.S. is only one of all other countries’ trading partners. As a result, though we expect most developed countries to approach zero growth, their slowdown should be shallower, thus allowing their stock markets, particularly domestic stocks, to continue to outperform U.S. stocks, as they have started to in 2025. Retaliation announcements by China, Canada and the EU highlight the growth downside risks from a tit-for-tat tariff response which simultaneously hurts the U.S. along with the trading partners.
Bond Market Impact
Historically, the Fed has cut the policy rate down to the level of inflation in recessions (i.e. zero real rates). Assuming the tariff-driven inflation spike is transitory, underlying inflation should slow to 2.0% in 2026, thus giving the Fed room to eventually cut rates by nearly 250 bps.
For most of this cycle, bonds have over-anticipated rate cuts due to the muscle memory of the post-GFC period of zero interest rates and QE. However, this time, inflation remains above 2%, likely putting a floor on Fed Funds at 2%. In that context, 10-year government bonds may only rally down to 3.25-3.50%, making bonds a modestly useful hedge to stocks, but not as powerful a hedge as in 2008 and 2020 when bonds rallied down to 2% and sub-1% respectively. The risk of fiscal crisis from rising debt levels and uncertainty from a post-Powell Fed should also put a higher floor on bond yields.
Bottom Line: markets stop panicking when policymakers start to panic – Trump and his advisors do not appear to be panicking and Congress, the courts or the Fed are not stepping in as circuit breakers – given the market damage is foretelling the economic damage, a policy shift is likely but, until then, the base case is for a recession and a full-blown equity bear market of -30 to -35% total, which we were halfway through as of April 4.
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Head of Global Multi-Asset Team
Global Multi-Asset Team
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