This week, Donald Trump steered the global economy away from the free trade era that has underpinned growth for decades. Within hours of his announcement of tariffs on what looked like a bookmakers board from Aintree, China had responded with its own: a 34 per cent tax on all US imports starting next Thursday.
The markets were horrified. US stocks suffered their worst week since 2020, with the S&P 500 shedding over $5 trillion in value. Over the course of the week, the index fell just over nine per cent. For context: at this point after their election wins, the S&P was up 9 per cent for Obama’s second term, 10 per cent for Trump’s first, and 19 per cent under Biden. Under Trump 2.0, it’s now down 7 per cent.
The fear of contagion is spreading. Germany’s main index has entered correction territory – down 10 per cent from its peak – while eurozone stock market volatility surged by its largest single-day jump in nearly three years. Barclays has halved its euro area growth forecast for 2025 and now predicts a recession lasting the rest of the year. Oil markets aren’t spared either: West Texas Intermediate barrels fell 14 per cent in just 48 hours, while Brent crude hit its lowest price since 2021. The global economy is bracing for impact.
Behind the market panic lies a blunt truth: these tariffs, effectively the largest US tax hikes in nearly a century, threaten to strangle global demand.
Recession is now firmly on the table. JP Morgan titled their latest client note There Will Be Blood, raising the probability of both a US and global recession from 40 to 60 per cent. Goldman Sachs upped theirs from 20 to 35 per cent. And as one investment banker put it to me: ‘The market is pricing in the worst-case scenario, which is a US, and maybe global, recession.’
Britain might avoid the worst if it doesn’t retaliate. But for Rachel Reeves, hopes of meaningful growth now seem dashed. Oxford Economics has slashed its UK GDP forecasts to below 1 per cent this year and next, down from 1.5 per cent. Barclays is even gloomier: just 0.5 per cent growth in 2025, as a result of weaker global demand.
With even poorer forecasts for the US it’s difficult to understand why Trump’s White House is prepared to stomach such economic cost. Aside from the immediate impact of a recession, the US unemployment rate is now forecast by some to surge from the 4.2 per cent it sits at now to 5.3 per cent. That’s nearly two million more Americans out of work or a city the size of Phoenix or Houston.
Part of the answer lies in America’s deep political polarisation – which now extends to economic perceptions. In the UK, economic sentiment cuts across party lines: a recent YouGov poll found 79 per cent of Tory voters and 77 per cent of Labour voters believe shop prices are rising faster than wages – even though wages are, in reality, rising nearly twice as fast as inflation.
In the US, perceptions diverge sharply depending on political allegiance, as the below graph shows. Democrats now expect inflation to soar to nearly 6 per cent – a spike since Trump’s reelection – while Republicans are bracing for deflation.
Two tribes living in two different worlds perhaps goes someway to explaining Trump’s confidence – or disregard – for the damaging impacts of taking the US’s effective tax rate to the highest level in a century. But it may also be part of the plan. His top officials aren’t exactly denying the risk. Treasury Secretary Scott Bessat saying he ‘can’t guarantee’ there won't be a recession and that prices could go up, but they ‘don't have to’. While Commerce Secretary Howard Lutnick said a recession that balances trade would be ‘worth it’. Trump, for his part, remains bullish: he claims the tariffs will raise $6 trillion in revenue, make America richer, and bring inflation down.
His next goal – and battle – appears clear: push the Federal Reserve to cut interest rates. On his Twitter rip-off, Truth Social, Trump declared:
This would be a PERFECT time for Fed Chairman Jerome Powell to cut Interest Rates. He is always “late,” but he could now change his image, and quickly. Energy prices are down, Interest Rates are down, Inflation is down, even Eggs are down 69 per cent, and Jobs are UP, all within two months – A BIG WIN for America. CUT INTEREST RATES, JEROME, AND STOP PLAYING POLITICS!
Markets are listening. Investors now expect more aggressive rate cuts – not only in the US, but also in Britain, where three 25 basis point cuts are now priced in for 2025, up from two just a week ago.
But it won't be so easy for JEROME (Powell) and his Fed. The market pricing of more rate cuts is the obvious response to recession fears, but the Fed is unable to ignore rising inflation expectations too. Survey respondents now expect inflation of 5 per cent compared with the 2.5 per cent prices are rising by now. Even if expectations turn out to be over-egged, they have a real impact because workers see them and are encouraged to seek better pay rises – turning expectation into reality. What's more, US jobs data released on Friday saw 228,000 new jobs created – far higher than analysts’s estimates of 140,000. A resilient labour market and sticky inflation may leave the Fed little room to bend to Trump’s demands.
The Bank of England’s rate setters now face a similar conundrum between speeding up their rate cuts in the face of trampled growth or slowing them down as the inflation risk lingers on.
As for Rachel Reeves, it now seems that her Spring Statement was, in the words of Oxford Economics a ‘stopgap’, and she’ll have to come back in the autumn to balance the fiscal books again. The Oxford economists say the Office for Budget Responsibilities’ central forecast on the effects of tariffs now looks most likely. In that one, almost all of Reeves’s £9.9 billion headroom is wiped out and she’ll have to come back either with an announcement to ditch her fiscal rules or with a tax hiking plan so that she can meet them.
So how are investors responding? In the City, analysts are beginning to make bets based on a certain reading of Trump’s plan. One international banker tells me:
Some investors also subscribe to the view that this is exactly what Trump has been trying to do. Fuck the equity market short-term, cause a recession so the Fed cuts rates, get investors to move money from equities to government bonds to reduce the cost of US borrowing to make it cheaper to service their ballooning debt.
Equities then become an opportunity: ‘On Thursday’, the source noted, ‘there was record amount of retail buying in US equities, going back for the past decade.’ In other words, punters are buying the dip.
Given how aggressive the sell-off has been – covid-level losses. I think it should be a good opportunity in equities soon. Especially if you’re thinking long term, I think there are decent entry points soon.
Still, with Trump, the only certainty is uncertainty. JP Morgan now believes a recession is more likely than not. But that outcome hinges on these tariffs being implemented in full, no meaningful trade deals emerging, and the rest of the world retaliating. If history teaches us anything, it’s this: when it comes to Trump, all bets are off.
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