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News about new U.S. tariffs on goods from Canada, Mexico, and China (and the announcement of retaliatory tariffs) prompted markets to sell off in an immediate response on the Monday after the announcement. Before the day had come to a close, however, we learned that the tariffs on Canada and Mexico would be delayed by a month. While these events continue to unfold, I think it’s important to take a look back at the market response to the tariff wars in the first Trump administration. History doesn’t repeat itself but it can rhyme – and the first Trump administration trade wars are arguably the best guide we have.
The 2018-2019 trade war between the U.S. and China had a significant impact on the U.S. economy. It caused disruptions, price increases (which squeezed some businesses’ profit margins), and elevated uncertainty, which led to stalled U.S. business investment and hiring.
Here are just some of the observations from Federal Reserve Beige Books during this period:
The 2018-2019 tariff war also had a significant impact on markets, taking them on a roller coaster ride. It led to higher volatility as ups and downs were dictated by news flow on trade talks and the removal of tariffs/application of more tariffs. In general, there was a flight to perceived “safe haven” assets globally.
In other words, tariffs caused short-term headwinds. Once markets grew accustomed to them and then a resolution was reached as the Phase I trade deal between the U.S. and China was announced, volatility eased and financial markets reaccelerated.
We have to remember that protectionist measures have tended to result in less optimal economic growth globally in the near term but have not necessarily served as a long-term hurdle for the stock market. Nonetheless, a period of trade policy uncertainty could potentially weigh on markets, as it did in 2018-2019, until greater clarity emerges. We could see a similar scenario unfold this time as we did in the first Trump administration – lots of drama but no real longer-term impact. I am cautiously optimistic that will be the case.
So why have markets reacted so negatively knowing recent history? I think because many assumed the Trump administration would be focused on keeping stocks buoyant and would use tariffs as a threat rather than actually implement them. Maybe that was just wishful thinking. However, I think markets will adjust, then experience a hiccup if more tariffs are levied, and so on and so on, similar to what we saw in the first Trump administration.
We also keep getting asked whether the U.S. should be worried about higher inflation or lower growth with tariffs.
In the near term, tariffs cause price increases, but they tend to quickly subside as tariffs are removed (which is why I have argued vehemently that when it comes to inflation, we should be far more worried about immigration policy) so they don’t typically result in sustainable inflation.
However, tariffs can suppress demand. So I believe growth is a far bigger issue – and it’s the risk we need to worry about if tariffs stay on for a long period of time. Also, retaliation magnifies and globalizes the effects of tariffs, meaning the global economy could end up with less growth and higher inflation. Keep in mind that the U.S. may have less to lose than any one trading partner, but if the war is being fought against a range of partners, the cumulative damage on the U.S. economy could be greater than on any one partner.
We’re already seeing signs that policy uncertainty is having a negative impact on U.S. consumer sentiment, as evidenced by a significant decline in consumer confidence in the Conference Board’s survey released in last January. Also, U.S. gross domestic product data showed that fixed investment spending was down in the fourth quarter, which could very well be due to business uncertainty about tariffs and other policies.
In short, tariffs tend to lead to less optimal outcomes but are unlikely to derail the current business cycle – but the risk grows as more tariffs are applied and the longer they’re in place. And so while both U.S. manufacturing Purchasing Managers’ Index surveys released Monday show a more optimistic outlook for the sector than we’ve seen in a while, that can easily change as the application of tariffs have entered the picture. We will want to keep an eye on signs of any kind of deterioration in sentiment or spending plans resulting from tariffs.
On a more positive note, I think it’s important to point out that while there have certainly been some disappointments, earnings season has been going well thus far for S&P 500 stocks overall. Of the companies that have reported thus far, 77% have had fourth quarter earnings come in above estimates.9 What’s more, the blended earnings growth rate for the S&P 500 is 13.2% which, if it comes to fruition, will be the best year-over-year earnings growth rate since the fourth quarter of 2021.9 I’m also encouraged to see more upgrades to earnings forecasts for Europe ex-UK and Japan stocks.
Finally, we heard from some major central banks in January. The Bank of Canada and the European Central Bank cut rates and indicated a lot of uncertainty about the future, largely fueled by the potential for US tariffs. They’re clearly leaning dovish – the Bank of Canada also announced the end of quantitative tightening – but recognize they are constrained to some degree by the inflation data.
The Federal Reserve decided to sit on its hands, as expected. It also has to contend with the impact of tariffs and other possible policies on the U..S economy but made clear that it is data dependent and willing to be very patient, which suggests to me the earliest possible rate cut for 2025 may not occur until the second quarter – likely late in the second quarter.
Kristina Hooper is Chief Global Market Strategist at Invesco. This article first appeared in the Invesco Insights – Markets and Economy page.
Notes
1. Source: Federal Reserve Beige Book, July 2018.
2. Source: Federal Reserve Beige Book, October 2018.
3. Source: Federal Reserve Beige Book, December 2018.
4. Source: Federal Reserve Beige Book, March 2019.
5. Source: Federal Reserve Beige Book, July 2019.
6. Source: Federal Reserve Beige Book, November 2019.
7. Source: Standard & Poor’s, as of December 31, 2019.
8. Source: MSCI, as of December 31, 2019
9. Source: FactSet Earnings Insight, January 31, 2025.
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