The S & P 500 has reversed its post-election rally and part of this downturn was credited to tariffs. There is a near unanimity that tariffs will cause inflation and slow down the economy.
How accurate is this view? There was also near unanimity [including the Federal Reserve and most money banks] that exponentially increasing the overnight rate from 0.00% to 5.5% in short order would cause a recession. The economy, however, expanded at the greatest pace since the commencement of the millennium.
Perhaps a more significant question to ask is whether tariffs will cause a financial dislocation. The markets are interlinked and the financial events in one segment of the market will impact another.
What are the odds a severe financial crisis occurs, the result of tariffs, perhaps defined as the unwinding of leveraged and carried trades that interspersed and interconnected across the debt and currency markets?
Most academics will state that for every 10% increase in a tariff, there will be a reciprocal 4% decline in the targeted country’s currency. Secretary of Treasury Bessent testified extensively about this relationship during his acceptance hearing.
Will currency adjustments negate the impact of tariffs? Will there be a surcharge to negate the impact of currency fluctuations as has been the case in times past?
Many try to explain the markets as a dichotomy…an either/or and mono variable environment. This is far from the reality. However in today’s algorithmic trading rage, a five word headline that is robotically written a million times will impact market direction.
Reality, however, will return but the question is as to when. All must remember the markets can remain irrational one day longer than one can remain sane or solvent.
Commenting on the bond market, the futures market is now suggesting that the Federal Reserve will lower interest rates in May, the result of tariffs hikes that may upend a weakening economy. Approximately 75 bps of interest rate cuts is now expected by years end. These concerns have been building over the past two weeks, ushering a major recalibration I the financial markets.
This is the gazillionith time monetary policy expectations have changed.
The yield curve again steepened yesterday as the short end rallied and the longer end nominally sold off.
The ISM Services index is released today. How will the data be interpreted?
Last night the foreign markets were up. London was up 0.43%, Paris up 1.92% and Frankfurt up 3.33%. China was up 0.53%, Japan up 0.23% and Hang Seng up 2.84%.
Futures are up 0.30% and 0.50% amid hopes there may be a compromise on tariffs. European markets surged and bonds tumbled on Germany’s spending plans. The 10-year is up 3/32 to yield 4.23%.
