Navigating tariffs

US President Donald Trump utilised emergency powers to impose a basic tariff of 10% on all imports, with higher reciprocal tariffs targeting key US trading partners. The EU was hit with a 20% tariff due to the bloc’s “unfair trade practices,” while China faced a steep 104% levy.

Southeast Asia was also severely impacted, with tariffs nearing 50%. The stated objective of these measures – which function as a tax on imports – is to reduce the US trade deficit, encourage domestic manufacturing, and increase government revenues amid growing fiscal pressures.

Markets had already been pricing in some tariff-related impact in the weeks leading up to ‘Liberation Day’.

However, the tariffs announced on April 2 were generally higher than expected, prompting a widespread ‘risk-off’ move as investors began to price in the possibility of an all-out trade war.

Trade wars are particularly costly in today’s interconnected global economy, where trade constitutes a large share of output. This has been reflected in global equity markets. The S&P 500 experienced one of its worst two-day stretches since the COVID pandemic, falling around 11% in the two days following the announcement.

The Eurostoxx 600, a broad European equity index, has lost approximately 18% since its early March peak.

Markets may recover if the tariff announcements trigger negotiations leading to lower tariffs over time. Trump has already begun discussions with Japan and has claimed that “50, 60, maybe almost 70 countries” have come forward to negotiate. Still, a full rollback to zero tariffs appears unlikely. As a result, both GDP and corporate earnings growth are expected to decline, while inflation is set to rise. Recession risks are also increasing.

In this environment, equity markets are likely to remain under pressure. The S&P 500 currently trades at about 20 times forward earnings, compared to a historical average of 16 times during recessionary periods over the past 30 years.

Bond markets have also experienced significant volatility, with sharp declines in government bond yields and wider credit spreads, particularly in high-yield debt. However, movements have not been one-directional; yields have also bounced back, notably in US Treasuries. This may reflect optimism around eventual trade deals, or alternatively, expectations that tariffs will be inflationary – leading bond investors to demand higher yields for longer maturities.

Tariffs have placed central banks, especially the US Federal Reserve, in a challenging position. Fed chair Jerome Powell had already expressed caution over the extent to which interest rates could be cut to offset growth risks. Even before the tariff announcements, inflation was proving more persistent than the Fed had forecast in its economic projections.

With tariffs now adding further upward pressure on prices, inflation poses an even greater challenge. Typically, such a scenario would argue for rate hikes to prevent inflation expectations from becoming unanchored. At the same time, should growth deteriorate rapidly, and the labour market weakens, the Fed may have no choice but to cut rates. Currently, markets are pricing in around 100 basis points of rate cuts for the year.

Trump announced a 90-day tariff pause on reciprocal tariffs on all major US trading partners and boosted tariffs on China to 125%- Colin Attard

Pressure is also mounting on the Fed to consider expanding its balance sheet through renewed bond purchases, particularly if long-term yields rise. The risk is that the US economy could slide into a stagflationary environment –something central banks are keen to avoid. In such a scenario, traditional diversification strategies may falter, as both equities and bonds could suffer simultaneously.

In the near term, it is understandable that investors reduce risk exposure. However, it is equally important to identify high-quality companies that were caught in the broad-based sell-off and may continue to perform well. While European equities face headwinds from evolving trade dynamics and potential euro strength, they remain attractively valued on a price-to-earnings basis.

They may also benefit – relatively – from capital being repatriated from US markets and from fiscal expansion in Germany and at the wider EU level. Within Europe, investors may wish to favour companies with revenues driven by domestic demand.

Fixed income investors might consider taking advantage of higher yields at the longer end of the curve, selecting bonds with extended maturities while limiting credit risk. As spreads widen, the yield premium becomes more appealing.

For euro-based investors, it may also be prudent to reduce exposure to the US dollar, as its safe-haven status is being tested amid risk-off flows, weakening growth prospects, and declining demand from foreign Treasury buyers.

While tactical adjustments are appropriate in this environment, investors should not lose sight of their long-term strategic asset allocation, which is designed to achieve enduring financial goals.

Shortly before going to print, President Trump announced a 90-day tariff pause on reciprocal tariffs on all major US trading partners while at the same time boosted tariffs on China to 125%. This led to a large rally in US and European stock indices.

Whereas this is a much-needed de-escalation that will avoid worst case scenarios from unravelling, heightened economic uncertainty remains and market volatility is expected to stay elevated as negotiations continue.

Colin Attard is chief investment officer at Curmi and Partners Ltd.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.