The Investment Management Team
Markets are reacting to the rapidly evolving news around tariffs on Canada and Mexico.
The stock market rallied on March 5 after President Donald Trump gave a one-month tariff exemption to automakers. The previous day, when the impending tariffs went into effect, the S&P 500 dropped by roughly 5% versus its recent all-time high on Feb 19. The United States’ major trading partners are now set to impose reciprocal tariffs, potentially impacting growth and putting upward pressure on prices.
Data collected by Bloomberg Intelligence notes that the recently announced tariffs lift the average U.S. levy from 2.3% to 11.5%, raising the risk of both a drag on gross domestic product (GDP) and an increase of 0.8% to the personal consumption expenditures (PCE) index—the Fed’s preferred inflation gauge.
Despite the near-term stagflation worries, the odds of Fed easing this year have notably increased. While a March cut is not predicted at this point, a cut in May is now close to a 50% probability (versus 25% 1 week ago). Stocks that have outperformed the most recently (like the Magnificent Seven, technology, and momentum) are amongst those leading the declines. Small caps are also falling due to the perceived impact from tariffs.
Market Reaction
Treasuries rallied again Tuesday March 4, as the policy-sensitive 2-year yield fell below 3.90%, its lowest since October 4. Meanwhile the 10-year touched 4.10%, its lowest since October 21. Going into the March 4 market day, Treasuries have outperformed stocks since the November 6 election, with Bloomberg's U.S. Treasury total return index up 2.1% since November 6, outpacing S&P 500 gain of 1.6%. The CBOE VIX index, which measures equity volatility, has spiked to ~25. This is its highest level since last December, which indicates heightened investor uncertainty.
Investment Management Team Observations & Perspectives
Most economists surveyed believe that tariffs will negatively impact gross domestic product (GDP). The Atlanta Fed's latest GDPNow update shows 2.8% contraction for Q1, cutting real personal consumption expenditures (PCE) and real private fixed investment outlook from 1.3% and 3.5% to 0.0% and 0.1%, respectively. In the near term, tariffs will likely increase prices to consumers. Piper Sandler estimates a roughly 1% increase, which will have outsized impact to small businesses and low-to-middle income consumers. The long-term implications to inflation remain unclear. If tariffs are kept in place and reciprocal tariffs implemented, odds of a recession increase, putting downward pressure on pricing.
The odds of Fed easing have increased. At the beginning of 2025, futures markets priced in around one and a half fed funds rate cuts by year-end. Today, markets are pricing in around three and a half rate cuts by year end, bringing the fed funds rate from ~4.25% today to ~3.5%.
Capital markets can shift rapidly in response to changes to fiscal policy. The implementation of tariffs has increased the likelihood of an economic slowdown, necessitating more accommodative monetary policy.
Final Thoughts
Sweeping tariffs on China, Canada, Mexico, and Europe could have significant economic and market implications. Sectors such as automobiles, apparel, technology, consumer goods, and agriculture (amongst others) could be some of the most exposed industries. The potential of a prolonged trade war increases the probability of recession, particularly for Canada and Europe.
The current environment is similar to 2018, when President Trump imposed new tariffs during his first term. That year, the S&P 500 experienced multiple market corrections, including a ~12% pullback in January/February and a ~20% decline in Q4. If the trade war rhetoric continues in the coming weeks, we could be in store for more volatility as the cloud of uncertainty prevails.
This serves as yet another reminder of why we diversify risk factors, as we employ a systematic approach to achieve long-term investment objectives. Even in strong years, intra-year double-digit percentage losses are more common than not, so we construct our portfolios to be resilient while tactfully positioning for mispriced opportunities.
This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Investing involves risk, including possible loss of principal.
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