Notes on tariffs, taxes, inflation, the Treasury market and more.
Do you remember when actress and Goop founder Gwyneth Paltrow and Coldplay frontman Chris Martin announced they were “consciously uncoupling” and the world wondered, what does that mean? For them, it meant a mindful divorce, without the typical anger and blame, and without the punitive financial repercussions that often accompany a separation.
I thought of that pop culture moment this week when Treasury Secretary Scott Bessent kept using the word “decoupling” to describe his trade talks with China.
“Both sides agree we do not want a generalized decoupling. The U.S. is going to do a strategic decoupling in terms of the items that we discovered during Covid were of national security interests—whether it’s semiconductors, medicine, steel,” Bessent said in a Bloomberg Television interview.
Just like in 2014 when Gwyneth first said it, the concept of Bessent’s strategic decoupling and a 90-day pause in punitive tariffs somehow made sense to investors, who took the news as a sign of significant progress, fueling a sharp rebound in risk assets this week.
This rally was perhaps for good reason, as U.S. and Chinese officials agreed to lower reciprocal tariffs to just 10% as officials work out a broader trade agreement. The U.S., however, will keep a 20% fentanyl-related levy in place on Chinese imports, meaning the total tariff rate on goods from China now stands at 30%. Recall, prior to last weekend’s negotiations, President Trump’s administration had imposed tariffs of 145% on goods from China, with Beijing responding in kind with its own 125% tariff on U.S. exports to China.
While markets are cheering this progress, history suggests it could take a long time to reach a detailed agreement, if one is possible at all. In 2018, the two sides also agreed to put their dispute “on hold” after a round of negotiations, but the U.S. soon backed away from that deal, leading to over 18 months of further tariffs and talks before the signing of a “Phase One” trade deal in January 2020.
In the end, China failed to live up to the purchase agreement in that deal and the U.S. trade deficit with China jumped during the pandemic, setting up the current trade war.
Even as the rebound in financial markets from the depths of “Liberation Day” provides welcome relief to all of us, many investors harbor skepticism over the durability of this rally especially as we process earnings reports and economic data that suggest damage has already been done.
While Walmart exceeded earnings expectations partly due to pre-tariff stocking by consumers, CFO John Rainey made clear his concerns about the future in comments to CNBC:
“We’re wired for everyday low prices, but the magnitude of these increases is more than any retailer can absorb,” he said. “It’s more than any supplier can absorb. And so I’m concerned that [the] consumer is going to start seeing higher prices. You’ll begin to see that, likely towards the tail end of this month, and then certainly much more in June.”
Besides Walmart’s outlook, economic data was also cloudy this week, including two U.S. regional manufacturing surveys that were below levels signifying expansion, weakening business and consumer confidence reports, and a lackluster April retail sales number following the surge in March driven by pull-forward pre-tariff demand. Initial jobless claims were perhaps the one bright spot, remaining at a benign 229,000.
For now, key inflation barometers remain in check, with both the Consumer Price Index and Producer Price Index showing declines in April. While not quite at the Federal Reserve’s target 2% level, the CPI has now fallen to 2.3% from a peak of 9.1% in June 2022. Even so, Fed officials continue to stress an increasing concern about cost pressures, especially as near-term inflation expectations have soared to the highest level since 1981. With that, it is unlikely policymakers will make any adjustments to interest rates while trade negotiations are a source of worry.
Stocks previously battered by tariffs, including consumer discretionary, info tech and communication services companies, and especially the Magnificent Seven, rebounded full throttle this week, as did steel companies, retailers, travel-related firms and delivery companies, on hopes of economic growth. It also helped that President Trump’s tour through the Persian Gulf included the announcement that Nvidia and Advanced Micro Devices will supply chips to Saudi Arabia’s artificial intelligence company Humain for a data center project.
The only sector not particularly euphoric this week was pharmaceuticals after the president’s executive order, which gives companies 30 days to work with the administration to lower drug prices and promising additional regulatory action if there is no significant progress in six months.
It is worth highlighting the bond market’s moves this week; Treasury yields rose amid Washington, D.C. budget negotiations. The proposed budget and tax bill demonstrates expansive fiscal policy including making the 2017 tax cuts permanent, no tax on tip or overtime income, making the interest on auto loans tax deductible, as well as increasing the child tax credit, standard deduction and state and local tax (SALT) deduction cap. The only meaningful revenue offset appears to be a tax on endowments of colleges and universities to as high as 21% from the current level of 1.4% in yet another swipe at higher education. Bond investors also noted Treasury Secretary Bessent’s comment that the debt limit would be breached in August without an increase. The proposed tax bill contemplates a $4 trillion increase in the debt limit, which, if passed, would take the issue off the table until 2027.
Until some of these discussions progress, on both the tariff and tax front, we remain in limbo in financial markets, looking for signs of progress even as a cloud of unanswered questions hangs over all of us. Now more than ever, we recommend diversification coupled with patience, and skepticism without cynicism. The U.S. economy, consumer and business sector have a strong track record of forging ahead, weathering setbacks and confronting doubt with resilience and innovation. We would not bet against that trend, even if we all want to decouple from this moment of uncertainty.
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