Markets In Correction. What Next?

Tariff Wars Don't End Well

Senator Reed Smoot and Representative Willis C. Hawley have a place in US history for one important reason. Increases in import tariffs on thousands of goods that they sponsored, and President Herbert Hoover’s signing those bills into law in June 1930, are widely blamed for deepening the Great Depression. Trade partners promptly retaliated in force to the Smoot-Hawley tariffs resulting in plunging world demand, reduced global production and employment.

There were no winners in that trade war.

With no lesson learned from history, the United States and the rest of the world are embarking on a similar exercise again. President Donald Trump went ahead Wednesday with imposition of a 25% tariff on imports of steel and aluminum irrespective of the country of origin. Canada, the principal source for the United States of both commodities, has threatened to retaliate. The European Union announced its plan to impose tariffs on $28 billion of American goods including whiskey. Retaliating to the EU retaliation, Trump threatened on Thursday to put a 200% tariff on alcoholic beverages from Europe. You get the drift!

Responding to the realization that there may be no quick relief from tit-for-tat trade policies, US equities went into correction territory Thursday with the S&P 500 index falling just over 10% from its recent high. Despite the relief rally that occurred yesterday, all the three major equity indexes had a losing week. Corporate chieftains who had cheered the incoming Trump administration in the hope of securing deregulation and reduction in taxes instead encountered the new reality that tariffs and counter-tariffs have become the focus areas for the President.

While specific sectors, e.g., US steel producers, have been beneficiaries of the Trump tariffs, overall prospects have turned sour for the economy and for inflation. Businesses are likely to postpone investment decisions in response to the massive uncertainty. The Federal Reserve Bank of Atlanta’s GDPNow estimated -2.4% growth in the current quarter as of March 6, reversing the +2.3% expansion in the final quarter of 2024.

There is no relief on the consumer front either with survey after survey suggesting that consumers believe that they will bear most of the burden of the tariffs and have increased their expectations for inflation during the coming years. They have cut back on spending and increased the savings rate. The University of Michigan survey released yesterday was especially stark, posting a slump in consumer confidence prompted by a surge in expectation of inflation during the coming year of 4.9%. That is why yields on two- and 10-year Treasurys rose yesterday despite relatively benign consumer and producer price inflation numbers released during the week.

What should be the role of monetary policy under these circumstances? The important thing for Federal Reserve Chairman Jerome Powell and his colleagues to realize is that even substantial reductions in interest rates cannot offset the adverse impact of tariffs on economic growth and employment. The best the Fed can do under these circumstances is to focus on keeping inflation under control. That may require higher interest rates.

Rather than state that the US economy “is in a good place” as Powell did last week keeping hopes of interest rate cuts alive, he needs to specify at his post-Federal Open Market Committee press conference next Wednesday that he and his colleagues stand ready to raise interest rates as the higher tariffs have their impact in pushing up inflation.

Will that not cause Trump to criticize him in public for an action the President may deem as worsening inflationary pressures? Yes, it would but Powell has also said repeatedly that he is apolitical when it comes to implementing monetary policy. This would be the opportunity for him to demonstrate his independence rather than by attempting to do so by repeatedly mouthing platitudes about not worrying about political developments.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

March 15, 2025

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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