Summary
Markets are pricing in the impact of Trump's tariff war on US growth. This implies US equity underperformance, while countries like China, India, and Japan implement expansionary policies to offset tariffs.
What’s top of investors’ minds
Look for outperformance from policy stimulus
Markets have begun trying to price the extent to which US President Trump’s tariff war will slow economic growth, damage earnings, and perhaps lead to Fed rate cuts. Complicating matters is Trump’s daily and at times intra-day vacillations about which countries and products will be affected and when. However, Trump’s rhetoric increasingly suggests that he will go through with significant and broad tariffs despite stock market weakness and risks to growth. We judge this commitment to tariffs to combine with his tighter immigration policy to point to US GDP growth slowing from 2.5% last year to 1.6% - 1.8% this year with risk to the downside if he follows through with reciprocal tariffs in early April.
For markets this implies continued US equity underperformance particularly relative to countries where policy is turning expansionary to offset the impact of tariffs. In Asia, China stands out, just having confirmed a fiscal stimulus worth about 2% of GDP. We expect India to increasingly qualify as the Reserve Bank of India accelerates interest rate cuts in the coming months. Japan’s pro-wage growth policy should also work to insulate Japan’s domestic economy from weaker exports to some extent. Further afield, Germany’s new government has proposed a large new fiscal stimulus, although this faces political challenges for passage.
The US Federal reserve is likely to be slow to respond to any weakening of US growth because tariffs are likely to be inflationary. This implies that although the directional bias for US Treasury yields will be down, duration is likely to remain volatile. A mix of rising concerns about growth and higher equity volatility is likely to introduce pressure to US credit products in favour of EM credit where central banks will likely be faster to cut rates.
Markets tend to punish bad policy and reward good policy
Chinese policy shifts to stimulus
China’s NPC ushered in an important policy shift back towards stimulus that will support China’s markets, in our view. Policy announced so far points to an increase in the in-budget deficit of 2.2% of GDP to about 9.9% on a cash basis and an increase in the broad, “augmented” deficit of about 1.7%-1.8% of GDP to roughly 15% of GDP. Although that was in-line with well expectations, officials suggested that the government had further policy measures in reserve if necessary. Local governments appear likely to gain new discretion over the amount of their bond quota they can use to buy excess housing and land inventory and, crucially, the price at which they can bid.
Officials suggested new support for private sector businesses in terms of cracking down on local government tax farming, increased pressure on local governments to settle arrearages to private companies and granting greater access to government contracts. China’s central bank also appears likely to cut interest rates and bank reserve requirements at least 50bps. This should boost liquidity and improve the attractiveness of property relative to interest rate products.
In sum, we expect that Beijing will spend whatever it takes to keep GDP growth above 4.5% in all but worst-case scenarios of the US raising its tariff rates on China to 50% - 60%.
Fiscal and monetary stimulus should support earnings revisions
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