(Another) tariff whipsaw

After a period of de-escalation, investors were once again whipsawed after President Trump threatened to impose a 50% tariff on Europe following a lack of progress on a trade deal and a 25% tariff on Apple, and other device makers, to encourage them to move their production to the US.

The threat towards Europe quickly proved to be a negotiation tactic, with President Trump extending the deadline to the already-in-place 9th July expiration date based on the pause on reciprocal tariffs. Equity markets recovered their losses and have climbed higher since (note that past performance is not a reliable guide to future performance).

It’s a reminder of the uncertain, unpredictable environment we’re in though. Tariffs, and tariff rhetoric, can change on a dime. That said, the latest consumer confidence data shows that sentiment has picked up following the de-escalation with China. Consumers are (rightfully) assuming tariffs will have a major influence in their prospects over the coming months.

We could see sentiment improve further if the latest court ruling blocking most tariffs is upheld. The US Court of International Trade deemed them illegal and gave the US 10 days to remove them. The Trump administration has said they will appeal, but it’s not clear how long that will take to resolve.

If upheld, this will have huge ramifications. The outlook for the global economy surely improves – better growth prospects and lower inflation – while financial markets have already reacted as such, with equities and bond yields rising sharply on the news. It also raises questions over the “Big, Beautiful Bill” currently making its way through Congress, which was (indirectly) reliant on tariff revenues.

So, uncertainty will still linger. In the meantime, trade negotiation processes will likely grind to a halt, while front-loading of goods purchases could be huge over the coming couple of months. The tariff fog is far from clear.

US fiscal concerns

The fiscal package currently making its way through Congress has also been in the spotlight this week. The step-change in the US budget deficit since the pandemic has episodically caused angst amongst investors. The recent US downgrade from Moody’s added fuel to the fire, even if there appears to be no forced selling of US Treasuries as a result.

The bill is likely to be amended as it goes through the Senate but extends many of the tax cut provisions in the Tax Cuts and Jobs Act (TCJA) from 2017 and adds new tax cuts. After including spending cuts, the bill is projected to increase the deficit by $2.5 trillion over 10 years (versus current law).

However, tariff revenues aren’t included in these numbers. If the current set of tariffs were to be made permanent (and the US court ruling overruled), then it would roughly offset the entire cost of the bill. Of course, these revenues have now been called into question after the US court ruling deemed a large chunk of the tariffs illegal.

There are still caveats around the exact numbers but this bill, even with the tariff revenue offsets (which are up in the air at this point), doesn’t do much to address US fiscal deficits. Alongside global spillovers from Japan (see more below), yields on long-term bonds have drifted higher in the last month or so as a result.

Japanese bond market

Despite the backdrop of fiscal concerns, ongoing quantitative tightening¹ and rising inflationary pressures, the recent surge in Japanese super-long-term bond yields seemed to be due to technical factors. However, the Ministry of Finance (MoF) hinted that they might be prepared to adjust the bond issuance mix – fewer super-long-term bonds and more shorter-term bonds – by sending out a questionnaire to market participants asking about this very subject. This was enough to puncture the rise in super-long-term Japanese bond yields, as they collapsed sharply.

This kind of ‘intervention’ is a little unusual so it’s clear that the rapid rise in yields is on policymakers’ radars and they are prepared to intervene further if necessary. The Japanese bond market might seem niche, but it comprises a large part of global government bond indices – second only to the US. So, not only can we see spillovers into other bond markets, but this also directly influences any globally diversified bond investor.