On tariffs and inflation:
According to Fox Business, Ford announced a spring initiative dubbed “From America, For America,” which gives consumers access to Ford’s employee pricing discounts through June 2. The employee price is below the dealer invoice price. Therefore, the initiative offers consumers a unique price advantage. In “retaliation” to Ford’s action, Stellantis, whose brands include Jeep, Ram pickup trucks, and Chrysler, will expand its employee discount program on most models to the public. Although prices for some automobile components may increase due to tariffs, these initiatives do not appear inflationary.
The reality is that most countries, if not all countries, exporting goods to the US pay little (2%) or no tariffs while accessing the largest consumer market in the world. The opposite is true. When American-made products are imported into our trading partner countries, American goods are subject to steep tariffs. According to a March 31, 2025, article in The Wall Street Journal, a Harley-Davidson motorcycle that sells for $28,000 in the US, sells for $77,000 in Denmark after a 25% value-added tax and a 150% luxury tax. The proposed EU tariff would increase the motorcycle’s price to $124,000. It is evident that for many countries, politicians, and the news media, free trade means being able to sell as much as possible to the US while imposing increasingly stringent trade barriers to US exporters. The US trade deficit has nearly tripled, increasing from $43 billion to $131 billion from 2020 to 2024. However, although our trading partners have been using tariffs for many years, their economies are not inflationary. Check the following table published by Trading Economics: https://tradingeconomics.com/country-list/inflation-rate?continent=world
Reducing government spending, deficit, and money supply is crucial to lowering inflation, not tariffs. The Trump administration is aggressively tackling all these areas. In plain economic terms, tariffs are not inflationary because they do not increase the money supply. And the US trade deficit is not due to fair and competitive market practices. Therefore, the only way to level the playing field is by imposing reciprocal tariffs as a negotiation tool to reduce tariffs and trade barriers to zero, thereby benefiting consumers worldwide. If achieved, it will be positive for all financial markets.
On the economy:
Over the years, I have found that a good measure of whether the US economy is in trouble during a sharp stock market selloff is to examine the behavior of gold and the German and Japanese sovereign bonds. These instruments are used to protect capital when the US economy is in a state of financial distress. Although gold has been moving up due to lower interest rates, on Thursday, the 3rd, and Friday, the 4th, the price of the precious metal dropped on both days, with a notable decline of 2.22% on Friday. At the same time, I have not noticed an abnormal demand for German and Japanese sovereign debt. This may be an indication that the US economy is not in trouble. At least, not yet.
Consensus recession probabilities for the US economy have recently risen to 30%. Nevertheless, J.P. Morgan issued a report stating that the recession risk in the US has increased to approximately 60%, which is a notable claim to make on the day of a significant selloff. I expect them to lower the number on the next stock market bounce (I’m being sarcastic). Let’s take a closer look under the hood.
The Federal Reserve (Fed) reported their expectation of US economic growth to remain in the 1.8% range during the year. For many investors, this number may be on the low end, which is understandable. However, remember that the Federal Funds target range remains at 4.25% to 4.50%. I would be particularly concerned with the GDP growth rate at 1.8% with a Fed Funds target range of 0.00% to 0.25%, similar to the levels seen in December 2008, December 2015, and again from March 2020 until March 2022. Back then, if the Fed needed to bring stability to financial markets, it had no choice but to lower the Fed Funds rate to negative levels, as the European Central Bank did. With the Fed Funds rate at current levels, the Fed has considerable room to maneuver, either to prevent an economic recession or to restore stability to financial markets.
I do not believe the US economy is at serious risk of a recession. Even if GDP growth slows down due to a reduction in government spending, this would be a positive sign of a vibrant and productive economy ahead, as the country transitions from a government-driven to a private-sector-driven model.
U.S. economic activity and inflationary pressure, measured by the Chicago Fed National Activity Index, rose to +0.18 in February, up from -0.08 in January. This suggests that economic activity is above its historical trend. Furthermore, the S&P Global U.S. Composite PMI, which measures private sector activity across manufacturing and services, signaled expansion rising from 51.6 in February to 53.5 in March, the most vigorous growth since December 2024. This should come as no surprise, given the Trump administration’s recent announcement of its pro-growth economic plan. The Consumer Confidence Index fell in March, dropping to 92.9, its lowest level in over four years. However, this is far from the levels seen in previous severe economic downturns, including 87.1 during the pandemic and 26.9 in the 2008 crisis. As reported on Friday, the unemployment rate stands at 4.2%, and the labor force participation rate is 62.5%.
Supply-side economics, which includes lowering taxes, decreasing regulation, and promoting free trade, are not inherently detrimental to the economy. On the contrary, this toolbox is a must-have if the US is going to recover its financial strength and again become a productive, competitive, and thriving economy. Every socialist country should do the same to promote the well-being of its citizens. The change can be painful in the short term, but significant benefits are expected to emerge in the long term.
On a negative note, Jerome Powell, the Fed’s Chairman, appears reluctant to cut interest rates because he believes there is too much uncertainty about exactly how tariffs will affect the economy to act at this time. He should examine countries around the globe to understand that tariffs have no significant impact on their economies and are not inflationary. The Fed has brought stability to financial markets during times of turmoil before, even when the turmoil occurred in a foreign market. This is important because I believe the US economy is rotating from Phase III in the economic cycle to Phase IV in Q2. In the former, GDP slows down, and inflation accelerates. In the latter, both decelerate. Therefore, I anticipate that volatility will continue. If Jerome Powell and his team are hesitant to act to bring stability to financial markets at a time when inflation is decelerating and GDP is cooling, they may end up mismanaging the current turmoil in the same way they mismanaged the recent inflation crisis. Again, I don’t believe the US economy will go into a recession, but if the Fed mismanages the current tariff anxiety, the economy may end up in one.
Understanding the yield curve and the bond market:
It is well known that financial markets anticipate the real economy. Think of the sine curve waves. The financial cycle wave moves in parallel with the economic cycle wave but one step ahead of it. Understanding the variables that move both waves is essential to anticipate the probable direction of the real economy. The economic cycle waves are divided into four phases: Phase I, Phase II, Phase III, and Phase IV. Inflation, interest rates as determined by the bond market, GDP, and monetary policy, as set by the Fed, interact cyclically throughout the economic waves. I’m concluding that the Fed, in charge of monetary policy, may not yet be in sync with the other variables. If true, this could pose a problem for investors. Another critical factor is determining whether a stock market correction or bear market is the result of a structural change in the economy or temporary uncertainty triggered by a catalyst.
Among other factors, inflation can cause structural damage to the economy. Catalysts such as tariffs and the COVID-19 virus can create short-term uncertainty and confusion in financial markets. That is when drastic price adjustments occur because the immediate question in investors’ minds is how this will affect the economy. Since they don’t know, prices adjust down. At the same time, one must examine the bond market to understand its message. I’ve been successfully using this approach during the last twenty years of my now almost forty years in financial markets. In brief, bond prices fluctuate in response to changes in interest rates. When interest rates rise or fall, bond prices move in the opposite direction. This is important because short-term interest rates are the tool central banks use to control inflation and economic growth.
Next, with a cold mind and politics aside, determine whether the economy is presently in trouble and whether the catalyst (tariffs) can create a structural problem for the economy. Is GDP expanding or contracting? Is inflation accelerating or decelerating? This analysis is crucial to understanding the four phases of the financial and economic cycles. Financial markets can tolerate short-term uncertainty and volatility without causing structural damage to the economy; however, longer-term uncertainty may have serious consequences. If tariffs prove to be a short-term source of uncertainty, the stock market is likely to recover rapidly. Otherwise, it’ll be a very different ball game.
If you translate the above comments into practical matters, you will conclude that the treasury yield curve has been dropping since the beginning of the year. Bond investors are sending a very clear message to Jerome Powell. Inflation is not a threat, and GDP is stable at best or decelerating; therefore, the Fed should lower the Fed Funds rate as soon as possible. Mr. Powell and his team appear to be reluctant to act regardless of the green light given by the bond market. They misread the spike in inflation when the two-year yield skyrocketed in April 2021. Hopefully, they will not mismanage the tariff crisis at a time when GDP growth and treasury yields are dropping together.
The million-dollar question is whether Mr. Powell understands what the bond market is telegraphing to him. Furthermore, the futures market is anticipating four to five cuts during the year. The message cannot be more realistic. Being able to interpret the bond market messages is crucial while anticipating the economic cycle and positioning oneself correctly. So far, the bond market has been indicating that rates need to be lowered to maintain financial markets and economic stability, which, in turn, supports the bull market. In the meantime, we must address the volatility caused by short-term uncertainty.
Conclusion:
- Our priority is to protect capital in times of uncertainty:
- Our portfolios are not fully invested, and I would not recommend being fully invested at times of uncertainty.
- We are not disinvested either; it would be a mistake to underestimate the US economy.
- The US economy is not in a recession, but it could end up in one because GDP and inflation are decelerating together. A recession is likely if:
- The US Senate does not pass the president’s economic agenda.
- The Fed does not cut rates, or it doesn’t do it soon enough.
- If the US Senate passes the economic agenda and the Fed cuts rates:
- We expect the US stock market to experience a “V-shaped” recovery regardless of tariffs imposed on trading partners.
- We expect trading partners to negotiate with the White House unless they are willing to lose the US consumer market. Can they afford it?
Daily chart of US Treasury yields moving lower since early 2025:
Please be aware that my conclusions are always based on the results of our quantitative analysis. Although this article is not the exemption, part of my conclusion here is based on my interpretation of current events, which you may disagree with.
With best wishes,
