Tariff Wars Take Heavy Toll on Equity Market

Amid the on again, off again brewing tariff posturing that has the U.S. equity market in total chaos, I’m pleased to say that the bond market has rallied sharply, drawing capital flows into assets that have reliable balance sheets. Even as some of the most beloved momentum stocks retreat as much as 30-50% off their recent highs, there is a welcome calm within the debt and credit markets.

The tariffs, and much of President Trump’s first hundred days sweeping agenda, has rattled markets. It’s like bad tasting medicine to address all the issues that investors are well aware of what he campaigned on. Markets are worried that tariffs will stymie growth and trigger new inflationary pressures. The latest Atlanta Fed GDPNow estimate for the first quarter of 2025 has been revised sharply lower to -2.4% on March 6, up from -2.8% on March 3, and down from a 3.8% growth rate posted on Jan. 30. This is a big revision with recent economic data not supporting such a pivot in their forecast.

The old saying of “markets hate uncertainty” is the operating phrase this week. And while some things are uncertain from a policy perspective, what is certain is that exports account for 20% of Canada’s GDP with 78% of Canada’s exports going to the United States. Additionally, exports play a significant role in Mexico’s economy, accounting for over a third of its GDP. Of these exports, more than 80% are directed to the United States. Conversely, U.S. exports to Canada make up 1.5% of U.S. GDP and exports to Mexico make up only 1% of U.S. GDP. Are markets overreacting? Yes, indeed.

For now, the air is thick with consternation, but the data points to Canada, Mexico and Europe agreeing on more equitable tariffs, a solidifying of the borders and way more support for Ukraine from Europe as the United States has done most of the heavy lifting in this ravaging war. Since the start of the war in February 2022, the U.S. has allocated approximately $175 billion in aid to Ukraine. There is no indefinite money for this war after the nearly 20 years spent in Afghanistan followed by a shameful exit.

As of January 2025, the U.S. national debt stands at over $36.2 trillion. In 2024, the United States spent approximately $1.16 trillion on interest payment for its national debt, which soars above the U.S. defense budget that stands at $850 billion for fiscal 2025. Because of concerns related to tariffs, inflation and the downsizing of decades-long bloated government, it sure seems the investment community has decided once again not to take the unsustainable federal debt bomb seriously due to market volatility.

I believe most of those that read our weekly Market Mail columns are of the old school view that if your own house (budget) isn’t in order, there are serious consequences. This current 7% pullback in the S&P 500 and 10% correction in the Nasdaq are nothing compared to what the inevitable would be if there was no coordinated plan to balance the budget first, and then working on a plan to reduce the federal debt. There is a time to spend money, and a time to save money. The U.S. government has done a terrible job of not saving and paying down debt during good times, and this just has to change.

The February employment data came in as forecast with the unemployment rate rising to 4.1% from 4.0% in January. The effects of the government DOGE job cuts will likely show up in the March and April data and the latest ADP report showed the number of future job openings shrinking month over month. All this translates to a softening in the labor market that brings down inflation but also can weigh on consumer confidence.

The latest CME FedWatch Tool reading shows the probability of the Fed cutting the Fed Funds Rate by a quarter point in May has risen to about 43% from 31% a week ago. There is no Federal Open Market Committee (FOMC) meeting scheduled for April. Next week’s inflation data will provide more information for whether that probability number heads higher, and I think it will. Anecdotal evidence definitely points to lower consumer spending. The bond futures market is now pricing in three rate cuts by year-end, and a complete turn of sentiment from the no rate cut narrative that was the accepted position just three weeks ago.

The pronounced selling pressure in the equity markets reflects an attitude of uncertainty that leads to caution, which is fueling the bond market rally. To this point, the stock market will be on the defensive over the near term. However, if the economy were heading toward a recession, the spreads on non-investment grade bond yields would be blowing out (widening bid and ask prices), and this is not anywhere near the case. High-yield bond spreads are tight, very tight, which in my opinion is a buy signal for stocks.

When fiscal order enters the room of party and spend like it’s 1999, it’s a buzz kill. Treasury Secretary Bessent recently discussed the U.S. economy is entering a “detox period” that refers to a transition from heavy government spending to increased private sector activity. He emphasized that the economy has become overly reliant on public sector spending and stimulus, and this adjustment might lead to temporary slowdowns in parts of the broader economy. The offset will be the Fed aggressively lowering interest rates over the balance of 2025 and well into 2026.

Again, the bearish canary in the coal mine of a future recession would be the widening of credit spreads in the high-yield fixed income and senior loan markets. As of last week, these markets have shown to be very stable, coupled with what is now a strong tailwind to the back of the Treasury market with the 10-year T-Note yield having rallied from 4.8% to 4.3% in the first quarter of 2025.

The market caught a bid from the spiraling bearish narrative last Friday when Fed Chair Jerome Powell basically stated the economy is in a good place with the Fed seeing no urgency to change its policy directive. A couple of facts. There are 3 million federal employees. For every federal government employee, there are 2 federal contractors, meaning the entire federal government is made up of roughly 9 million people with the U.S. labor force standing at 160 million works. Those that lose their jobs within the federal government will have to find work in the private sector. Corporations cut and build all the time. The road ahead won’t be full of punch bowls and stimulus, but the way forward will prove to be very reassuring for credit markets and ultimately equity markets.