Tariff Ripple Effects

Thursday, May 8, 2025

Tarriff Ripple Effects

We are reminded of Newton’s third law: for every action, there is an equal and opposite reaction. The global economy is contending with a powerful new force: tariffs. While the headline rates are easier to measure, the equal and opposite ripple effects are far more complex. A computer, for example, is built from thousands of components sourced from dozens of countries. Many of these parts cross borders multiple times before reaching the end consumer. That complexity does not cleanly translate to a new sticker price. Even if that complexity were fully transparent, it still would not be simple arithmetic. It is also a behavioral equation: how much cost companies will eat, how much they pass along, and how consumers respond. The reality is more tangled than any headlines may let on. In uncertain times, we must distill noise to primary signals and in this case we do so through pragmatic human behavior.

The Economic Shot Clock: A Bump, Then a Fade

Holding all else equal, meaning tariffs remain in place, our expectation is a temporary bump in economic activity and inflation followed by a fade in both. Why the bump? Consumers may front-load purchases they believe will become more expensive, temporarily boosting retail sales and corporate earnings. When this economic placebo fades and businesses and consumers face higher costs and growing uncertainty, they begin to pull back. This translates to something like “plan for the worst and hope for the best.” For businesses, planning for the worst rarely includes hiring. Additionally, as profits compress, costs come under the microscope. Falling corporate profits are among the most reliable leading indicators of rising unemployment. That is why we believe the economic shot clock is running. Sentiment clearly has shifted and without an offset or de-escalation, current policies are likely to exert greater downward pressure on the economy.

Any attempt at a prescriptive version of the future is fraught with error. We also know that reality rarely colors inside the lines we draw for it. That said, we can envision a number of likely paths in which this could unfold.

The Path(s) Forward

Door #1: A Tweet Will Set You Free - There is a non-zero chance the current economic course we have set abruptly shifts. The same stroke of the pen that imposed tariffs could just as swiftly undo them. If so, while real economic damage has been done, markets may peer through their newly applied black eye and regain optimism.

Door #2: It Takes Time, But Is Resolved In Time - The U.S. is currently navigating what we call an "event-led correction.” As a self-inflicted event, it also means the remedy is within reach. Over time, trade concessions are negotiated and the market could slowly recalibrate. The key factor here is that it will take time and in the interim, prices may continue to drift lower with uncertainty. In such an instance a classic rebalance may be required, simply selling what has done well to buy what has done poorly. Yet, the dislocation may not be large enough to fundamentally alter our 10-year forward view and we choose to rebalance back to the targeted allocations with which we began the year.

Door #3: Oops - Should the situation deteriorate further, the U.S. could shift from an event-led correction into a recession-led bear market. In that case, asset prices would likely decline sharply and forward-looking assumptions would need to be reset. Still, such a scenario may also present opportunity. For example, in such an environment, wider credit spreads may offer more attractive entry points, potentially shifting our current positioning from a multi-year low to something more substantial.

As always, please reach out with any questions; we would be happy to discuss our thoughts on these events in further detail with you.