Tariff Tantrum: No Exit Strategy in Sight
The tariffs announced on Wednesday far exceeded expectations, including our own. While the scale of the tariffs is a concern, the bigger issue is the absence of a clear strategy to reverse course. The administration aims to reduce the US trade deficit by imposing tariffs based on the size of a country's trade balance relative to total imports. That formula won't change significantly unless there is a substantial shift in the relative competitiveness of the two nations.
Contrary to expectations that tariffs would support the US dollar, the currency weakened sharply against major peers. This reaction may hint at a broader policy direction. One key factor behind the persistent trade deficit is the dollar’s overvaluation, a result of loose fiscal policy combined with tight monetary conditions. Measures like the Big Mac Index highlight this imbalance, with the Japanese yen appearing undervalued by 46% against the dollar.
Last year, we noted the potential for a modern version of the 1985 Plaza Accord—a coordinated move to weaken the dollar. The dollar’s drop after the latest tariff news brings to mind President Nixon’s 1971 actions. Back then, Nixon imposed a 10% import tariff and ended the dollar’s convertibility to gold, effectively abandoning the Bretton Woods system. His goal was to weaken the dollar to reduce the trade deficit and boost US competitiveness. Though initially disruptive, the strategy eventually succeeded. Today’s policies may reflect a similar intent.
However, deliberately weakening the dollar brings risks, including higher inflation. That could complicate the Federal Reserve’s policy path, especially if growth slows at the same time. The result could be stagflation—low growth coupled with persistent inflation—making policymaking significantly more challenging.
For investors, the outlook is increasingly clear: bond yields are likely to fall. Tariffs raise uncertainty and pressure economic growth, increasing demand for safe-haven assets. Long-duration US Treasuries are particularly well-positioned to benefit from falling yields in such an environment. Historical precedent supports this—when growth slows and uncertainty rises, high-quality bonds tend to outperform.
Investors should also monitor for signs of coordinated international action to weaken the dollar. Although not widely discussed in the mainstream press, there is speculation about a possible Mar-a-Lago summit, where a coordinated devaluation of the dollar could be agreed. This would simultaneously improve US competitiveness and reduce the need for tariffs. Even hints of such moves could ease tensions and restore stability. Until then, markets are likely to experience subdued growth, falling bond yields, and rising volatility. Bond markets have been under pressure in recent years, but the current environment is very supportive of long-duration, high-quality fixed income.
If you would like to receive The Daily Update to your inbox, please email markets@epicip.com or click the link below.