Tariff talk and rate cut hopes amid economic caution

Guy Foster, Chief Strategist, examines how the U.S. may be prepared to moderate its position on trade with China. Plus, Janet Mui, Head of Market Analysis, discusses the potential negative impact of tariffs.

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Softening tone from Trump. Will it last?

There are more U-turns from the White House, likely from the compounded market pressure due to the sell-off of U.S. stocks, the U.S. dollar and U.S. treasuries in unison.President Trump said he would be willing to “substantially” pare back his 145% trade tariffs on China and said both sides have been talking, though China has denied the latter. From being unapologetically provocative on China to the suggestion of “being nice” in just a matter of weeks, it’s no wonder “Trump chickens out” is a top trending hashtag on Chinese social media Weibo.

The softening in aggressive rhetoric came after a meeting with key U.S. executives from Walmart, Home Depot and Target. The sky-high tariff rates on China will significantly disrupt supply chains, risk empty shelves when inventories are run down, and raise the price of imported goods for the average American consumer. This is an indication that opinions from the Corporate American elites have some sway on President Trump.

Though perhaps the reason for backing down is simple – the trade war between the U.S. and China is “not sustainable”– as Treasury Secretary Scott Bessent neatly put it. The U.S. has a trade deficit of $274 billion with China, from where it imports $439 billion and exports $165 billion. At first glance, it seems China stands to lose the most, if a large part of these export revenues is lost. But as China stands firm and as days go by, it becomes increasingly apparent that the U.S. will suffer more in the near-term given its heavy reliance on a range of household goods and industrial inputs from China. American businesses and consumers will either find it difficult to substitute those Chinese imports or will pay a higher price due to tariffs.

Given the sensitivity of U.S. consumers on inflation and how integrated U.S. businesses are with supply chains in China, it’s difficult to see how these astronomical tariff rates can last for weeks, let alone months or years.

Aside from tariffs, President Trump also U-turned on his claims of firing Fed Chair Jay Powell. While President Trump reiterated his call for interest rate cuts, he said he had no intention of firing Chair Powell. Whether he means it from the bottom of his heart is debatable, but the point is, the bond market serves as a guardrail on how far he can test the boundaries.

While the trade drama is almost certain to continue, the recent developments did provide hope that the worst of the provocations are over. What we can learn from last week is that economic pragmatism and market pressures do hold Trump back, at least to some extent. That said, some credibility on the U.S. administration is damaged and investors are assigning a higher risk premium on U.S. assets under Trump 2.0.

The economic cost of tariff uncertainty

It’s certainly a welcoming development that the most aggressive tariff rates may scale back. Given the economic damage is self-inflicted, the U.S. administration does have control to reverse all these damaging decisions. What it cannot control and easily amend is the confidence and credibility lost. The impact of policy uncertainty on economic activity is often manifested through the confidence channel. We have already seen a plunge in various U.S. consumer and business surveys, with a worrying combination of higher price expectations and a decline in the desire to spend or invest. The latest PMIs in major developed economies provided yet more evidence of the potential stagflationary (higher inflation, lower growth) impact of Trump’s tariffs.

Source: Refinitiv Datastream.

Since the escalation of trade tariffs, various high-profile executives and sell-side economists have been warning about the negative impact. The latest World Economic Outlook by the IMF presents another authoritative voice on the subject. Unsurprisingly, the IMF has downgraded global growth forecasts due to trade tensions and deteriorating sentiment. The 2025 U.S. GDP growth forecast has been slashed by 0.9% to 1.8%, a very significant downgrade in just a matter of three months. While a U.S. recession is not expected, the IMF has raised the probability of this happening to 40%. Setting aside cyclical worries, the new reality highlighted by the IMF is that the global economic system, that has operated for the last 80 years, is being reset.

Rate cuts to cushion the tariff blow?

After the decisive rate cut by the European Central Bank due to economic concerns, the question is how far will central banks go to cushion the economy from tariff blows. There is a willingness to cut rates to support the economy for sure, but it all depends on whether there’s room to do so i.e. does inflation mean monetary policy can be loosened.

It’s interesting to hear the views of Monetary Policy Committee (MPC) member Megan Greene on the subject. She feels tariffs actually represent more of a deflationary risk than an inflationary risk. While the tariffs are expected to raise prices in the U.S., the UK could see the opposite effect due to the diversion of cheap Asian exports, a weaker dollar and the softening of demand from slower growth. The takeaway from the perspective of one of the most hawkish policymakers of the Bank of England is that the concern on growth probably outweighs that of inflation.

While Fed Chair Jay Powell is applauded to stand firm on no rate cut for now, two Fed officials expressed support for a rate cut if there’s more evidence of an economic slowdown and deterioration in the labour market. It seems that central bankers are adopting an agile mindset to deal with this new macro environment of multiple shocks. As growth outlook deteriorates, traders are pricing in a few more rate cuts in the UK, U.S. and the Eurozone for the rest of 2025.

Coming up

• Tariff negotiations: We anticipate news on negotiations between the U.S. and Japan, South Korea and India, as well as any follow-up on the proposed lowering of tariffs on certain U.S. goods by China. 
• Inflation update: We’ll get personal income, spending and Personal Consumption Expenditures (PCE) inflation data from the U.S. Any sign of slowdown in consumer spending may inject more worry into the markets.
• Big tech earnings: Tech heavyweights including Meta, Microsoft, Amazon and Apple are due to report next week. Analysts will be keen to hear how CFOs are modelling and navigating tariff risks in their financial projections.

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