News in Charts: A busy week for economists

It has been a busy week for economists, especially for those engaged in financial markets. By our reckoning, the cumulative increase in the US effective tariff rate since inauguration day went from around 12 percentage points on Monday morning, to some 30 percentage points as US markets opened on Wednesday. It eased back to 28 percentage points before the end of the day, as blanket tariff increases above 10 percentage points on most countries were suspended, while the increase imposed on China was raised to 125 percentage points. On Thursday, that 125 percentage points turned into 145 percentage points and the overall effective increase was back to 30 percentage points – we think! If it sticks, and it is a big ‘if’, it will be the sharpest increase since the 1860s, and the highest effective rate since the 1930s.

IN HOUSE

Against this backdrop, equities have, understandably, been volatile. The S&P500 traded in a range close to 11% on Wednesday, the largest intraday move since the depths of the financial crisis. There was a lot of money to be made this week… if one knew what was coming.

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In response to the events of recent weeks, Fathom has revised down its forecast for global growth. Our central case embodies an increase in the US effective tariff rate close to that currently in place (but only if we exclude the punitive tariff levied against China from the calculation), which leads to a mild recession in most major economies. With little to go on in the way of recent experience — we are living through a form of economic experiment — the predictions of statistical models must be taken with a heavy dose of salt. Nevertheless, in our judgment, the odds of a four-quarter contraction in US GDP over the next two years have risen from around 30% when we finalised our Global Outlook, Spring 2025 in mid-February to around 60% today. In the past, the euro area (EA) economy has been hit harder than the US by an increase in US tariff rates; it is likely that this reflects the greater dependence of the EA economy on international trade (the EA accounts for 18% of global GDP and as much as 30% of global trade, while the US accounts for 26% of global GDP but just 11% of global trade). Much will depend on the outcome of trade negotiations, and the scale of fiscal support provided, particularly through increased spending on defence. Nevertheless, we consider that the odds of a four-quarter contraction in EA GDP are even higher than they are in the US.

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Whatever the outcome of the expected trade negotiations, elevated uncertainty will have had an impact on the macroeconomy, and this will start to become visible in published data (it is already visible in measures of US consumer confidence, which fell through February and March by more than in any two-month period since the early days of the COVID-19 pandemic). According to a model published by a team of US federal reserve economists during Trump’s first term, the increase in trade policy uncertainty that we have seen since the US election on 5 November 2024 would in itself be sufficient to remove 1.0%-1.5% from the level of GDP over the next four quarters. This effect is purely from the increase in uncertainty and makes no separate allowance for the increase in tariff rates, which will further depress US economic activity [1].

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It is an open question, in Fathom’s view, whether there has been an enduring loss of confidence in the US policy framework that could threaten the status of the US dollar as the world’s reserve currency. Were this to occur, US dollar assets would no longer be seen as a ‘safe haven’ to the degree that they are today. Recent movements in exchange rates, with the dollar tending to fall on days when there have been announcements about higher tariffs, and vice versa, is indicative of a step in this direction. Historically, the US dollar has tended to rise in value during periods when there has been bad news about equities, and vice versa. This effect can be seen in our final chart, which compares monthly movements in the MSCI World index with monthly movements in the value of the US dollar against sterling. We shall continue to monitor and assess the impact of trade policy and trade policy uncertainty on the macroeconomy and its financial markets, and we will return to the issue of the reserve currency status of the US dollar in our forthcoming Global Outlook, Summer 2025.

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[1] ‘Does trade policy uncertainty affect global economic activity?’ by Caldara, D, Iacoviello, M, Molligo, P, Prestipino, A and Raffo, A.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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