The economic outlook begins and ends with trade and tariffs. After turning DOGE loose on government waste and inefficiency to reduce the federal deficit, the administration has recently changed its focus to the trade deficit. Some historical context may be helpful.
Bretton Woods:
The Bretton Woods agreement reached in 1944, established a new global monetary system after World War II, aiming for economic stability and cooperation. It primarily involved the creation of the International Money Fund (IMF) and the World Bank and a system of fixed exchange rates, with the US dollar pegged to gold1. When our country went off the gold standard in 1971, the system was replaced by a managed floating exchange rate system, where central banks can intervene in the foreign exchange market to influence currency values, according to the CEPR. This means that while currencies are not fixed, central banks can, and often do, take actions to stabilize exchange rates or achieve other macroeconomic goals.2
What Happened?
As our economy advanced, it evolved from a manufacturing export driven model to a service based one. Other countries sent us their cars, phones and clothes (goods) and in return they purchased our bonds, software and management consultants (financial instruments and services). As Americans, we consumed more than we produced. The trade deficit is a manifestation of that reality. On the plus side of the trade imbalance, global growth accelerated as consumers benefited from lower prices and shareholders benefited from greater profits. On the negative side, the trade imbalance led to the closing of many factories and the loss of blue-collar jobs. It also created fragmented supply chains and caused global firms to focus on cost reduction at the expense of innovation.
Covid
The globalization of free trade hit a snag with the spread of the Corona virus in 2020. As a nation we found we relied heavily on supply chains located in other countries. “If Covid taught us anything, supply chains are extremely complex and difficult to arrange overnight”.3 Then there’s the national security concern. “…trade with China had hurt U.S. citizens and endangered national security by outsourcing production of military components to a potential adversary”.4 If we go to war, it will help if we could make our own tanks and ships without relying on imports.
Tariffs
Our President has responded to this situation by declaring our trade deficits an “unusual and extraordinary threat to national security and economy of the United States”.5. Although the US constitution gives congress the power to levy tariffs, this declaration allows the President to use the International Economic Emergency Powers Act that was passed in 1977 and enact tariffs without congressional approval.6
Politics
The timing of this trade war is not accidental. The President’s party does not have to face the electorate for another 18 months. Trump may also be looking for an opportunity to reward the rust belt worker who voted in large numbers for the current president at least partially based on his promise to return manufacturing to the United States. Former President Reagan supported trickle-down economics whereas the current President’s trade policy could be aptly described as bottom up. All government economic policies favor one group at the expense of another. President Trump seems to be saying it’s the blue-collar worker’s time.
End Game
The President appears to have two factions warring for influence in his tariff policy. Howard Lutkin and Peter Navarro have both publicly stated their opposition to negotiate. They believe we need tariffs to raise money to fund the government. “The tariffs are permanent… Because the problem is permanent.”7. Treasury Secretary Scott Bessent seems to favor using tariffs as a negotiation tool. “My general view is that at the end of the day, he’s (President Trump) a free trader. It’s escalate to de-escalate,”8 In fact, Bessent has repeatedly claimed that Trump would prefer to reduce rather than increase tariffs. “Donald Trump views tariffs as a way (to negotiate), not as an end to free trade. You know, if you bring down your tariffs, we will bring down ours.”8
The Bond Market:
By recently pausing all tariffs, except those on China, the President seems to be siding with Bessent. This is welcomed news for the global economy. Why did the President seemingly change his mind? When the tariffs were announced on April 2nd the interest rates on our treasury bonds declined on the expectation of slower growth and fears of a recession. Because our country has $6.16 trillion in T-bills (representing 21.29% of our outstanding debt) maturing within 12 months9, the lower rate would help our budget and perhaps give the administration room for tax cuts this year.
What has happened?
After interest rates initially declined, they rocketed higher beginning Monday April 7th. The 10-year US treasury note increased from 3.99% to 4.49% for the week.10 Why is that? There are four prevailing theories. 1. It could be global investors are selling. For years dollar denominated US treasuries have been the investment of choice for global investors in times of turmoil. Is it different now? “US assets are losing some of their safe-haven status, said Jack McIntyre, a bond fund manager at Brandywine Global.”11. 2. It may be that the “basis trade” is unwinding. Highly levered hedge funds have made money by buying treasury futures and shorting the cash market. Unwinding this trade could cause Treasury prices to fall. The Federal Reserve Bank explains the trade this way, “The Federal Reserve has noted a significant increase in basis trading activity since the first quarter of 2022, estimating an approximate $317 billion rise. This uptick suggests that the basis trade has returned to prominence in recent years.”12 The spreads between the cash and the futures market have widened recently13 giving credibility to this argument. 3. Some have speculated that the Japanese and Chinese are selling US Government bonds as a retaliatory measure in the trade war. However, there is no evidence of this. In fact, the move in rates would likely be much larger if that were the case. 4. It may be that the bond market is anticipating a shrinking trade deficit because of the tariffs. If that is the case, foreign businesses and governments would have fewer US dollars with which to buy US treasury bonds. Whichever event caused the runup in treasury yields, it was enough for the President to pause the tariffs for 90 days.
What about the dollar
Higher US treasury rates typically attract more foreign investment, causing the dollar to rise. Instead, it is fallen dramatically. Gold was up 6% the week of April 7th and is up 23% year to date as of April 11th.14 The dollar is down this year against most currencies and 8.8% against the Euro year to date.15 So what gives? “The market is re-assessing the structural attractiveness of the dollar as the world’s global reserve currency and is undergoing a process of rapid de-dollarization.” (Deutsche Bank analyst George Saravelos)16. Maybe, but a weaker dollar helps exports and aids in shrinking the trade deficit. President Trump is not a strong dollar advocate.
The Response
China responded with retaliatory tariffs of their own. Other countries have lined up to negotiate new trade deals. China is attempting to create a trade alliance of their own. The BRICS+ coalition (Brazil, Russia, India, China, South Africa) “…now extends to an array of partner countries representing almost half the world’s populations.”17 In anticipation of a global slowdown, Central banks in India, New Zealand and the Philippines are beginning to cut rates now. “Increases in global trade barriers weaken the outlook for global economic activity”, reported the Reserve bank of New Zealand.18
Conclusion
No one knows what the future holds, but by suspending the tariffs and agreeing to negotiate the President may have avoided a global recession. “Economists calculate the tariffs would be equivalent to the biggest U.S. Tax increase in over a half-century; that led to the 1969-70 recession”19 Still there are reasons to be optimistic. If we can reach agreements with a few countries in the next 90 days, perhaps China will feel the pressure to make a deal. Regardless, we believe, as Jamie Dimon says, “This is still the most prosperous nation on the planet, with the deepest and widest capital markets the world has ever seen.” The future remains bright.
- https://imf.org/external/about/histend.html
- https://www.imf.org/external/about/histend.htm
- https://cepr.org/voxeu/columns/foreign-exchange-interventions-frequent-and-effective?mod=article_inline&utm_source=chatgpt.com
- Why Negotiating the End of the Trade war won’t be easy, Barron’s April 7, 2025
- Jamie Dimon, CEO JP Morgan Chase, in a Letter to Shareholders, April 7, 2025
- President Trump, in his news conference detailing the new tariffs. April 2, 2025
- U.S. Congress. International Emergency Economic Powers Act, Pub. L. No. 95–223, 91 Stat. 1626 (1977), codified at 50 U.S.C. §§ 1701–1707
- https://americanbazaaronline.com/2025/02/11/navarro-say-steel-tariffs-national-security-imperative-459387/?utm_source=chatgpt.com
- https://unherd.com/newsroom/can-scott-bessent-moderate-trumps-tariff-policy/?utm_source=chatgpt.com
- https://www.jec.senate.gov/public/vendor/_accounts/JEC-R/debt/Monthly%20Debt%20Update.html?utm_source=chatgpt.com
- https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?field_tdr_date_value=2025&type=daily_treasury_yield_curve
- “Investors are Exiting America”, Wall Street Journal April 14, 2025
- https://www.federalreserve.gov/econres/notes/feds-notes/quantifying-treasury-cash-futures-basis-trades-20240308.html?utm_source=chatgpt.com
- https://www.thetimes.com/us/business/article/the-1-trillion-basis-trade-explained-g6tlnrsds?region=global
- https://www.marketwatch.com/story/as-markets-unravel-gold-heads-for-its-best-three-day-rally-since-the-covid-19-chaos-6bf9298f?utm_source=chatgpt.com
- https://www.exchange-rates.org/exchange-rate-history/usd-eur-2025?utm_source=chatgpt.com
- https://www.cnbc.com/2025/04/12/investors-are-growing-concerned-about-a-us-asset-exodus-as-treasuries-and-the-dollar-decline.html
- An Updated Investing playbook for the New Geopolitics, Barron’s April 14, 2025.
- World takes Urgent Steps on Economy, Wall Street Journal April 12-13
- Fed is in ‘No Hurry’ to cut Rates. Has it Checked the News?, Barron’s April 7, 2025
- Wall Street Warns over Trade War, Wall Street Journal April 11, 2025