Macro views

Don't give in to the siren song of recession

April 09, 2025 - 6 min read

Pricing ETFs: How premium/discount is calculated

The chaos after the liberation

Game theory teaches that a cooperative equilibrium is better in terms of utility (or gain) than a strategy based on maximising individual interest. In other words, cooperation works better than dividing. Yet it seems the US administration has not considered this conclusion in its scenario. ‘Liberation day’, the unprecedented tariff offensive that was decided on 2nd April, is a further illustration of the isolationist and non-cooperative direction in which President Trump wishes to take the US.

The decision to impose reciprocal tariffs, in addition to those already in place, has three objectives:

Firstly, to force foreign companies to produce locally, with the aim of reindustrialising America and promoting employment in the US.

The second objective of the US administration is to generate sufficient budgetary leeway to reduce the tax burden on households and businesses from next years.

Additionally, Donald Trump's goal is to break all the rules of global trade to establish American economic supremacy over its main trading partners, and thus generalise the logic of bilateral negotiations. The US President has also repeatedly spoken of the need to weaken the US dollar to support US exports of goods and services to the detriment of its trading partners, thereby fuelling the rhetoric of a cooperative equilibrium.

Before analysing the consequences of these tariff measures in terms of growth and inflation, it is pertinent to remember that in both the short and long term, these non-cooperative, unilateral and discretionary strategies are likely to feed a phenomenon that has been absent for many decades: economic volatility. The volatility of the macroeconomic cycle should therefore become an integral part of the economic landscape, and a dimension that should henceforth be integrated into all investment decisions.

The determination of reciprocal tariffs is based on the size of the US trade deficit with third countries (excluding services), modulated by a corrective factor set at two. This simplistic approach ignores all, or almost all, of the determinants of trade flows between two countries. China's exports are subject to ever changing tariffs, Europe's 20%, the UK's 10% and Japan's 24%. Before 2nd April, US imports were taxed at an average of 2.8%, compared with almost 20% today.

The US has therefore increased the average tariff on its imports by a factor of almost seven. What are the consequences of this?

Don't give in to the siren song of recession

Tax revenues from customs duties reached almost $82 billion in 2024, while corporate income tax brought in $670 billion for the US government over the same period. Assuming a unitary elasticity of customs revenue in relation to tariffs, we estimate additional revenue for the federal budget of $420 billion in 2025. Over a full year, customs revenues could thus bring in $650bn, offsetting a possible cut in corporate and household tax rates, which we anticipate in 2026. As in 2018, Trump is therefore planning to support business revenues through tax cuts, which are likely to be significant.

The impact of these tariffs on US inflation is more difficult to measure. To do this, we use the following parameters: a monthly variation in the price of manufactured goods of 20%, the weight of manufactured goods in the consumer price index (20%), the content of imported manufactured goods in final consumption is 25% (Figure 1).

Figure 1: Share of US industries in US demand (OECD sources)

Source : Bloomberg and NIMI. Data as at 31 March 2025.

Taken together, these assumptions imply an impact of around 1.4 percentage point on the year-on-year change in US consumer price index. In other words, US inflation could be close to 4% by the end of the second quarter of this year, before easing to 2.6% in Q2.26. Even if this significant surge in inflation remains lower than that seen at the end of 2021, it nevertheless excludes diffusion and second-round effects (margin behaviour and the Philipps effect) that could prolong the inflationary shock beyond Q1.26 and consequently constrain monetary policy.

Assessing the impact of tariffs on economic activity is open to debate, given the multiple and interconnected transmission channels. Our initial assessments suggest growth of between 1.1% and 1.3%, ie a revision of around 0.6 to 0.8 pp compared with the projections made prior to 2nd April.

In detail, GDP growth could move into negative territory in Q2.25, driven by the consequences of the uncertainty shock on the components of domestic demand, the reduction in purchasing power, the negative wealth effect and the absence of a safety net that was present during the Covid crisis (excess savings). Uncertainty shocks are not intended to be persistent, however, and the statistical analyses we have carried out show that this type of shock dissipates after two quarters.

Figure 2: Impact on US GDP growth rate breakdown

Source : Bloomberg and NIM Solutions. Data as of 28 February 2024.

US growth could therefore falter in the short term before picking up again by the end of the year, in line with President Trump's motto: ‘short pain, long gain’. Despite the scale of the shock and its nature (negative supply shock), we are not giving in to the siren calls of recession and believe that risky asset markets have probably overreacted to the shockwave of tariffs.

The assumption of a market overreaction seems, to us, even more justified given that government bond yields have risen by more than 30 basis points (bps) since the lows observed. This normalisation of the long end of the yield curve is likely to precede that of implied volatility derived from equity markets, which is synonymous with a return to calm.

Against this backdrop, how might the US Federal Reserve react? Could the Fed cut its key interest rates to prevent any adverse developments in the US cycle? The Fed’s chair, Jerome Powell, has been clear in his recent speeches. He has stressed the uncertain nature of the economic environment and rejected the stagflation theme at this stage. Powell believes that the economic environment is not conducive enough to informed decision-making and that the Fed should not act pre-emptively. Interest rates can be maintained, especially as the Fed has no tangible evidence to support such a decision. It will probably wait until this summer to cut its key rate (75 bps) to support the US cyclical recovery (see Figure 2).

As in the US, these new tariffs will have a negative impact on economic activity in the eurozone. The estimated impact on eurozone GDP is between 0.2 pp and 0.3 pp. We suspect GDP growth in the eurozone would not exceed 0.8% in 2025, probably giving the ECB the arguments to step up its monetary policy easing cycle. Yet again, however, this scenario depends on the reaction of European leaders to any retaliatory measures.

Conclusion

The paradigm shift brought about by the US administration has triggered a great deal of uncertainty as to how the US and global economic cycle will evolve.

Both growth and inflation will be subject to greater variability, particularly in the US. The current period will continue to be tinged with significant uncertainty, which is bound to fuel major turbulence in risky asset markets

Nevertheless, we believe it is essential to qualify the market reaction, which we consider excessive in view of the expected impact on US growth, which we expect to remain in a range of between 1.1% and 1.3% in 2025.

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