The Price of Protectionism - Tariffs Toll On Growth

We revisit our outlook in light of newly announced tariffs and rising economic uncertainty.

KEY POINTS

What it is

We reexamine our macroeconomic outlook in light of newly announced tariffs, which have exceeded market expectations and prompted us to update our assumptions and analysis.

Why it matters

The tariffs represent a meaningful supply-side shock, likely to slow growth and raise inflation, shifting the path forward for both corporate performance and central bank policy.

Where it's going

We’re watching how quickly growth slows, as the speed and nature of the downturn could determine the timing and the intensity of potential Fed easing.

Summary

The U.S. has added significant and broad-based tariffs that exceeded market expectations, while quickly evolving retaliation measures could worsen the macroeconomic consequences. Absent a significant pivot in trade policy, we expect global growth to meaningfully slow and inflation to move higher this year. This raises the likelihood of more forceful central bank easing, with the timing dependent on the speed at which growth slows.

Detail

Announced tariff policies represent a significant shock to what has otherwise been a decent U.S. growth backdrop. We view tariffs as a supply-side shock that reduces output while raising prices. Beyond direct transmission mechanisms, elevated policy uncertainty is likely to continue to be a drag on growth. A key focus of our analysis will be the speed at which growth slows. We would expect an economic downturn that occurs sooner and in a non-linear fashion to lead to earlier and more forceful Fed policy easing. If inflation rises before economic activity materially worsens, we believe the Fed would be more patient in its response.

Given elevated uncertainty, we find it helpful to assess the economic outlook in terms of four major economic areas: corporates, consumers, fiscal policy and financial conditions:

The U.S. corporate sector is entering the slowdown from a supportive starting point. Cash flow generation has been strong, robust profit growth has been supported by higher margins, and balance sheets are healthy. Policy risk could manifest in weakness via a few avenues. Margins could move lower as companies are forced to re-route supply chains and absorb some of the higher costs from tariffs. Also, continued tariff policy uncertainty risks corporations "pausing" investment decisions. Fed researchers have asserted that trade policy uncertainty from the 2018-2019 trade war had adverse effects on Gross Domestic Product (GDP) and business investment. When trade policy uncertainty spiked in 2018, business fixed investment moved lower over the next several months, with the most weakness seen in equipment. Investment is one of the more volatile components of GDP and is typically the component that sees the most weakness in recession. So, while consumption represents the bulk of GDP at around 68%, swings in private business fixed investment, which represents 14% of GDP, should not be overlooked. Key indicators we will be watching include the new orders component of Purchasing Managers Index (PMI) figures, which have already shown signs of weakness. We will also look toward the change in capex intentions from regional Fed and small business surveys, and CEO confidence measures. Finally, the first quarter earnings season kicks off next Friday and will be key for insight into how companies are assessing the impact of tariffs.
The U.S. consumer is also starting from a decent position, but we see high risk from the policy shock. Higher inflation risks eating into real income gains and weighing on consumer spending. This is particularly the case for lower income consumers who spend more of their income on non-discretionary items and have less flexibility to substitute. Regarding broader income growth, the April jobs report showed that the labor market remains on firm footing overall, consistent with jobless claims. With an average gain of around 150,000 jobs in the past three months, nonfarm payrolls are well above negative levels typically associated with recession. However, we do not believe recent labor market data reflects much of the impact from tariffs yet, and survey-based leading indicators of labor demand have pulled back. There is also risk to consumer spending from wealth effect drag. From 2019 through 2024, household net worth increased over $52 trillion, most of which accrued to higher income consumers who account for the lion’s share of personal consumption. This coincided with consumers tapping into their savings to support spending. While previously a support, a meaningful decline in asset prices could present incremental consumption drag. In terms of seeing a consumer slowdown, some signs we will be looking for include a rise in initial jobless claims, slower income growth, cracks in high-frequency spending metrics and continued weakness in high income consumer confidence.
Regarding fiscal policy, our top risk case heading into the year included disruption from trade policy. For now, we assume that trade policy remains a significant headwind on economic activity. It is possible that we will see some trade deals struck over the coming weeks, however, some of the more complex trade negotiations could take over a year. Moreover, while reciprocal tariffs are being negotiated, it is probable that the 10% universal tariff is here to stay for the time being. Tariff revenues could equate to around 2% of GDP, which creates room for more meaningful tax cuts. As part of the broader fiscal package, Congress may attempt to raise the debt.
A key component of financial conditions is the Fed’s reaction function to what we expect will be a lower growth, higher inflation environment. Without some signs of growth weakness materializing, the Fed policy decision is much trickier given inflation could be above-target and rising; even if tariff inflation impacts may only be temporary. However, if a growth slowdown does materialize, we would expect the Fed to ease earlier and more forcefully. Inflation expectations will be very important to keep an eye on, as a rise in market-based long-term inflation expectations (e.g., 5y5y forward) could limit the Fed’s ability to respond to growth concerns. Outside of expectations for Fed policy, we will continue to monitor bank lending conditions, small business credit conditions, corporate spreads and financial condition indexes.

Potential upside surprises in the global financial landscape could stem from opportunistic trade agreements between the U.S. and individual nations, boosting international commerce. Lower-than-expected inflation shocks, driven by corporations effectively absorbing higher input costs, may stabilize economies, while increased hiring and growth among domestic firms signal a rejuvenated business environment. The prospect of an EU-U.S. trade deal could further enhance cross-continental collaboration, and substantial monetary and fiscal support across Europe and Asia could inject additional resilience and growth into these regions, fostering a more robust global economy.

Adverse shocks in the global economy could arise from escalating tensions between the U.S. and China, which might provoke foreign leaders to resist U.S. trade rhetoric. Higher tariffs could place unsustainable pressure on consumers, leading to retrenchment and weakening economic activity. This strain may exacerbate challenges in the retail sector, driving an increase in bankruptcies. Additionally, the Federal Reserve might find itself in a precarious position, reluctant to take aggressive actions amidst a trade war, potentially leaving the economy vulnerable to further shocks.

Given the uncertainties, please do not hesitate to reach out with any questions or concerns. We are happy to assist in any way we can.

IMPORTANT INFORMATION

This content may not be edited, altered, revised, paraphrased, or otherwise modified without the prior written permission of Northern Trust Asset Management (NTAM). The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTAM and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.

This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.

All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM’s efforts to monitor and manage risk but does not imply low risk.

Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult an NTI representative.

Hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over-compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of (NTI) or its affiliates.

Forward-looking statements and assumptions are NTAM’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.

This information is intended for purposes of NTI and/or its affiliates marketing as providers of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (ERISA). NTI and/or its affiliates are not undertaking to provide a recommendation or give investment advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. NTI and/or its affiliates may receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing, and other services rendered to various proprietary and third-party investment products and firms that may be the subject of or become associated with the services described herein.

Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.

Not FDIC insured | May lose value | No bank guarantee

Issued in the United Kingdom by Northern Trust Global Investments Limited, issued in the European Economic Association (“EEA”) by Northern Trust Fund Managers (Ireland) Limited, issued in Australia by Northern Trust Asset Management (Australia) Limited (ACN 648 476 019) which holds an Australian Financial Services Licence (License Number: 529895) and is regulated by the Australian Securities and Investments Commission (ASIC), and issued in Hong Kong by The Northern Trust Company of Hong Kong Limited which is regulated by the Hong Kong Securities and Futures Commission.

For Canada, Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. For U.S. NTAM, the information contained herein is intended for use with all current or prospective clients of Northern Trust Investments, Inc (NTI).