"New Federal Reserve News Agency": Trump's tariffs are a high-risk gamble that may bring high costs to the financial markets

On Thursday Eastern Time, Nick Timiraos, known as the "New Federal Reserve Correspondent," wrote in The Wall Street Journal that the United States is attempting to overturn the global trade order it has built, ushering in an era filled with uncertainty.

Nick Timiraos stated that President Trump’s announcement on Wednesday represents a high-risk gamble, aimed at reshaping what he has long considered to be extremely unfair global economic relations for the United States.

Although the U.S. economy has performed better than other developed countries post-pandemic, this move has also raised market concerns—this round of tariffs could trigger a typical "stagflation shock," with rising prices putting the economic growth of multiple countries, including the United States, at risk of recession.

Tariff Intensity Unseen in a Century

On Wednesday Eastern Time, according to Xinhua News Agency, President Trump officially announced a package of new trade tariffs in the White House Rose Garden, including a 20% tariff on EU goods and a general increase of at least 10% on imports from all countries. According to JP Morgan's estimates, this move will raise the average tariff level in the U.S. from 10% before the announcement to 23%, setting a new high in over a century, while last year this figure was only 2.5%.

Economists say that if these tariff policies are implemented long-term, their impact could be comparable to President Nixon's decision in 1971 to abandon the gold standard, which ended the post-war financial framework established with World War II allies, where the dollar was exchanged for gold at a fixed price of $35 per ounce.

Michael Gapen, Chief U.S. Economist at Morgan Stanley, believes:

“This will be the most radical restructuring attempt of U.S. tax and trade structure since Nixon abandoned the gold standard in the early 1970s.”

He added that they have been warning clients that the market may underestimate the risks of tariffs, but the content announced on Wednesday is broader and more severe than they had previously anticipated.

Douglas Irwin, a trade economist and historian at Dartmouth College, pointed out that this wave of tax increases is particularly aggressive because even traditional duty-free items like coffee, tea, and bananas, which are not significantly produced domestically in the U.S., have been included in the tax list.

Compared to the Trump trade war in 2019, this round of tariffs applies to a wider range of products and is more intense. For example, half of Nike's shoes are produced in Vietnam, which will now face a 46% tariff. Consumer electronics manufacturers from South Korea will also face at least a 25% tariff. However, this round of tariffs temporarily exempts oil, natural gas, and refined products.

Who Will Bear the Cost of Tariffs?

Nick Timiraos wrote that President Trump's erratic and chaotic trade policy , including a 25% tariff on imported cars, has already impacted corporate investment and consumer confidence. GlobalData TS Lombard's Chief U.S. Economist Steven Blitz stated:

"This is equivalent to a massive tax increase, primarily on the corporate side, but like all corporate taxes, it will ultimately be passed on to consumers. In a tax-increasing environment, the economy cannot grow."

KPMG's Chief Economist Diane Swonk indicated that the newly announced tariffs could severely shrink the real income of the American public, pushing the U.S. economy into a recession risk zone this year. She pointed out that this entire set of tariff measures is almost the worst-case scenario in various market expectations prior to the announcement.

Moreover, it remains uncertain how other trading partners will respond, which means that the uncertainty in the global trade environment may persist for a longer period. Swonk stated:

"If the goal of these tariffs is to bring businesses back to the U.S., that may be very difficult to achieve. Because it typically takes three to five years from project initiation to factory establishment, and no one can be sure whether these tariffs will still be effective by then."

Will the global capital flow mechanism be disrupted?

Nick Timiraos wrote that the U.S. current account deficit is expected to reach $1.1 trillion in 2024. This record deficit reinforces Trump's and his allies' rhetoric about the "need to reshape global trade rules."

While tariff measures can bring new fiscal revenue to the government, they also come at a cost, such as a severe impact on financial markets. Over the past two years, the continuous rise in U.S. asset prices has been driven by investors' expectations that the U.S. economy is performing better than other developed countries, including technological advancements and confidence in a soft landing.

Under Trump's administration, the U.S. economy experienced robust growth and declining inflation, but there are multiple fragile factors, such as a stagnant real estate market, a cooling labor market, and potential risks from high stock market valuations.

Trump has long viewed trade deficits as a sign of economic weakness, but in the process of his administration's efforts to reduce the deficit, other countries may reduce their purchases of U.S. Treasury bonds and be less willing to invest in the U.S. real estate, stock, and private credit markets.

Economist Blitz pointed out:

"The real pain point here is that the long-standing global capital flow mechanism may be disrupted. It is a fantasy to expect to sever trade ties without affecting capital inflows."

Will the U.S. experience uncontrollable inflation?

UBS predicts that if tariffs persist long-term, the core PCE inflation favored by the Federal Reserve will rise from 2.5% in February to 4.4% by the end of the year, while the U.S. economy may enter negative growth in the first half of next year, meeting the criteria for a technical recession, with the unemployment rate potentially rising from 4.1% in February to around 5.5% next year, which is known as stagflation, characterized by economic slowdown and rising prices.

Under the pressure of high inflation combined with low growth, the Federal Reserve will face a dilemma: should it prioritize stabilizing employment and loosening policies? Or should it prioritize combating inflation and tightening policies?

This is precisely the classic dilemma faced by the Federal Reserve in the face of "negative supply shocks." For example, a surge in oil prices can reduce economic output. Some commodity prices may skyrocket, leading to a shrinkage in the real income of the American public, ultimately dragging down overall economic growth Although standard monetary policy theory suggests that if such shocks only temporarily and one-time raise prices, Federal Reserve officials should see through these shocks; in other words, they should not change the original path of interest rate hikes or cuts due to such short-term disturbances.

However, theory is one thing, and practical operation is far from simple. If global supply chains are reshaped due to tariffs, and this process will last for years, then it will be difficult for Federal Reserve officials to view the price increases caused by tariffs as temporary.

The ultimate result is that the Federal Reserve may initially take a wait-and-see approach and not rush to cut interest rates until they see a substantial slowdown in economic activity and an increase in unemployment, at which point they will begin to use interest rate cuts to cushion the decline in demand.

UBS economists have stated that they expect the Federal Reserve to initially be very cautious in gradually cutting interest rates, as a hasty rate cut now could exacerbate inflation. However, once the unemployment rate rises and economic growth clearly weakens, the Federal Reserve will accelerate the pace of rate cuts, with short-term rates expected to drop by more than two percentage points by the end of next year