'Protectionism’, once considered an extreme idea in United States politics, has now become a guiding principle for the new regime. As promised, on April 2, Trump announced sweeping “reciprocal tariffs” against all trading partners. These included a basic tariff of 10% across the board, which came into effect on April 5, while individual reciprocal tariffs were set to begin on April 9.
This move sparked a tariff war between the US and China. In retaliation, China imposed a 34% tariff on US imports. It also imposed sanctions on select US companies, along with a ban on certain rare earth exports critical to the US electronics industry. Angered by this, the US in turn imposed an additional 50% tariff on Chinese imports, raising the tariffs on Chinese goods to an unprecedented 125%.
The apologists of Trump tariffs argue that
there is logic behind imposing such abnormally high tariffs. One key argument
is that the significant uncertainty created by these high tariffs may cause
panic, leading to a “risk-off” scenario, in which investors may exit stocks and
flock to US Treasuries. This automatically lowers yields on the Treasuries.
This could make it easier for the US to refinance its debt of $9.2 tn maturing
in 2025, potentially with lower interest payments. Furthermore, if the Fed cuts
interest rates, the path to roll-over of debt becomes smoother, and hence the
call for a rate cut from Fed Chair Jerome Powell.
Secondly, tariffs are considered powerful revenue generators—expected to bring in $600 bn to $700 bn annually. The next argument is that tariffs could be used as strategic tools by the US to force negotiations with allies like Europe, Japan, Australia, South Korea and Taiwan—countries that depend on the US for their security, in such a way that the outcome benefits US trade and investment. Their final argument in favor of tariffs is their potential to reshore manufacturing activities to the US, though no estimates are available about the likely investment, the number of jobs that such a move would create, and how long it would take for them to materialize.
While these arguments remain largely aspirational, the severe volley of tariffs unleashed by Trump on “Liberation Day” set global markets on fire: Stocks plummeted, portfolios evaporated, and panic swept across global trading floors. The US stock market suffered the worst of it: the S&P 500 was down by 3.3%, the Dow Jones Industrial Average lost 1160 points, down by 2.7%, and the Nasdaq composite was down by 4.5%.
After the meltdown in financial markets, Trump announced a 90-day pause on reciprocal tariffs on all countries except China, which faces a tariff of 125%. However, the baseline tariff of 10% and the tariff of 25% on aluminum and steel imports and the automobile sector remain as it is. With this policy reversal, stock markets rebounded on April 9: The S&P 500 jumped by 9.5%—its largest one-day gain in over a decade, and the tech-heavy Nasdaq Composite also soared. Markets in Europe and Asia followed suit, with the pan-continental STOXX 600 rising 5.3%. Major indices in London, Paris, and Frankfurt surged by 4.1% to 5.6%.
Intriguingly, during this fall and rise of the US and global stock markets, a puzzling phenomenon is noticed. Modern financial history tells that there is a reliable relationship between US equities, Treasury yields, and the value of the dollar. Traditionally, during market panics, investors are known to flock to US Treasuries and the dollar as safe havens. As a result, Treasury yields are driven down, causing the dollar to appreciate.
Surprisingly, after the tariff announcement, US bond yields went up—the 10-year yield jumped from 3.99% to 4.5% within just a week, despite turbulence in the equity market. At the same time, the ICE US dollar index, which measures the greenback against a basket of foreign currencies, fell as low as 97.92, the lowest since March 2022. All this could mean that investors are using less of the US Treasury as a “risk-free” asset.
Analysts suggest that this shift in global investor behavior is a fallout of aggressive tariffs, which have raised concerns about long-term US economic stability. Neel Kashkari, Minneapolis Fed President, observed that the dollar’s decline, alongside the tariffs, offers “credible evidence of investor preferences shifting”.
This divergence from the historical relationship between US equities, Treasury yields, and the dollar points to investors’ reduced confidence in the dollar’s reserve currency status; reassessment of Treasuries as “risk-free” assets given fiscal/policy risks; and potential long-term higher funding costs for the US government. The cycle of large deficits necessitating more borrowing, which in turn drives up interest rates and burdens debt servicing, could have significant economic implications. And that, in itself, is the irony!
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