Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 273

It’s getting hot in here

Tariff wars, emerging markets in crisis, and the US economy overheating … where does one start when trying to work out what it all means?

Well, as always I like to start with history. Have we seen this before? Pretty much. We have many historical examples to ponder, and so many possibilities, but for me the 1960s and the 1990s come to mind.

Let’s start with tariffs. Is it simply brinkmanship, where Trump’s true desire at the end of the day is to force the Chinese to lower tariffs? Or is it something more pernicious, perhaps a multi-decade turning point in globalisation?

If brinkmanship, how will it end? The market assumes rather gently, with the US stock market generally happy to look through the shenanigans and assume a positive end result. Perhaps that will be the case, but key to securing large concessions through brinkmanship is not only threatening large repercussions, as Trump is currently doing, but convincing your combatant that you are deadly serious about following through. More often than not, deadly serious means actually following through.

Kennedy knew this. For a perspective on successful brinkmanship, one can’t go past 13 days in October, 1962 – the Cuban missile crisis. In August 1962, the Soviet Union snuck nuclear missiles into Cuba (in response to the US placing nuclear missiles in Turkey three months earlier) and assembled launch pads before the US noticed. Despite some suspicions, the US did not realise that a nuclear arsenal had been deployed until 14 October when aerial reconnaissance confirmed launch pads and missiles ready to go in Cuba.

Kennedy threatened to invade if they were not removed. The Soviet Union protested. The missiles in Cuba were purely for Cuba’s defence, and any invasion by the US of Cuba would trigger a war with the Soviet Union. Kennedy publicly moved to DEFCON 2 and said that the United States will:

" ... regard any nuclear missile launched from Cuba against any nation in the Western Hemisphere as an attack by the Soviet Union on the United States, requiring a full retaliatory response against the Soviet Union."

After some rather tense exchanges, they took his threat seriously, and agreed to remove the missiles. Pretty heavy brinkmanship when the consequences of escalation were so high for both parties. See: http://www.nuclearfiles.org/menu/key-issues/nuclear-weapons/history/cold-war/cuban-missile-crisis/timeline.htm

Of course we are not talking about the same consequences here. But we are talking about the same game, namely the game of brinkmanship. To get big concessions, big threats need to be made convincingly. Which as we are seeing, needs some follow through. Sometimes the outcomes aren’t as intended. Beyond brinkmanship, there are a few other examples that come to mind.

Perhaps inflation breaking out, like in the late 1960s when the Fed allowed unemployment to breach new lows? Or can the US economy handle stronger growth, like the productivity surge Greenspan embraced in 1996-97 to forestall rate hikes? Or does none of this matter, because we are about to repeat an EM crisis like 1997-98? Perhaps there is no historical analogue? After all, we don’t have a historical analogue of 10 years of zero to negative interest rates in the major economies of the world, combined with 18 trillion dollars of bond purchases by their central banks! (But we do have analogues of low interest rates generating financial bubbles) Do you have a conviction? If you are highly convicted, perhaps you should heed Alexander Pope’s famous phrase, “A little knowledge is a dangerous thing”! Nonetheless, I think one can have conviction in how scenarios might play out. So let’s start with the scenarios.

The scenarios

1. Tariff escalation. If Trump imposes a tariff of 25% on US$200 billion of US imports from China, and particularly if he follows it up with another US$267 billion of tariffs, that is all that will matter for markets in the next 6 months. With the latter, one can’t escape both a significant growth and inflation impact in coming months. EM equities will fall a further 10-15%, and US equities will likely fall 5-10%. The USD would soar 5-10%, at which point the Fed stops hiking.

2. Tariff de-escalation. If the US agrees a resolution with China, the focus turns back to the current status of the US economy. It is too strong. Initially equities rally, the USD likely falls as emerging market equities outperform, and bond yields rise markedly. At some point in the next 6-12 months the market realises the Fed needs to take a restrictive policy to slow the economy and quell inflation, and a recession gets priced in.

3. A bubble bursts. What bubble? As I wrote in June, after 10 years of zero interest rates and low bond yields, money has poured into any bonds that give a little extra yield. We have seen the wobbles already.

At the moment, with the unresolved tariff war, it is impossible to be emphatic. But the time is nigh when it will pay to be very decisive indeed. And conversely, a disaster, potentially, if you are not.

Am I being too alarmist? Or even too simple? Let me give you some facts, after which you can decide.

How bad can a tariff war be?

Well I could start with the Bank of England’s prognosis:

Wow, 5% off US growth …

However, note there are some pretty dire assumptions in there. Firstly, they assume every country imposes a 10% tariff. The impact of that is shown in the dark blue (about half the overall impact). The rest of the impact comes predominantly from higher bond yields, lower equity markets, and greater uncertainty. There is no assumption of stimulus, either from rate cuts or fiscal policy (which has just had a windfall from the tariff ‘tax’).

So it is fair to say that the impact would be much less than this. But how much? Well the first point is we don’t know what the final tariffs are yet. But if Trump proceeds with tariffs on all Chinese imports (about $500 billion), as he is threatening, reasonable estimates would see a growth impact of 1-2% for each economy. And that will hurt.

Of course, many assume this is nothing more than brinkmanship. A game of chicken. As John Cirace argues, to win the game of chicken, the individual must “create the impression that nobody is crazier or badder than me”. [Law, Economics and Game Theory. John Cirace, page 120]. Ipso facto, Trump will win!

Or crash ... I’m not sure he realises crashing is a possibility. So he just might not see it coming. What does a crash look like? US stocks down 10%. That would get his attention, though not necessarily a reaction.

Will it happen? Well, by the time you are reading this, the answer might be clear. But I strongly believe as I write, one cannot hold a view on the evolution of the confrontation with conviction. We pay many consultants who are experts on Chinese and US politics. The more you know, you realise the less you can be sure.

 

Brett Gillespie is Head of Global Macro at Ellerston Capital and has worked in the financial services industry for over 28 years. This article is for general purposes and has been prepared without taking account your objectives, financial situation or needs.

RELATED ARTICLES

REITs: a haven in a Trumpian world?

Welcome to Firstlinks Edition 606 with weekend update

Howard Marks: the investing game has changed

banner

Most viewed in recent weeks

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.