Tariff uncertainty unlikely to derail US markets, says Capital Economics

Investing.com -- The lack of clarity around US tariff policy is not expected to hold back US markets, according to Capital Economics, which maintains its outlook for US equities and the dollar to rally through the remainder of the year.

The US tariff situation has impacted markets in two key ways over recent months.

First is the direct effect on US inflation, economic growth, and potential central bank responses.

With the administration extending the pause on additional "reciprocal" tariffs until next month, market participants must wait longer for clarity on the final tariff structure.

Treasury Secretary Bessent has indicated that without deals, "Liberation Day" tariffs would begin in early August, but progress toward many of these agreements remains unclear.

The second major question is how much trade policy uncertainty will affect US markets.

The unpredictable development of the policy appeared to trigger early-April sell-offs in US assets and the dollar, raising concerns that policy uncertainty might deter investors from US markets for an extended period.

However, these concerns seem to have diminished.

The weekend’s announcement about the tariff pause extension did not cause any significant reaction in equity futures or the dollar.

The US equity market is trading near all-time highs, and equity risk premiums have returned to levels close to recent lows.

While Treasury bonds have recovered since April, this appears to reflect higher "term premia" being offset by increased expectations for rate cuts.

This could indicate compensation for greater policy uncertainty, particularly regarding inflation effects, though it may also reflect concerns about the federal deficit.

The dollar’s ongoing weakness could reflect some concern about US trade policy implementation, but might also stem from other factors, such as possible deliberate appreciation of certain currencies against it or changes in foreign exchange hedging behavior.

Capital Economics maintains that tariff uncertainty alone is unlikely to severely impact the US economy or dampen investor enthusiasm for US equities.

However, the firm believes the uncertainty will significantly influence the Federal Reserve, as many FOMC members appear reluctant to cut rates until the inflationary effects of tariffs become clearer.

Capital Economics doubts the Fed will cut rates this year, which could negatively impact Treasury bonds but potentially boost the dollar eventually.

This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.