Trump must understand he’s gone too far this time: strategist

Investing.com -- The S&P 500 has plunged more than 10% since U.S. President Donald Trump introduced the new harsher-than-expected reciprocal tariffs.

Commenting on the new measures, Capital Economics said that "even the pugnacious Trump must understand he’s gone too far this time."

The macroeconomic research firm postulates that Trump is likely to recognize the severity of the market’s reaction and may soon propose a series of "deals" to alleviate the impact of the tariffs on some countries, except possibly China.

These deals are expected to involve minor concessions in return for reduced tariffs, which could lead to a recovery in equities, the firm said.

“By the end of that process we suspect that those countries would end up facing reciprocal tariffs of between 10% and 20%,” it wrote in a note.

Certain goods from Canada and Mexico may receive exemptions or reduced tariffs in line with the USMCA agreement.

On the other hand, Capital Economics feels less convinced about the removal of tariffs on steel, aluminum, and autos, while other products such as pharmaceuticals and semiconductors may see delayed or scrapped tariffs.

If Trump’s strategy unfolds as expected, the firm estimates the overall effective tariff rate may rise modestly to 14%-18%, as opposed to a 24% rate if Trump intensifies his tariff policy without offering concessions.

This rate would be the highest since 1938, but Capital Economics does not believe it would necessarily lead to a recession.

The firm predicts a 10%-15% decrease in imports over an extended period, with the tariffs potentially generating around $350 billion annually, roughly 1% of GDP. This revenue could be redistributed through tax cuts.

Meanwhile, CPI inflation is expected to reach near 4% by year-end, “which we think would keep the Fed on the side lines this year,” the note states.

Capital Economics also outlines a less optimistic alternative scenario where Trump does not compromise, leading to a further escalation in tariffs and reciprocal measures from other countries.

That could result in a significant loss of confidence in households and businesses, potentially triggering a recession within a few months.

The downturn could be exacerbated if Congress fails to pass fiscal stimulus due to internal disagreements, leading to a severe economic downturn and market instability, the note cautioned.

In such a scenario, the Federal Reserve might be forced to cut interest rates, albeit reluctantly, with a 100 basis point reduction being the maximum anticipated by futures markets even in a recession.