After U.S. President Donald Trump announced his "Liberation Day" tariff policy, global capital markets saw a sharp and sustained decline, resulting in the worst week for global stock markets this year. There were consecutive large declines for American stocks, with a market value loss exceeding USD 6 trillion. The degree of market volatility was similar to that seen during the global spread of COVID-19 in the spring of 2020. The Dow Jones Industrial Average fell by more than 3,000 points this week, a drop of 7.9%, pushing this blue-chip index into a technical correction. The Nasdaq, dominated by tech stocks, plummeted by 10%, entering a bear market, meaning the index had fallen by 20% from its previous high. The S&P 500 index dropped by 9.1% this week. Other major markets experienced similar declines. On April 4, Germany's DAX index, the FTSE 100, and France's CAC index saw drops of 4.95%, 4.95%, and 4.26%, respectively. Japan's Nikkei 225 index fell by 2.75%, and Thailand's SET index dropped by 3.15%. On that day, the VIX Index, a barometer for market uncertainty, was 45.31, an increase of more than 50%.
The turbulence in the capital markets is primarily driven by panic over President Trump's tariff policy, which exceeded expectations, leading to a revaluation of assets. The decline in the stock market signifies that the capital markets are anticipating a global economic recession triggered by the trade war caused by the U.S. imposing additional tariffs. The risk of economic recession has also led to a plunge in global commodity markets. On April 4, U.S. crude oil futures experienced a sharp drop, falling by 6.92%, while Brent crude oil dropped by 5.82%. Natural gas futures plummeted by 7.71%. Even gold, which had been hitting new highs this year, saw a sell-off, losing its safe-haven appeal. New York gold futures experienced a significant drop, closing down 2.1%.
Before this, the market was concerned that Trump's tariff policy would lead to higher prices for U.S. imported goods, driving up U.S. inflation. Now, Trump's widespread tariffs are more likely to cause a global economic recession, including in the U.S. According to a report by the International Monetary Fund (IMF), if the trade war lasts for a year, global GDP could lose up to 7%. JPMorgan's team of economists has raised the probability of a global recession from 40% to 60%. This suggests a decline in corporate profits and a long-term restructuring of global supply chains. In the short term, the result will be price surges caused by disruptions in the supply system. All these factors indicate that market values need to be re-priced, which is the root cause of the recent turmoil in global capital markets.
Currently, many market institutions expect that tariffs will weaken the U.S. economy, potentially even leading to a recession. The latest U.S. non-farm payroll report for March shows an increase of 228,000 jobs, surpassing the expected 140,000, indicating that the labor market remains resilient before the full impact of the tariffs. However, due to an increase in labor force participation, the unemployment rate rose to 4.2%. This is linked to new policy changes, such as large-scale government employee layoffs. These developments indeed suggest that the U.S. economic outlook is bleak. Barclays forecasts that the American GDP will contract in 2025, leading to a recession. Citigroup economists have downgraded their 2023 American economic growth forecast to just 0.1%. JPMorgan has made a significant adjustment to its forecast for the country’s real GDP in 2025, revising it from a projected growth of 1.3% to a contraction of 0.3%, a decrease of 1.6 percentage points. JPMorgan's report suggests that if a recession materializes, the U.S. economy will face multiple challenges, including weak consumption, declining corporate profits, and financial market turmoil. According to JPMorgan, the tariff policy is the main driver behind the GDP downgrade, as it raises import costs and suppresses both consumption and investment. JPMorgan predicts that the recession will push the unemployment rate up from the current 4.2% to 5.3%, adding approximately 1.7 million unemployed individuals. They also warn that if inflation remains high due to tariffs, combined with an economic downturn, it could lead to a "stagflation" scenario, where growth stagnates while prices continue to rise, which would put the Federal Reserve in a dilemma that cutting interest rates to stimulate the economy might worsen inflation, while raising rates to curb prices could worsen the recession.
Due to concerns about a U.S. economic recession, the market has adjusted its expectations, anticipating that the Fed may accelerate the pace of interest rate cuts. Currently, market expectations for the Fed to cut rates this year have increased from three times to four, as investors believe the Fed will need to increase its easing efforts to cope with the downward trend of the U.S. economy. However, on April 4, Fed Chairman Jerome Powell did not commit to such actions. He noted that U.S. tariff measures are likely to push inflation higher while slowing economic growth. Powell acknowledged that the announced "reciprocal tariffs" were significantly higher than expected, and their economic impact would likely be greater than anticipated, but the exact magnitude and duration of these effects remain uncertain. Powell stated that the Fed would not adjust interest rates until the full impact of the tariffs becomes clearer. This statement altered the trajectory of the U.S. dollar's decline. After the dollar index dropped below 102, it quickly rebounded to around 103 but did not continue to climb. This shift contrasts with previous expectations of a "strong dollar", with the focus now shifting more toward the outlook for the U.S. economy, rather than solely on changes in its foreign trade.
This is contrary to Trump's idea that a weaker dollar would help boost exports. In this context, the current market developments are not unfolding as Trump had expected. At the same time, whether the Fed will cut interest rates has become a key factor in determining the success of Trump's tariff policy. Before Powell's comments, Trump publicly urged the Fed to lower interest rates, emphasizing that now was an ideal time for Chairman Powell to do so. This suggests that Trump was, in fact, prepared for the potential consequences of tariffs weakening the U.S. economy and causing capital market volatility, and he is ready to bear the associated costs. However, the implementation of tariff policies remains constrained by several factors, with the Fed being one of them. A rate cut by the Fed would still come at the cost of a weakening U.S. economy, which indicates that tariffs are also not advantageous for the U.S. The fact that the Fed’s response is being considered highlights that the broader economic impact of the tariff measures may be more damaging than expected.
In addition to the issues facing the U.S. itself, the market is also deeply concerned about the ongoing escalation of the trade war and how far it will go. China has already announced a series of retaliatory measures against U.S. tariffs, and some European countries have also issued statements; some calling for negotiations, while others threaten reciprocal retaliation. Not only will tensions between the U.S. and China continue, but Europe and other regions in Asia-Pacific will also react. The worsening trade situation could inflict further damage on the global economy. In response, Trump argued that China has been “hit harder” and "we are bringing back jobs and businesses like never before”.
Trump also stated that the U.S. is no longer the "whipping post" of global trade. Despite market volatility, he urged Americans to "hang tough”. At the same time, Trump has expressed a willingness to negotiate. He mentioned that if other countries could propose favorable terms, he would be open to lowering tariffs. For example, he suggested that if China agreed to sell TikTok to U.S. investors, he would consider reducing tariffs in exchange. This suggests that the final tariff levels might be lower than initially announced by Trump. In fact, the U.S. has already granted exemptions for certain goods. This approach shows that tariffs are being used as a tool, but they have created significant headaches for governments around the world and left markets uncertain. The uncertainty surrounding these policies has caused market contraction, meaning the impact is not limited to the U.S. alone; countries around the world are also feeling the negative effects. This uncertainty is a primary factor driving global market volatility, and such intermittent instability is likely to persist in the future.
For China, the universality of Trump's tariff policy means that its impact may not be as severe as in 2018. On one hand, this is due to China's adjustments in its external trade structure in the context of U.S.-China geopolitical competition. On the other hand, China's economic structure is becoming more inward-focused, accelerating its shift toward domestic consumption and production. So far, the yuan has not shown significant volatility since Trump announced his new tariff policy, staying below 7.30. Some institutions had previously predicted that if Trump imposed a 60% tariff on Chinese imports, China's exports to the U.S. would decrease by 85%. Some studies also suggest that a 60% tariff would negatively affect China's GDP by about 1%, with less than a 1% drag on China's GDP growth rate. Currently, the cumulative tariff increase under Trump's second round of tariffs has reached 54%, and if we include the tariffs from his first round, the total tariff burden on Chinese exports to the U.S. is around 66%. However, considering the exemptions and potential future negotiations, the actual impact on China's economy may not be as severe as some institutions have predicted. According to a senior researcher at ANBOUND, even considering extreme scenarios where exports to the U.S. fall to zero and China completely exits the U.S. market, the growth of China's economy could fall below 5%, but it would likely only drop to around 4%. This may explain why the domestic stock market in China has experienced a relatively smaller decline compared to countries like Japan and South Korea. Additionally, there is room for policy countermeasures within China. With increasing fiscal policy support, there is a possibility that policies like "timely reserve requirement ratio and interest rate cuts" could be implemented to alleviate external pressure. This suggests that, despite Trump's "tariff war", the factors that still stabilize China's economy such as its economic foundation and large market scale, remain strong. In contrast, smaller export-oriented economies are more likely to feel a greater impact from these tariffs.
The chaos caused by Trump's tariff policy will, in the short term, exacerbate the distortion of global supply chains. However, it is unlikely to result in the reshoring of manufacturing to the U.S. as Trump hopes. Instead, it may lead to a step-by-step reintegration of production processes in a more "inner circulation" manner for various countries. In fact, the universality of Trump's tariffs means that efforts by Chinese enterprises to invest in countries like Vietnam and Mexico to circumvent tariff barriers are rendered meaningless. This long-term disruption is not only due to the varying tariff levels imposed by the U.S. on different countries but also because of the reshuffling of domestic production factors within these economies. Ultimately, the market scale of each country's "inner circulation" will remain the fundamental factor determining the outlook for capital markets. As capital continues to flow globally, achieving a new stable state will depend not only on the stability of production but also on the stability of demand. This will influence the movement and restructuring of international capital flows. Therefore, the future trajectory of global markets will be shaped by how these internal markets evolve and stabilize amidst the ongoing trade tensions.
Final Analysis Conclusion:
Trump's "reciprocal tariff" policy has actually exceeded market expectations and understanding, causing significant volatility in global capital markets. This turmoil is primarily driven by concerns about a potential global economic recession. The tool-like nature of Trump's tariff policy means that its flexibility and impact cannot be fully assessed at this stage. This uncertainty suggests that capital markets will continue to experience periodic fluctuations as they adjust to the evolving dynamics of a global economy shifting toward an "inner circulation" model.
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Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.
