Tax cuts may have more influence than tariffs, but the timing could be problematic. Just when it seemed unlikely that Donald Trump would shift away from his aggressive tariff policies, the market forced the U.S. president to reconsider. However, this change in direction may not stem from a fear of market declines, but rather from his own tax agenda. Last week saw one of the most turbulent five-day stretches in U.S. equity markets in nearly 60 years, as reported by Sentiment Trader.
Despite significant losses that followed Trump’s tariff announcement on April 2, it took turmoil in the bond market to prompt a temporary halt to the tariffs for 90 days, rather than the equity market’s reaction. Intensified Treasury selling reflected rising concerns that inflation driven by tariffs and a burgeoning trade war might edge the U.S. toward recession, further enlarging the already significant federal deficit. The dollar weakened considerably, highlighted by the DXY index dropping from a high of 110 to below 100. Normally, bonds act as a safe haven during stock market downturns, but this time, their efficacy was in question, prompting fears of escalating losses.
Although the suspension of tariffs offered a moment’s relief, the uncertainty from a 90-day delay remains troubling. Current average tariff rates sit at approximately 25%, the highest since the early 1900s and significantly above the global average. Morgan Stanley’s updated growth forecast suggests only a modest economic expansion of about 0.5% in the coming years, with inflation expected to persist around 4% by year-end and unemployment climbing to approximately 5% by 2026. Simultaneously, House Republicans have pushed legislation that would significantly increase the deficit.
Trump’s focus on tax cuts continues to drive his agenda, mirroring his priorities from his first term. He has indicated intentions for what he claims would be the largest tax cut in U.S. history and aims to make the 2017 Tax Cuts and Jobs Act permanent. However, any new tax cuts could exacerbate deficits, which are currently estimated to be substantially short of what was initially promised, thus necessitating debt financing. When tariffs began undermining the bond market, it became clear that a retreat was necessary.
This suggests that while tax cuts may have initially prompted some tariff actions, Trump’s priority now appears to be ensuring the ability to finance these cuts through debt, rather than relying on potential tariff revenue. Yet, with growing concerns about U.S. credibility and its asset safety during market stress, foreign investors may become increasingly wary as the administration intensifies deficit spending and issues more Treasuries.