Investors are losing confidence in US assets

American exceptionalism is under threat as US assets sink under the weight of escalating tariffs and the unpredictability of Trump’s economic policy.

The unprecedented increase in tariffs to levels far above what markets were expecting is unique in economic history. Increased 10-fold, the average US tariff rate is now at its highest in over a century. At almost 150%, the rate on Chinese imports is effectively an embargo on the world's second-largest economy, which is unsustainable in the long run.

President Trump’s embrace of protectionism ends a long period of deregulation, which had been very positive for global economic growth.

Delivering on ambitious economic agenda faces complex challenges

The administration is clear on its aims: revive US industry by bringing manufacturing back home; reset the balance of trade by increasing exports and reducing imports; and generate revenue to pay for tax cuts.

But, in the best-case scenario, it will take time – measured in years – to see if these measures achieve their goals. Reshoring manufacturing is expensive. It requires very significant investment, which cannot be drummed up in a short space of time and may not turn out to be profitable enough. Production costs will inevitably rise and final prices will also go up sharply, which could dampen consumer demand and cut into company margins. While it seems far from certain that this protectionist trade stance will bring lasting benefits, in the near term, the consequences are – unsurprisingly – clearly negative.

Initial impacts on confidence indicators

Trump’s trade shock has shaken confidence among both businesses and consumers, the main engine of domestic growth. Further compounding problems, consumer expectations for 12-month inflation have surged to levels not seen since the early 1980s.

It’s important to remember that the top 20% of earners in the US account for roughly 40% of consumer spending. This high-income segment is now feeling the negative wealth effects of the recent market correction, with the S&P 500 down 20% in local currency from its mid-February peak. To add to these woes, those on the lowest incomes have exhausted their Covid-era savings.

Source: University of Michigan, Banque de Luxembourg

Source: University of Michigan, Banque de Luxembourg

More surprising and worrying than the stock market sell-off is the spike in long yields in early April. In a clear signal to a US administration burdened with severely strained public finances, the bond markets have pushed back to rein in Mr. Trump. The dollar also slumped as President Trump attacked the Federal Reserve’s monetary policy and threatened to replace its Chair Jerome Powell, stoking fears for the Fed’s independence.

In response to market pressure, Donald Trump was forced to announce a pause on “reciprocal” tariffs – except on China – for a short 90-day period. A first U-turn to allow a little time for bilateral negotiations and calm the markets. In a further retreat, the US President exempted electronic goods, such as computers and mobile phones, from the new tariffs, bringing the rate on these goods from China to 20%.

Chinese retaliation gets cold reception

President Trump did not appreciate China’s retaliation with a series of increases that raised tariffs on imports from the US to a prohibitive 125%.

Yet he seems to be underestimating China’s capacity for resilience. The United States imports some USD 450 billion worth of goods from China, amounting to around 13% of its total imports and 1.5% of US GDP. It will have difficulty finding substitutes for a large share of these imports, especially in the technology sector. China, on the other hand, can more easily shift its supply chains and reduce dependence on American imports – especially for agricultural goods. US imports made up 13.4% of its total imports in 2024, down from 20% in 2016.

China has also announced other non-tariff measures. It has suspended exports of some rare earths, which are essential components for many US industries (in defence, technology and more). Moreover, Chinese consumers are turning away from US brands, a trend that is bound to weigh on the sales of these multinationals. China also has more flexibility to loosen fiscal policy to boost consumption at home.

To sum up, the trade war launched by the new Trump administration is likely to slow global growth and to higher inflation in the near term. We cannot rule out the possibility that our transatlantic neighbour may be headed for recession. The longer it takes to make trade deals with its main trading partners – and China in particular – the greater the knock-on effects will be. While the United States still has considerable competitive advantages in technology, energy and the military, this abrupt turn to protectionism is likely to undermine the country's credibility as a reliable and trusted trading partner.

Damien Petit, Head of Private Banking Investments
Banque de Luxembourg