At the World Economic Forum in Davos in January, the great and good of global business and finance were relishing the prospect of Donald Trump’s second presidential term.
Chief executives, hedge fund managers and private equity investors could scarcely contain their enthusiasm for a president who had promised mass tax cuts for corporations, deregulation of the financial system and for market capitalism to let rip in the world’s largest economy.
Even Trump’s opponents, like Larry Summers, a former US treasury secretary under Bill Clinton, were looking on the bright side. “There hasn’t been a moment when the technological possibilities ahead of the world have been as bright as they are today,” Summers told the forum.
• Markets live: follow latest as FTSE 100 plunges
Trump’s other main economic promise — to hit all US trading partners with tariffs of at least 10 per cent — was dismissed as a negotiating tactic to extract trade deals from the rest of the world. After all, this was how the president used the stick of tariffs in his first administration. Trump, the businessman, would not jeopardise US economic prosperity and the fastest growth rates in the G7.
Less than four months later, it is patently clear that the Davos crowd got it wrong. Deregulation has been scant, Trump’s promised tax cuts have not been renewed and the swingeing tariff agenda represents the biggest tax rise on American companies and workers since the 1950s.
In a matter of weeks Trump has driven US protectionism to the highest level since the 1910s as part of a radical experiment to rewire the world’s largest economy, unfettered by stock market panic where recession warnings are flashing red.
For the rest of the world “the feeling that the US was a kind hegemon and a reassuring presence in times of need has now gone”, Louis-Vincent Gave at Gavekal, a research group, said.
US stock markets have reversed all traces of the exuberant “Trump trade” that drove equity valuations and the dollar to the highest on record at the start of February. The greenback, which is supposed to strengthen in times of volatility, has wiped out yearly gains as Trump has pursued his trade policy with an ideological zeal that few on Wall Street expected.
Economists warn that US prospects have flipped from being a rare high-productivity, high-growth economy with a booming jobs market, to one which is on the precipice of an era of stagflation, where growth craters and consumer prices are on the march. The odds of a US recession have jumped from 40 per cent to 60 per cent this year, according to JP Morgan, in a note to investors titled, “There will be Blood”.
The stock market reversal is more than just a correction of misplaced buoyancy, according to Steven Blitz, chief US economist at TS Lombard. Equity valuations are reflecting a new reality where “the 40-year run of expanding profit shares for US corporates is done”, he says.
For the past three decades the global trading system has been set up to allow firms to “expand margins by building in low-cost countries and selling into high-income nations”, Blitz says. “Tariffs are priced to reverse this trend. Breaking trade is what Trump aimed to do, and he has done it. The fallout is a massive reset of equity multiples because pricing based on sustained to widening profit margins is now wrong.”
Anxiety on Wall Street is having a ripple effect across global markets and the world’s major finance ministries. China on Friday became the first major player to announce retaliatory tariffs of 34 per cent on top of existing levies of about 25 per cent on US goods entering the country.
• UK draws up £18.5bn retaliation list of US imports
Beijing’s response also puts paid to diminishing hopes that Trump would prioritise a trade deal with China, as was the case in 2018-2019. “China’s leadership has put the ball back into Trump’s court to see if he wants to de-escalate,” Leah Fahy at Capital Economics said.
In Europe governments are scrambling to conjure up emergency fiscal stabilisers to cushion the impact on their households and business. Spain’s centre-left-led government was first out of the blocks with a €14.1 billion package of loans and subsidies for export-oriented industries such as cars and agriculture.
France’s finance minister has said that the government may have to delay long-planned spending cuts and tax rises and allow the country’s large budget deficit to widen further to prop up fragile economic confidence. Other EU member states are now calling on Brussels to issue joint bonds to finance an EU-wide unemployment guarantee scheme as they did during the pandemic.
Global central banks are also likely to be jolted into action with aggressive interest rate cuts to counteract the impact of US protectionism. Traders are betting on the European Central Bank and the Bank of England to lower borrowing costs at least another three times this year.
In the UK the cash-strapped Labour government has almost no fiscal levers at its disposal to support companies or households. Rachel Reeves, the chancellor, is relying on the Bank to deliver the main source of stimulus to consumers through looser monetary policy.
• How the world might respond to Donald Trump’s ‘new era’
The UK’s 10 per cent tariff hit is lower than the 20 per cent on the European Union, but a global trade war with tit-for-tat tariffs will have large indirect impacts on the economy. Growth could be lower by 0.6 percentage points and unemployment could rise by as much as 100,000, according to estimates from Deutsche Bank.
As for the US, Trump and his officials are sticking to their guns in defiance of Wall Street, diplomatic overtures from US allies and the weaponisation of trade and tax policy against the US in the rest of the world.
Marco Rubio, the US secretary of state, on Friday said that “markets will adjust” to a world in which the US turns towards autarky and protectionism over co-operation and market liberalisation. “The president rightly has concluded that the current status of global trade is bad for America and good for a bunch of other people. And he’s going to reset it,” Rubio said.
