INSIGHTS

On April 14, 2025

AAM Viewpoints — Tariff Tsunami

Over the past several days a tariff tsunami has washed over the markets as $10 trillion in global equity value was wiped out. The market meltdown is a fierce reaction to the threat of a global trade war, which could result in the two worst economic outcomes: a steep recession and high inflation. President Trump’s goal of resetting the global trade order has shaken political and corporate leaders. The president’s unexpectedly severe tariff hikes, including on our closest trading partners, have cast a dark cloud of uncertainty over the global economic outlook. For the past 40 years, many countries have built their economies on trade with the United States, and President Trump is trying to resolve a $1 trillion trade deficit in a matter of days or weeks. The administration believes that current trade deficits are unsustainable and have hollowed out America’s industrial base, posing a national security threat. The short-term concern is the implementation of severe retaliatory measures such as China’s proposed 34% increase in tariffs on their imports, which is shaping up to be the opening salvo of an all-out trade war. This tariff tsunami has triggered shockwaves across the financial markets and caused a negative wealth effect, weighing on investor and consumer sentiment.

TRENDING TOPICS

The Trump Administration is playing a high-risk game of economic “chicken.” The central question is whether these aggressive tactics of sharply higher tariff rates are going to lure political leaders to the negotiating table to achieve mutually beneficial trade relationships.

The announcement of an average trade tariff of 25% is aimed at reducing the trade deficit; however, these fees will not resolve trade barriers, in which countries hinder imports of American goods with onerous regulations. Violating trade rules and manipulating currencies have been chief among President Trump’s concerns.

The U.S. imported approximately $4.1 trillion in goods last year, meaning 14% of the $29.7 trillion gross domestic product (GDP) would be impacted by higher tariffs, though the ripple effects may be significantly greater. While the administration believes these tariffs could raise significant revenue, they may come at the cost of U.S. GDP growth and an inflation rebound.

Conversely, the administration has announced over $5 trillion of new plant and equipment investments, including plans for many overseas corporations to build manufacturing facilities in the U.S. However, new tariffs will have an immediate impact on prices while building new manufacturing facilities and onshoring supply chains will take several years to implement.

The current period of trade realignment is a bridge between two policies. The legacy policy of economic globalization is being upended with the hopes of a domestic manufacturing renaissance. Hopefully, President Trump does not overplay his hand and provoke a retaliatory wave of anti-American sentiment.

MARKET RETURNS

Source: Shenkman Capital

ECONOMIC UPDATE

Uncertainty was the overarching theme in the markets during the quarter, which weighed heavily on consumer and investor sentiment. Escalating tariff rhetoric and concerns over higher prices pushed consumer confidence to the lowest level since early 2021.

The Conference Board’s index of consumer sentiment slumped to 92.9 in March, a 7.2-point drop from the prior month. The report’s expectations index, based on the short-term outlook for income, business, and the labor market, dropped 9.6 points to 65.2 — the lowest level in 12 years and well below the threshold of 80 that typically portends an impending recession. Notably, the March 19 survey cutoff predates the “Liberation Day” tariff announcements and subsequent equity market selloff.

Service sector activity declined to the slowest rate in nine months as employment dropped and orders cooled. The Institute for Supply Management’s service gauge sank to 50.8 in March from 53.5 in the prior month. The employment metric shed 7.7 points to 46.2, the lowest in nearly five years.

Small business optimism plunged in March by the most in nearly three years, according to the National Federation of Independent Business. The index sank by 3.3 points to 97.4 last month, though expectations for business conditions over the next six months plummeted 16 points, the sharpest drop since 2020.

HIGH YIELD UPDATE

The high yield bond market significantly outperformed equities in March despite declining by the most since October 2023 as an impending trade war, stubborn inflation, and growth fears weighed on most markets. The ICE BofA US High Yield Index (H0A0) returned -1.07% in March, closing the quarter at a gain of 0.95%. Concurrently, 10-year Treasuries and investment grade bonds — as measured by the ICE BofA Current 10-yr U.S. Treasury (GA10) and U.S. Corporate (C0A0) indices — gained 4.01% and 2.36% respectively for the quarter.

Returns by rating in March showed a clear quality bias in favor of higher-rated credits. During the month, BB, single-B, and CCCs returned -0.56%, -1.31%, and -2.72%, respectively, as longer-duration BBs also benefitted from lower interest rates. A similar tone carried through much of the first quarter as BBs and single-Bs gained 1.45% and 0.70%, respectively, while CCCs declined by -0.67%.

High yield bond capital markets activity rebounded to a five-month zenith in March but was largely subdued during the first quarter. A total of $26.6 billion in new high yield bonds priced in March via 37 transactions, a 42% increase over the prior month and slightly ahead of the 2024 monthly average volume of $24.1 billion, according to JPMorgan, but Q1 issuance remained 22% behind the same period a year ago.

Leveraged loans declined by -0.31% in March, according to the Morningstar LSTA US Leveraged Loan Index, the first monthly decline after 16 consecutive monthly gains for the asset class. Leveraged loans gained 0.48% in the first quarter. The asset class experienced a $4.1 billion outflow in March, the first outflow in six months; however, inflows remain +$10.8 billion in 2025.

Leveraged loan primary market activity subsided further in March as gross new issuance totaled $56.7 billion, according to JPMorgan data, marking a 39% month-over-month decline. For context, 2024 monthly average issuance totaled $110.6 billion. Refinancing/repricing activity, accounted for 67% of issuance during the month. Meanwhile, March CLO (collateralized loan obligation) formations declined 12% from the prior month to $47.9 billion ($16.8 billion excluding refinance/reset). Despite the modest decline, issuance remains well ahead of full year 2022 and 2023 monthly averages of $12.7 billion and $11.6 billion, respectively.

Default/distressed exchange activity in the leveraged finance markets ticked higher in March as three loan issuers defaulted during the month affecting $2.4 billion in face value. During the first quarter, seven companies defaulted impacting $1.2 billion in bonds and $4.8 billion in loans. The trailing 12-month JPMorgan par-weighted U.S. high yield and leveraged loan default rates ended March at 0.27% (unchanged month/month) and 1.24% (-4 basis points month over month), respectively, versus long-term average of approximately 3%.

MARKET OUTLOOK

Financial markets thrive on predictability and certainty. President Trump is a case study in unpredictability and hardball negotiations. Markets are notoriously reactive to fear and emotions, and the tariff tsunami has caused a wave of unpredictability and uncertainty.

There have been six recessions since 1980, each one triggered by outside forces. If there is a recession this year, it would mark the first self-inflicted recession in the modern era.

Despite the market reaction, tariff-related disruptions may unwittingly resolve several long-simmering issues: high interest rates are beginning to fall, oil prices have sharply declined, the fiscal stimulus era has ended, and elevated valuations have been slashed.

One of the more significant variables is whether the Federal Reserve will proactively cut interest rates and provide greater liquidity in the system to mitigate a potential recession. It is still unknown whether Chair Powell will maintain the current high rates for too long, putting the Federal Reserve behind the curve.

In our view, the best outcome would be for President Trump to take a more flexible stance and avoid an economic reckoning with our trading partners. While the equity markets have apparently priced in a recession, political and financial pressures may force all parties to the negotiating table to reach a trade compromise.

CRN: 2025-0403-12454 R

Past performance does not guarantee future results. It is not possible to invest directly in an index.

The opinions and views of this commentary are that of Shenkman Capital and are not necessarily those of Advisors Asset Management.