The Price of Protectionism

The current economic outlook suggests a significant risk of recession largely driven by recent tariff implementations, which are among the largest tax increases in U.S. history. These tariffs, if maintained for several months, are likely to lead to a consumer income hit and investment freeze, potentially triggering a recession with a 70% probability. However, if tariffs are reduced swiftly, the economy may suffer a severe growth hit but avoid recession, with a 25% probability.

The stock market is projected to experience a decline of 30-35%, surpassing the historical median bear market decline due to high starting valuations and a reactive Federal Reserve. In a less severe scenario, the market decline might be around 23%, with a more modest impact on earnings and multiples, though a quick rebound is unlikely.

Global growth is expected to suffer due to the U.S. tariffs, but the impact should be less severe compared to the U.S. as it is only one of many trading partners for other countries. This could lead to outperformance of international stock markets relative to the U.S. market. Retaliatory tariffs from China, Canada, and the EU further exacerbate growth risks.

In the bond market, while the Fed may cut rates in response to a recession, inflation is likely to keep rates from falling too low, limiting the effectiveness of bonds as a hedge compared to previous crises. The prospect of rising debt levels and uncertainty regarding future Fed policies also suggests a higher floor on bond yields.

Overall, without significant policy shifts, the outlook remains challenging with a high likelihood of recession and substantial market declines, although potential off-ramps and offsets could mitigate some of the negative impacts.