Market Brief: Tariff Celebration Proves Short-Lived

Financial markets this morning celebrated a temporary reprieve from President Trump’s trade war after the bipartisan US Court of International Trade ruled that he overstepped his authority in using emergency powers to impose tariffs – but the relief rally is fading in the face of data that suggests the economy is losing momentum. North American equity indices are still marching toward solid gains – partially supported by last night’s positive earnings release from artificial intelligence bellwether Nvidia Corp. – and implied volatility expectations are declining, but ten-year Treasury yields are falling, and the dollar is conceding territory as the session progresses.

The court unanimously found the 1977 International Emergency Economic Powers Act – which the White House has used as the legal basis for its actions – does not provide for the president’s use of tariffs. Three judges – appointed by Reagan, Obama, and Trump himself – said “Because of the Constitution's express allocation of the tariff power to Congress,” the Act does not “does not authorize the President to impose unbounded tariffs,” and further, its “limited authorities may be exercised only to ‘deal with an unusual and extraordinary threat with respect to which a national emergency has been declared... and may not be exercised for any other purpose’”. This invalidates the administration’s 10-percent 'baseline' levies, its significantly higher 'reciprocal' duties targeting specific trading partners, and the fentanyl-related penalties imposed on China, Canada, and Mexico earlier in the year. Under the ruling, the White House has ten days to suspend its tariff collection activities and is also required to begin refunding monies collected thus far.

In theory, the ruling could deliver major upside shock to the US and global growth outlooks. If average tariff rates are reset to around 4.7 percent* – roughly double those that prevailed before Trump took office, but down dramatically from what had been threatened last month – the cost imposed on the American economy could shrink to levels that can be sustained over time. The chart below, which (somewhat unconventionally) illustrates import duties as a share of gross domestic product over time, shows that the tax burden would fall to a threshold last reached in the late thirties, as opposed to the pre-First World War levels previously estimated.

In practice, the path ahead is unclear. The administration could seize on the ruling as a face-saving opportunity to abandon a clearly-untenable approach to rebalancing global trade. This seems unlikely. Instead, the White House might ask for a stay of the injunction, taking its case to the federal appellate court and then to the Supreme Court, keeping prevailing rates in place while exploring other legal avenues for applying tariffs. Obtaining broad-based Congressional approval could prove challenging, given that many Republicans represent districts that could suffer from a rise in import taxes. More targeted measures could be pursued – Section 232 of the Trade Expansion Act of 1962, which allows for tariffs on imports deemed a threat to US national security; under Section 122 of the Trade Act of 1974, which authorises temporary 15-percent levies on countries with substantial bilateral trade surpluses; under Section 201 of the same Act, which addresses trade 'dumping'; or under Section 301, which requires that a comprehensive investigative process be completed before duties are raised.

We think this leaves currency markets in a quandary. With the administration’s tariff push likely to become bogged down in procedural hurdles and legal challenges, the range of expected economic outcomes could narrow slightly. But overall uncertainty levels will stay spectacularly high, and could go higher still if President Trump chooses to redouble his rhetorical efforts. “Bullwhip effects” are set to extend for longer as businesses and consumers again attempt to recalibrate buying and investment activities. Signs of softness in the economy are likely to weigh on overall risk appetite even as the Federal Reserve’s room for manoeuvre remains severely limited. A clear directional decline in the dollar could come to an end, but trading ranges might widen as investors grapple with deepening uncertainties.

Revised data released this morning showed US output falling by more than initially estimated in the first three months of the year, suggesting that the handoff into the second quarter was weaker than markets had anticipated. According to the Bureau of Economic Analysis, the economy shrank at a -0.2-percent annualised pace in the quarter ended in March. This was down from the -0.3-percent rate previously reported after consumer spending growth was lowered from 1.8 percent to 1.2 percent and net exports subtracted a greater-than-estimated 4.9 percent. A separate report showed initial applications for jobless claims jumping by more than expected in the week just ended.

Tomorrow’s data releases could add more colour. The US personal spending and income report should shed more light on consumer behaviour and price developments in April – ahead of the president’s climbdown on Chinese tariffs – and Canada’s gross domestic product report might help investors better assess the odds of an economic downturn this year. At the moment, the economic consensus sees the odds of a recession in Canada sitting near coin-toss levels, but that could shift dramatically if evidence of continued consumer resilience appears in the growth data.

*Please note that modelling effective tariff rates is an inexact science at the best of times, and these, dear reader, are not the best of times. My estimates have changed on more than 30 different occasions this year, but are ultimately based on the trade mix that prevailed in 2024 – which the economy has clearly moved away from. Take them with a very, very large grain of salt.

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