The Unfought Trade War

Understanding the Impact of Tariffs on the US Economy

Since the declaration of "Liberation Day" by former US President Donald Trump on April 2, there has been a growing understanding of the dynamics shaping current trade negotiations. One of the most significant aspects of this period is the implementation of tariffs, which have had tangible effects on both domestic and international markets.

According to US customs data, these tariffs are not entirely borne by foreign exporters. Instead, they are partially absorbed by US importers and predominantly by American consumers, who effectively face an increase in their tax burden. This has led to a stagnation in real personal consumption growth, even as asset inflation continues to create a positive wealth effect.

Overall, the evidence suggests that these tariffs have contributed to stagflationary pressures within the US economy while simultaneously exerting deflationary effects on the rest of the world. The US administration's strategy, led by Treasury Secretary Scott Bessent, aims to address the public deficit by fostering economic growth through private sector borrowing. This approach relies on the private sector stepping in as the federal government reduces its spending.

Rebuilding the Private Sector Credit Cycle

For Trump, the key to reviving economic growth lies in initiating a new private sector credit cycle. This requires affordable loans, which in turn depend on lower interest rates. The housing market, currently facing affordability challenges similar to those seen in 2007 before the residential real estate crash, is a critical factor in this equation.

However, there is a risk associated with this strategy. Lowering short-term interest rates can only be beneficial if long-term rates follow suit. The repeated questioning of the Federal Reserve’s independence by Trump adds an element of uncertainty, making this approach potentially risky.

Market Recovery and the Dot-Com Analogy

Since reaching a low point in early April, the market has experienced the fastest and strongest recovery on record, reminiscent of the boom-and-bust cycle of the dot-com era in 1999. Back then, the rise of the internet was fueled by central bank liquidity following events such as the introduction of the euro, the Asian financial crisis, and concerns over the Y2K IT blackout.

Today, it is challenging to argue that the market is being driven by excessively loose monetary policy, as most leading central banks have recently normalized their policies. Short-term rates remain high in the US, and Japan may see further increases.

AI and the Future of Technology

The second-quarter US earnings season has continued on a strong note, with technology giants at the forefront. Remarkably strong results from hyperscalers have added momentum to the artificial intelligence (AI) narrative, confirming that the capital expenditure cycle is not only intact but accelerating.

Capex expectations for key players since Liberation Day have increased by 6%, reflecting both higher budget commitments and ongoing infrastructure supply constraints. This environment continues to support the broader AI value chain, particularly infrastructure and semiconductor companies that are essential for the buildout.

Investors are now asking what could derail the AI train. One scenario involves AI infrastructure and data center supply surpassing demand, but this is unlikely in the near term given current supply constraints and increased capex budgets. Another possibility is a sharp slowdown in top-line growth, though the US economy and corporate spending have shown resilience, with revenue growth benefiting from AI-supported products.

Investment Outlook

Currently, the AI train continues its rapid journey, and none of the hyperscalers are showing signs of slowing down. With momentum intact, selective exposure to unique franchises in US technology remains a viable strategy. Outside the US, European cyclical and value sectors offer better exposure to domestic recovery and reduced sensitivity to foreign exchange and tariff issues.

China's Economic Resilience

Meanwhile, the onshore and offshore Chinese markets have gained more than 6% and 25% respectively year-to-date. While some consolidation of gains is expected, especially in the offshore market, this could set the stage for another trading window later this year when domestic policies are anticipated to strengthen.

Our overweight position in the market is primarily driven by improving bottom-up arguments, despite persistent macroeconomic challenges. Despite a tough business environment, companies have shown meaningful improvements in profitability, driven by efficiency gains. Chinese firms are also increasing shareholder returns, mirroring trends in Japan and South Korea.

Thematic ideas such as AI and new consumption continue to buoy sentiment in the market. From a flow perspective, the offshore Chinese market is another beneficiary of diversification flows out of the US.