Why stagflation now seems like America's "optimistic scenario"

“The post-World War II… world economic order” is finished, says Reshma Kapadia in Barron’s. On Wednesday 9 April, sweeping US import charges on most countries in the world came into effect, including tariffs of 20% on the EU and 104% in the case of China. As during the pandemic, ultra-efficient global supply chains are being disrupted, raising inflationary pressure. The latest tariffs, which Donald Trump unveiled on Wednesday 2 April in an event dubbed “Liberation Day”, take the average US tariff rate from 2.5% last year to 22% now, according to calculations by Fitch Ratings. That is the highest level since 1910.

Is the US headed for stagflation?

Investors have gone into tariff shock. The US S&P 500 dropped 12% in the four trading days following Trump's "Liberation Day" tariff announcement. Down 18% since Trump’s inauguration, American stocks sit on the cusp of a bear market. Germany’s Dax was off 9% since “Liberation Day”, with the FTSE 100 falling 8%, correct at the time of writing. Asia has been hit especially hard. Trading has been exceptionally volatile, with the Vix index – known as the stock market’s fear gauge – spiking to its highest level since the 2020 Covid crash.

“Wall Street blew it,” says James Surowiecki in The Atlantic. For months, US stock investors have been in denial that Trump was actually going to do what he said he was going to do. Trump’s beliefs about trade – “deficits are horrible, and tariffs are great” – have been “strikingly consistent” for almost 40 years. Markets have been guilty of “wilful blindness”.

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The stock plunge heralds “a severe economic slowdown”, says The Economist. JPMorgan Chase’s analysts put the chances of a global recession this year at 60%. While the US has been hardest hit, the selloff across other major bourses has been almost as bad, suggesting that tariff pain will be widely felt.

The tariffs amount to a $600 billion tax hike on the cost of living that will hurt consumers, says Bill Dudley on Bloomberg. In the past, the Federal Reserve has ridden to the rescue of a weaker economy. Don’t expect a repeat this time. Annualised US inflation is likely to reach nearly 5% over the coming months, reducing the space for interest-rate cuts. “All told, stagflation is the optimistic scenario. More likely, the US will end up in a full-blown recession.”

The S&P is on the verge of its 13th bear market – defined as a 20% fall from the peak – since 1950, says Russ Mould of AJ Bell. The average post-war bear market lasted 381 days and knocked a third off stock valuations. “The bigger the prior bull-market gain, the bigger the post-party hangover” tends to be – not reassuring, given how overheated US markets became in 2024. Eventually, stocks sell off so much that they become a good deal, but the US market has a long way to fall before that becomes the case. On 19 times forward 2025 earnings, valuations are “still not cheap” by historic standards. And remember that those valuations bake in forecasts of strong corporate profit growth this year – forecasts that are likely to be cut as the trade war bites into the bottom line.

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