Highlights:
· Daily uncertainty on trade has been replaced with longer-term uncertainty. This makes business planning difficult, even though hard economic data has held up to this point.
· Trade deals will be judged by how much barriers go up, not by how much they go down. This potentially makes the trade deal with the U.S. a victory for the U.K. only insofar as other countries may come out worse. Discussions continue with the EU and China, however, it appears clear that the continued threat of extensive tariff imposition will remain the primary U.S. trade strategy.
· Long-term investors who are willing to endure the volatile times we are currently experiencing will continue to have a high probability to outperform those that avoid investing altogether or attempt to time the markets.
Commentary:
“There’s no question that trade…can be an act of war. I think it’s led to bad things. The attitudes it’s brought out in the United States – I mean, we should be looking to trade with the rest of the world and we should do what we do best and they should do what they do best. I do not think it’s a great idea to try and design a world where a few countries say ‘Hah-hah-hah, we’ve won’ and other countries are envious.”
-Warren Buffett, Annual Berkshire Hathaway meeting on May 3, 2025
The U.S. may have made some progress on trade deals during the quarter that, for the time being, have let investors take a breather, but they are far from being able to relax. What unfolded during the quarter was daily uncertainty on trade being replaced with longer-term uncertainty, with trade policy living on month-to-month cycles that make business planning extremely difficult. Despite trade deals with the U.K. and Vietnam as well as a preliminary deal with China, tariffs are still in place, prices are still rising, and deal deadlines with major trading partners still loom. There is only so much U.S. officials can accomplish in such a short period while dealing with more than a dozen governments, especially without involving Congress. Trade officials cannot offer concessions that involve changing U.S. law. As it is, the trade deals that were struck with the U.K. and Vietnam are scant on details and leave much to be worked out.
In fact, President Trump recently re-escalated the trade war by levying a 50% tariff on copper and sending out letters to roughly two dozen countries, including three of America’s closest foreign allies, Canada, Japan and South Korea, with new tariff rates of at least 25% that will go into effect on August 1 with, supposedly, no further delays. The situation changes daily with the latest salvo being an increase to 30% for Mexico and the European Union (EU). The Trump administration used a similar tactic back in April when it took an aggressive posture on pending tariffs, but with a deadline just far enough out that trading partners could still respond with last-minute offers. These most recent announcements are consistent with the administration’s strategy of pressuring trade partners into new bilateral deals in an attempt to reduce the U.S. trade deficit. President Trump is likely feeling empowered by the recent stock market rally, saying as much shortly after his surprise announcement about Canada – “I think the tariffs have been very well-received. The stock market hit a new high today.” Reducing the trade deficit took on even more importance with the passage of President Trump’s signature “One Big Beautiful Bill” that is expected to add $3.4 trillion to the federal debt over the next decade, which is on top of the over $30 trillion that the U.S. already owes.
Not to get lost in the shuffle is a 10% universal tariff that remains in place, resulting in tariffs that are much higher than they were before Trump’s second term, regardless of how present tariff negotiations play out. Many economists have warned that a universal 10% tariff would hurt the economy, but to this point, hard economic data such as inflation and jobs remain steady. The fact remains, however, that the consensus opinion from business leaders is very negative and rightfully so, as tariffs with major trading partners are not only higher than they have been in decades, they have also become far more volatile. The weighted average tariff was as low as 6.9% during the quarter and as high as 28%, according to calculations by the Yale Budget Lab. It was just 2.4% at the start of this year, and is 16.6% as of the writing of this commentary. With 10% import taxes looking like the new minimum, while other countries with more contentious trade relationships are likely to continue to see significantly higher tariffs, there could be sand in the gears of global commerce for some time.
The ultimate impact that tariffs will have on inflation remains the elephant in the room. U.S. inflation picked up slightly last month, but in general, higher prices for groceries and imported goods were largely offset by cheaper gas, travel services, and rents. Core inflation also remains stubbornly above the Federal Reserve’s (Fed) 2% target, which is why the Fed appears to be waiting to see if higher tariffs might derail the central bank’s ongoing fight to defeat inflation, leaving its benchmark rate in the 4.25%-4.5% range at its most recent meeting.
While the Fed projects weaker growth and higher inflation than they envisioned three months ago, before President Trump’s “Liberation Day”, they still may resume rate reductions later this year if they see milder-than-expected price readings or soft employment data. Of course, sticky inflation tied to tariffs, migration-fueled wage pressures, and widening deficits could cause the Fed to keep rates at current levels or even raise them further. Even if the Fed does begin cutting rates this year, Fed Chairman Jerome Powell has suggested the Fed might be only a few cuts away from a neutral stance, suggesting any resumed rate reductions would likely be limited and gradual if the economy can avoid a serious downturn.
Trade uncertainty and a corresponding murky economic outlook is making business planning extremely difficult. Constantly shifting deadlines have led to fear amongst business executives that the trade wars that the Trump administration started in April don’t have a fixed end date. This is resulting in a frozen job market characterized by slowing U.S. job growth as employers are hiring more cautiously and workers are becoming more inclined to stay put in their current jobs. Put another way, those with a job are likely to remain employed, but those without one are likely to stay unemployed. AI is exasperating this trend as employers begin to experiment with how to make their workforces more productive. The path to unfreeze the job market is likely to be driven by either a pick-up in hiring or a pick-up in layoffs, with the outcome having a strong propensity to materially impact the U.S. economy in one direction or the other.
Wage growth continues to outpace inflation, but slower hiring should ease wage pressures, which could help tame inflation. A cooling, but not collapsing, labor market, with an unemployment rate that actually fell last month from 4.2% to 4.1%, reinforces the soft-landing narrative the Fed has been preaching the last couple of years and allows them to stay patient on rate cuts. The next big test is whether inflation cooperates as higher tariffs work their way through the economy. The job market is the linchpin of the economy and, for the time being, equity markets are content with a job market that is chugging along, albeit at a slower pace, given all the uncertainty surrounding tariffs.
Then, there is the consumer, the lifeblood of the economy. May’s consumer spending report showed household spending slipped for the first time in four months. Consumer spending accounts for over two-thirds of U.S. economic activity, so a prolonged slowdown has the potential to seriously stall economic growth. Businesses can probably only eat trade costs for so long before raising prices. This could fuel the tariff-driven inflation, which is why many economists continue to warn that the true inflationary impact of tariffs has not yet been entirely passed through to consumers. Rising costs would put further pressure on consumer demand, which could lead to the slowdown in growth that many economists predicted would happen in the face of higher tariffs.
Looking abroad, the Bank of England also left its key interest rate unchanged at 4.25% at its last policy meeting. The U.K. central bank’s caution has been reinforced by the Israel and U.S. conflict with Iran, which has pushed oil and natural gas prices higher and threatens to create inflation around the world. Although there is currently a ceasefire, just the prospect of Iran taking actions to blockade oil and gas exports through the Strait of Hormuz pushed up oil prices. The narrow channel between Iran and Oman is the chokepoint for a quarter of the world’s seaborne oil trade and around one-fifth of all oil movements.
The U.K. also reached a trade deal with the U.S. during the quarter, but its exports to the U.S. will still face a minimum tariff of 10%, up from less than 2% in 2023, with some exceptions being made for steel and jet engines. Exports of autos above 100,000 units will face a 25% tariff, while the U.K. will ease restrictions on U.S. beef and ethanol. The fact that both countries declared this a good outcome is indicative of how much the trade landscape has changed, even between countries that have shared a “special relationship” since World War II. The U.S. under the Trump Administration is a high-tariff, protectionist country. Trade deals will be judged by how much barriers go up, not by how much they go down. This makes the trade deal with the U.S. a victory for the U.K. only insofar as other countries will probably come out worse.
European Central Bank (ECB) President Christine Lagarde warned that international trade will be changed forever by the tensions over tariffs, even as some of the world’s largest countries aim to join the U.K. and edge toward some compromises with the U.S. “While it is fairly obvious that international trade will never be the same again, it’s also pretty clear that there will be further negotiations,” she said at last month’s Group of Seven meeting of finance officials in Canada. Trump's latest moves appear designed to expedite this process.
The uncertainty surrounding international trade was amongst the chief reasons that the ECB reduced its key interest rate to the lowest level since early 2023, and signaled it is nearing the end of its rate-cutting cycle due to abating inflation. The deposit rate cut to 2% from 2.25% was the ECB’s eighth reduction in the last year, and deepens a divergence with the U.S. Europe’s growth has been far weaker than the U.S.’s in recent years, weighed down by slow growth in China, a key export market, and the effect of the war in Ukraine. Benchmark borrowing costs are now more than 2% lower in Europe than the U.S., where the Fed has not cut rates one time so far this year. The ECB has been able to justify its rate cuts because inflation has fallen back toward its 2% target, with wage growth and energy prices moderating, and a stronger euro weighing on import prices.
The outlook for growth in Europe is being muddled by roller-coaster U.S. tariff policy. Many European countries saw a temporary economic boost earlier this year as exports surged due to U.S. companies rushing to receive shipments ahead of tariffs. There is a good probability though that growth slows as the impact of tariffs kicks in. Currently, most European exports to the U.S. face a 10% tariff, but that levy could rise if the EU and the U.S. do not reach a trade deal by the White House’s new August 1 deadline.
A rising euro is another headwind for European companies, making exports, an engine of Europe’s economy, more expensive. On the plus side, NATO and the EU recently announced a significant fiscal and defense plan it is referring to as ReArm Europe. The plan aims to modernize infrastructure and boost defense spending.
Perhaps no stakes are higher in the Trump administration’s tariff war than the ongoing negotiations with China. President Trump believes that China needs us more than we need them, and that we can outlast China in a trade war. He believes these advantages will lead to big concessions from China and rebalance global commerce. To this point though, it is the U.S. that has made the concessions, already cutting its China tariffs from 145% to a minimum of 30% for at least a few months while both sides keep talking. China reciprocated by lowering its retaliatory levies from 125% to 10%, but importantly made no concessions. This was consistent with other Trump tariff negotiations where he backs down without the other country giving up anything meaningful. This would appear to diminish the administration’s negotiating position because it sends a message that the U.S. seems to need other countries’ trade as much as they need ours.
This makes sense because trade is inherently mutually beneficial. The fact that the U.S. runs a trade deficit with China is because Americans have more disposable income and want what China is producing. This is why China did not panic when the Trump administration initially assessed 145% tariffs on its goods. It bet that as prices for many goods rose and stock markets fell, eventually the U.S. would give in. At least for now that strategy seems to have worked, but that does not mean China still doesn’t have a lot to lose in a prolonged trade war with the U.S. Quite the opposite actually, as China continues to lean on foreign demand to power its economic recovery. The net result of China’s export-heavy economy is a structural imbalance in China’s growth model that is driven more by outbound shipments than sustainable domestic demand.
China has been attempting to rebalance toward domestic consumption for many years, but its progress has been marginal due to subdued consumer confidence exasperated by an ailing real estate market. With the global backdrop shifting towards protectionism, re-shoring, and increasingly fragile supply chains, the long-term viability of an export-led strategy is tenuous. China’s ability to evolve from an export powerhouse to a consumption-driven economy will likely shape China’s future and determine how much advantage it has in long-term trade negotiations with the U.S. and its other trading partners.
The U.S. trade deal with Vietnam that allows American goods to enter Vietnam duty-free will have implications for China. The deal closed a loophole that allowed goods from China, amongst other nations, to pass through Vietnam and then to enter the U.S. without being subject to a levy. Goods to the U.S. that are shipped through Vietnam would now face a 40% tax, twice the 20% rate that would apply to regular imports from Vietnam. This would seem to suggest a floor for trade negotiations with China, which would otherwise maintain a competitive manufacturing advantage.
While the U.S. has been backing away from free trade, much of the rest of the world is not. There has been a flurry of activity since “Liberation Day” as countries across the globe attempt to deepen trade ties and offset some of the pain from U.S. tariffs by trading more with one another. For example, the U.K. and EU announced a trade and security deal during the quarter, which was monumental given the U.K.’s decision to leave the EU nearly a decade ago. The deal aims to ease trade barriers and address security concerns amid Russia’s war in Ukraine and a shifting U.S. role in Europe. While the EU remains the U.K.’s largest trading partner, U.K. exports to the EU have fallen 21% since Brexit. This agreement is projected to add nearly $12 billion to the U.K. economy by 2040.
The U.K. also completed a trade agreement with India during the quarter that had been stuck for several years. The EU is negotiating its own deal with India, and recently agreed on one with South America’s Mercosur trading bloc. Canada and Asian countries are also revisiting old trade deals. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership, a trade group consisting of 12 countries, is considering new applicants, including Costa Rica and Indonesia. While the U.S. accounts for 26% of global economic output, it only accounts for 13% of global imports, which leaves plenty of goods for the rest of the world to exchange.
It is possible that trade wars and fighting in the Middle East, Ukraine and other parts of the world persist for some time. That will not stop companies from trying to innovate and increase profits as the resilience of corporations has been proven numerous times throughout history. One of the biggest downsides of the information age that we are now living in is the persistent negative headlines and seemingly endless amount of doomsayers on social media. However, we will almost certainly continue to make progress to improve the quality and longevity of our lives, and the global economy is extremely likely to grow over the long run as this progress is made. Long-term investors that bet that the future will be better than the past and are willing to endure the bad times, will continue to have an extremely high propensity to outperform those that avoid investing altogether or attempt to time the markets. We will end with a quote from one of our model growth component managers, John Neff of Akre Capital Management, that we believe captures this sentiment:
“Compounding takes place over time periods long enough to include a host of bad and scary things. We find this a very comforting thought. Still, many investors try to anticipate, avoid, or otherwise navigate the next scary or uncertain thing. Their challenge is two-fold. First, many bad and scary things are unforeseen prior to their occurrence (e.g. 9/11, COVID). Second, even if investors correctly anticipated such events, gauging the timing, direction, and extent of market reaction is another matter entirely. For example, if you were told in advance that there would be a global pandemic in early 2020 that would shut down much of the world for 12-18 months and take the lives of millions, would you have then guessed that the ensuing bear market would last just one month (which it did)? Foreknowledge of events does not necessarily translate into market wisdom.”
Urban Financial Advisory Corporation – July, 2025
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