Insights

‍

‍

This morning, I was asked to discuss Sarah Hunter’s presentation from yesterday. Sarah, the Assistant Governor and Chief Economist at the Reserve Bank of Australia (RBA), delivered a detailed and competent discussion on the conventional view of tariffs’ impact on the international economy. She highlighted that tariffs typically increase inflation and reduce economic output, a perspective echoed by the OECD in a similar presentation overnight. Sarah’s analysis focused on the potential shocks tariffs could cause, particularly their effects on GDP and inflation.

Drawing on my experience as an Australian trade commissioner and my work in Australian embassies, I found her presentation particularly interesting. My background allowed me to bring specialist knowledge to the conversation, which I believe gave me an edge. Notably, I observed that the RBA seems to lack analysts closely tracking individual policymakers in the Trump administration, such as Scott Bessent, whose views on tariffs and competition differ from the general assumptions. The conventional view assumes a world of perfectly competitive countries adhering to international trade rules and unlikely to engage in conflict—a scenario that doesn’t align with the current global trade environment, especially between China and the United States.

China, operating as a Marxist-Leninist economy, aims to dominate global markets by building monopolies in areas like rare earths, nickel, copper, and other base metals. It maintains a managed exchange rate, despite promises to the International Monetary Fund for a freely floating currency. If China allowed its currency, the RMB, to float, it would likely appreciate significantly, increasing imports and reducing its trade surplus. This would create a more balanced international trade environment, potentially reducing the need for other countries to impose tariffs. However, major institutions like the OECD and RBA seem to misjudge the nature of this trade shock, relying on outdated assumptions about global trade dynamics.

The international community also appears to overlook specific U.S. policy intentions, such as those articulated by figures like Peter Navarro and Scott Bessent. The U.S. aims to use tariffs selectively to bolster industries like pharmaceuticals, precision manufacturing, and motor vehicles. This misunderstanding leads public institutions to perceive unspecified risks, as reflected in Sarah’s otherwise able presentation. Because the RBA and similar institutions view the world as fraught with undefined risks, they are inclined to keep interest rates low, responding to perceived threats rather than an equilibrium model.

Interestingly, data from the U.S. economy contradicts the expected negative impacts of tariffs. The Chicago Fed National Activity Indicator, a reliable gauge of economic growth since the 2008 financial crisis, shows U.S. growth above the long-term trend for the first four months of this year. This suggests resilience despite tariff-related shocks. Ideally, growth will slow later this year, prompting the Federal Reserve to cut rates, facilitating a soft landing and a decline in the U.S. dollar to boost global commodity prices. However, this nuanced outlook wasn’t evident in yesterday’s presentation.

Moreover, the anticipated rise in U.S. inflation due to tariffs isn’t materialising. Scott Bessent recently noted that U.S. CPI inflation is lower than expected, with core inflation shown as the (16% trimmed mean) at 3% for the past two months . Core inflation  excluding  food and energy CPI  is only at 2.8%. This suggests that Chinese suppliers are absorbing tariff costs to maintain market share, rather than passing them on as higher prices. Recent Chinese data supports this, showing a slight decline in manufacturing confidence and coal consumption, indicating reduced factory output and electricity use. This points to a modest slowdown in China’s economy. So far the expected negative effects on U.S. prices and output are not occurring.

In summary, the fears expressed by institutions like the RBA and OECD about the Trump administration’s trade policies appear overstated. The U.S. economy is not experiencing the predicted declines in output or increases in inflation. While these effects may emerge later, the current data suggests that the risks are not as severe as anticipated, highlighting a disconnect between theoretical models and real-world outcomes.

‍

‍

‍

Today, I’m presenting the first page of my updated presentation, which focuses on GDP growth and inflation expectations for major economies. Before diving into that, I want to clarify a point about U.S. trade negotiations that has confused some media outlets.

In the previous Trump Administration ,there was single trade negotiator, Robert Lighthizer, held a cabinet position with the rank of Ambassador. This time, to expedite negotiations and give them more weight, Trump has appointed two additional cabinet-level officials to handle trade talks with different regions. For Asian economies, Scott Bessent and Ambassador Jamison Greer, who succeeded Lighthizer and previously served on the White House staff, are managing negotiations, including those with China. For Europe, Howard Lutnick, the Commerce Secretary, and Ambassador Greer are negotiating with the European Trade Representative. When the EU representative visits Washington, D.C., they meet with Lutnick and Greer, while Chinese or Japanese representatives engage with Bessent and Greer.

In my presentation today, I’m outlining the economic outlook for growth and inflation in the U.S., the Euro area, China, India, and Australia, drawing data from the International Monetary Fund, the Congressional Budget Office, European sources, and my own analysis for Australia.

For the U.S., the best-case scenario is a soft landing, with growth slowing but remaining positive at 1.3% this year and rising to 1.7% next year. This slowdown allows the Federal Reserve to continue cutting interest rates, leading to a decline in the U.S. dollar. This in turn ,triggers a recovery in commodity prices. These prices have stabilized and are now trending upward, with an expected acceleration as the dollar weakens.

U.S. headline inflation is projected to be just below 3% next year, with higher figures this year driven by tariff effects.

‍

‍

In the Euro area, growth is accelerating slightly, from just under 1% this year to 1.2% next year, with inflation expected to hit the 2% target this year and dip to 1.9% next year.

China’s GDP growth is forecast  at 4% for both this year and next, a step down from previous 5% rates, reflecting a significant slump in domestic demand and very low inflation  Chinese Inflation is only  :   0.2% last year, 0.4% this year, and 0.9% next year.  Despite a massive fiscal push, with a budget deficit around 8% of GDP, China’s debt-to-GDP ratio is rising faster than the U.S.. Yet this is  yielding more modest  domestic growth.

India, on the other hand, continues to outperform, with 6.5% GDP growth last year, 6.2% this year, and  6.3%  next year, surpassing earlier projections.

Positive earnings surprise

In our International Reporting Season Review, we provide an overview of the March 2025 quarterly results season for companies in the Americas, Europe and Asia. For all the volatility in markets caused by US trade policy, the results were positive. For all the 187 high profile and blue-chip companies in our International Watchlist, the median EPS beat vs consensus was 3.2%, nearly twice that recorded in the December quarter (1.8%). 37% of companies exceeded consensus EPS expectations by more than 5% and only 9% missed by more than 5%. Communication Services was the most positive sector, led by Magnificent 7 companies Alphabet and Meta Platforms. The median EPS beat in that sector was 13%. Consumer Discretionary was the biggest disappointment (though only a mild one) with EPS falling 0.6% short of analyst estimates on a median basis.

Alphabet and Meta among the best performers

Across our Watchlist, some of the best performing stocks in terms of EPS beats were Alphabet, Boeing, Uniqlo-owner Fast Retailing, Meta Platforms, Newmont and The Walt Disney Company. Notable misses came from insurance broker Aon, BP, PepsiCo, Starbucks, Tesla and UnitedHealth. The latter saw by far the worst share price performance over reporting season, its earnings weakness compounded by the resignation of its CEO and the launch of a fraud investigation by the Department of Justice. British luxury fashion label Burberry had the best performing share price as it gains traction in its turnaround plan.

Tariffs were the main talking point (of course)

The timing of President Trump’s ‘Liberation Day’ on 2 April, just before the March quarter results started rolling in, guaranteed that US tariffs would be the main talking point throughout reporting season. Most companies took the line that higher tariffs presented a material risk to global growth and inflation. The rapidly shifting sands of US trade policy mean the impact of tariffs is highly uncertain. This didn’t stop many companies from trying to estimate the impact on their profits. This ranged from the very precise ($850m said RTX) to the extremely vague (‘a few hundred million dollars’ hazarded Abbott Laboratories). The rehabilitation of AI as a systemic driver of long-term value was a key theme of reporting season, with many companies reporting what Palantir Technologies described as an ‘unstoppable whirlwind of demand’ and others indicating an increase in planned AI investment. The deterioration in consumer confidence was another key talking point, though most companies could only express concern about a possible future softening in demand rather than any actual evidence of a hit to sales.

Our International Focus List continues to outperform

In this report, we also report on the performance of the Morgans International Focus List, which is now up 25.3% since inception last year, outperforming the benchmark S&P 500 by 20.4%.

‍

Morgans clients receive exclusive insights such as access to our latest International Reporting Season article.

Contact us today to begin your journey with Morgans.

‍

US and Chinese actions had led to an unintended embargo of trade between the world’s two largest economies.

In recent days there has been discussion of the temporary “cease fire” in the tariff war between the US and China.

The situation was that both countries had levied tariffs on each other more than 125%. This had led to a mutual embargo of trade between the two world is two largest economies. Then as a result of negotiation between the Deputy Premier of China and US Treasury Secretary Scott Bessent both China and the US agreed to a 90 day pause in “hostilities” where both sides agreed to reduce the US tariff on the China to 30 percent and the Chinese tariff on the US to 10%.

Some suggested that this meant that “China had won” others suggested that the “US had won.” To us this really suggests that both parties were playing in a different game. The was a game in which both sides had won.

To understand why this is the case we must understand a little of the theory of this type of competition. Economists usually use discuss competition in terms of markets where millions of people are involved. In such a case we find a solution by finding the intersection of supply and demand which model the exchange between vast numbers of people.

But here we are ware talking of a competition where only two parties are involved.

When exceedingly small numbers like this are involved, we find the solution to the competition by what is called “Game Theory.”

In this game there are only two players. One is called China, and the other is called the US. Game theory teaches us that are there three different types of games. The first is a zero-sum game. In this game there two sides are competing over a fixed amount of product. Again, this is called " A zero sum game “. Either one party gets a bigger share of the total sum at stake and the other side gets less. This zero-sum game is how most of the Media views the competition between the US and China.

A second form is a decreasing sum game. An example of this is a war. Some of the total amount that is fought over is destroyed in the process. Usually both sides will wind up worse than when they started.

Then there is a third form. This form is called an ‘increasing sum game.’ This is where both sides cooperate so that the total sum in the game grows because of this cooperation. We think that what happened in the US and China negotiation was an increasing sum game.

As Scott Bessent said at the Saudi Investment Forum in Riyadh soon after the agreement was signed, “both sides came with a clear agenda with shared interests and great mutual respect.”

He said, “after the weekend, we now have a mechanism to avoid escalation like we had before. We both agreed to bring the tariff levels down by 115% which I think is very productive because where we were with 145% and 125% was an unintended embargo. That is not healthy for the two largest economies in the world.”

He went on, “when President Trump began the tariff program, we had a plan, we had a process. What we did not have with the Chinese was a mechanism. The Vice Premier and I now call this the ‘Geneva mechanism’”.

Both sides cooperated to make both sides better off. Bessent added “what we do not want, and both sides agreed, is a generalised decoupling between the two largest economies in the world. What we want is the US to decouple in strategic industries, medicine, semiconductors, other strategic areas. As to other countries; we have had very productive discussions with Japan, South Korea, Indonesia, Taiwan, Thailand. Europe may have collective action problems with the French wanting one thing and the Italians wanting a different thing. but I am confident that with Europe, we will arrive at a satisfactory conclusion.

We have a very good framework. I think we can proceed from here.”

What we think we can see here is that the United States and China have cooperated to both become better off. This is what we call an increasing sum game.

They will continue their negotiation using that approach. This will do much to allay the concerns that so many had about the effect of these new tariffs.

‍

‍

‍

In the 1930s, the US Treasury Secretary Henry Morganthau was widely regarded as the finest Treasury Secretary since Alexander Hamilton. However, if the current Treasury Secretary Scott Bessent, continues to deliver results as he is doing now, he will provide formidable competition to Morganthau’s legacy.

The quality of Bessent’s work is exceptional, demonstrated by his ability to secure an agreement with China in just a few days in complex circumstances.

The concept of the "effective tariff rate" is a term that has gained traction recently. Although nominal tariff rates on individual goods in individual countries might be as high as 100% or 125%; the effective tariff rate, which reflects the actual tariffs the US imposes on imports from all countries, is thought to be only 20.5%. This figure comes from an online spreadsheet published by Fitch Ratings, since 24 April.

‍

‍

This effective tariff rate of 20.5% can be used in assessing the impact of import tariffs on US inflation. To evaluate this, I used a method proposed by Scott Bessent during his Senate confirmation hearing. Bessent began by noting that imports account for only 16% of US goods and services that are consumed in the US Economy. In this case, a 10% revenue tariff would increase domestic prices by just 1.6%. With a core inflation rate of 2.8% in the US, this results in a headline inflation rate of 4.4%. Thus, the overall impact of such tariffs on the US economy is relatively modest.

A couple of weeks ago, Austan Goolsbee, the President of the Chicago Fed, noted that tariffs typically increase inflation, which might prompt the Fed to lift rates, but they also reduce economic output, which might prompt the Fed to rate cuts. Consequently, Goolsbee suggested that the Federal Reserve might opt to do nothing. This prediction was successful when the Open Market Committee of the Fed, with Goolsbee as a member, left the Fed Funds rate unchanged last week.

A 90-day agreement between the US and China, masterfully negotiated by Scott Bessent, has dramatically reduced tariffs between China and the US. China now only imposes a 10% import tariff on the US, while the US applies a 30% tariff on Chinese goods—10% as a revenue tariff and 20% to pressure China to curb the supply of fentanyl ingredients to third parties in Mexico or Canada. It is this fentanyl which fuels the US drug crisis. This is a priority for the Trump administration.

How Import Tariffs Affect US Inflation.

We can calculate how much inflation a tariff adds to the US economy in the same way as Scott Bessent by multiplying the effective tariff rate by the proportion that imports are of US GDP. Based on a 20.5% US effective tariff rate, I calculated that it adds 3.28% to the US headline Consumer Price Index (CPI). This results in a US headline inflation rate of 6.1% for the year ahead. In Australia, we can draw parallels to the 10% GST introduced 24 years ago, where price effects were transient and vanished after a year, avoiding sustained high inflation.

Before these negotiations, the US was levying a nominal tariff on China of 145%. Some items were not taxed, so meant that the effective tariff on China was 103%. Levying this tariff meant that the US faced a price effect of 3.28%, contributing to a 6.1% headline inflation rate.

If the nominal tariff rate dropped to 80%, the best-case scenario I considered previously, the price effect would fall to 2.4%, with a headline US inflation rate of 5.2%. With the US now charging China a 30% tariff, this adds only 2% to headline inflation, yielding a manageable 4.8% US inflation rate.

As Goolsbee indicated, the Fed might consider raising interest rates to counter inflation or cutting them to address reduced output, but ultimately, it is likely to maintain current rates, as it did last week. I anticipate the Fed will continue to hold interest rates steady but with an easing bias, potentially cutting rates in the second half of the year once the situation stabilises.

My current Fed Funds rate model suggests that, absent this year's tariff developments, the Fed would have cut rates by 50 basis points. This could be highly positive for the US economy.

‍

I’d like to discuss a presentation delivered by Austan Goolsbee, President of the Federal Reserve Bank of Chicago, to the Economic Club of New York on 10 April. Austan Goolsbee, gave a remarkably animated talk about tariffs and their impact on the U.S. economy.

Goolsbee is a current member of the Federal Reserve’s Open Market Committee, alongside representatives from Washington, D.C., and Fed bank Presidents from Chicago, Boston, St. Louis, and Kansas City.  

Having previously served as Chairman of the Council of Economic Advisers in the Obama White House, Goolsbee’s presentation style in New York was notably different from his more reserved demeanour I had previously seen when I had attended a talk of his in Chicago.

During his hour-long, fast-paced talk, Goolsbee addressed the economic implications of tariffs. He recounted an interview where he argued that raising interest rates was not the appropriate response to tariffs, a stance that led some to label him a “Dove.” He humorously dismissed the bird analogy, instead likening himself to a “Data Dog,” tasked with sniffing out the data to guide decision-making.

Goolsbee explained that tariffs typically drive inflation higher, which might ordinarily prompt rate hikes. However, they also tend to reduce economic growth, suggesting a need to cut rates. This creates a dilemma where rates might not need adjustment at all. He described tariffs as a “stagflation event” but emphasised that their impact is minor compared to the severe stagflation of the 1970s.

When asked if the U.S. was heading towards a recession, Goolsbee said that the "hard data" was surprisingly strong.

Let us now look at our model of US GDP based on the Chicago Fed National Activity Index. This Index   incorporates 85 variables across production, sales, employment, and personal consumption.  In the final quarter of last year, this index indicated the GDP growth was slightly below the long-term average, suggesting a US GDP growth rate of 1.9% to 2%.

However, data from the first quarter of this year showed stronger growth, just fractionally below the long-term trend.

Using Our Chicago Fed model, we find that US GDP growth had risen from about 2% growth to a growth rate of around 2.6%, indicating a robust U.S. economy far from recessionary conditions.

We think that   increased government revenue from Tariffs might temper domestic demand, potentially guiding growth down towards 1.9% or 2% by year’s end. Despite concerns about tariffs triggering a downturn, this highlights the economy’s resilience and suggests   a “soft landing,” which could allow interest rates to ease, weaken the U.S. dollar, and boost demand for equities.

We will provide monthly reviews of these indicators. We note that, for now, the outlook for the U.S. economy remains very positive.

‍