Easterly EAB - Macro Insights

Tariffs: We Have Nothing to Fear but Fear Itself

The market has been on edge with concerns about tariff application, a potential loss of U.S. AI dominance, and the ability of big tech to keep earnings growth at elevated levels. As a result, the U.S. yield curve has undergone significant flattening. This has sparked debate among economists and investors. Some argue that this movement may be premature, while others believe it signals an impending economic slowdown.

Yield Curve Flattening May Be Premature

Inflationary Pressures: Recent data indicates that inflation remains above the Federal Reserve’s 2% target. In 2025, the Consumer Price Index (CPI) is projected to be 2.8% on a Q4/Q4 basis, with core CPI at 2.9%¹. Persistent inflation suggests that the economy is still experiencing price pressures, which could warrant a steeper yield curve.
Economic Growth Projections: The Conference Board forecasts that real GDP for the U.S. will expand by 2.3% in 2025, with stronger growth in the first half of the year. Data from Feb. 7, 2025 showed Q4 GDP at 2.4%, which was stronger than the expected 2.2%. This positive outlook does not align with a flattening yield curve, which often predicts slower growth.
Federal Reserve Policy: The Federal Reserve (Fed) has adopted a “wait-and-see” approach, maintaining current short-term interest rates after previous cuts. This stance must balance inflation control with supporting economic growth and capital markets activity. A flattening yield curve shows bondholders are afraid of tariffs slowing the economy.

Does a Yield Curve Flattening Indicate a Potential Slowdown?

Declining Consumer Confidence: In February 2025, consumer confidence experienced its largest monthly decline since August 2021, marking the third consecutive monthly drop. Diminished consumer sentiment can lead to reduced spending, potentially slowing economic growth.
Cooling Housing Market: The housing market shows signs of sluggishness, with affordability issues persisting due to elevated interest rates. A weakened housing sector can have ripple effects throughout the economy.
Investor Sentiment: The narrative of U.S. economic exceptionalism took a hit when DeepSeek’s announcement of potentially cheaper AI shook confidence. But factors such as cooling economic growth, underperforming tech companies, and inflation concerns could legitimately contribute to a lackluster performance in U.S. stocks. This shift in sentiment may reflect broader economic uncertainties and reduce the P/E multiple that investors may be willing to pay on future earnings.

What Does this Tug-of-War Mean for Investors?

Certain indicators like persistent inflation and projected GDP growth suggest that the yield curve flattening may be premature. Other factors such as declining consumer confidence, a cooling housing market, and shifting investor sentiment point toward a potential economic slowdown. The interplay of these factors presents a wider range of outcomes that should support a higher level of fixed income volatility that affects bond and asset allocation portfolios. As the shape of the yield curve impacts equity cycles and valuations, there is a likelihood that equity volatility will remain elevated or rise further. The outcome of this process will remain fluid until the results of the administration’s tariff policies become clearer.

Tariffs as Consumption Tax and an Investment Response

We believe tariffs are a form of consumption tax that is paid more heavily by higher volume consumers. If managed correctly, to avoid tariffing staples and products consumers depend on, these taxes can, in some ways, be a fairer form of taxation. To maximize the economic benefit of tariffs, the U.S. can simultaneously use an investment-driven strategy to offset the economic drag of higher import costs. The key is whether capital expenditures (CAPEX) in targeted industries generate enough productivity and supply chain resilience to counterbalance the inflationary and consumer burden effects of tariffs.

Estimated Tariff Revenues (A Wide Gulf of Estimates)

China: Proposed tariffs could generate approximately $40-50 billion annually based on current import volumes and tariff rates.¹
Mexico: Tariffs on Mexican imports could yield $15-20 billion, with auto and manufacturing goods being the primary contributors.²
Canada: Tariffs on Canadian goods could add $10-15 billion, mostly from raw materials and energy.¹
Reciprocal Tariffs: U.S. exports facing retaliatory tariffs could see $30-40 billion in losses, impacting agriculture, industrial goods, and technology.³
Net Effect: Gross tariff revenue could reach $65-85 billion annually, but reciprocal tariffs and economic adjustments may reduce the net benefit.²
The administration projects higher figures that could reach as high as $900 billion. This assumes no foreign concessions or exceptions. If the gulf of estimates stays this wide, how can the market so easily extrapolate economic slowing or inflationary impacts? Simply put, it shouldn’t.²

Impact on the U.S. Economy

Higher Consumer Costs: Tariffs act as a consumption tax, raising prices on imported goods. This can disproportionately impact lower-income consumers unless food and staples tariffs are managed carefully.
Investment as a Solution: CAPEX incentives (tax breaks, subsidies, loan guarantees) can boost domestic production and reduce reliance on imports.
Key Risk: If CAPEX doesn’t translate into productivity and output gains, costs will rise without offsetting benefits.

Impact on Tariffed Countries

China: There will likely be reduced U.S. demand, along with potential supply chain shifts, and possible currency devaluation or export subsidies to stay competitive. In order to avoid such tariffs, China will likely offer some concessions to provide greater access to U.S. sellers or invest in U.S. productive capacity.
Mexico, Canada, & Southeast Asia: Likely beneficiaries as manufacturing relocates to avoid tariffs. U.S. nearshoring could strengthen regional trade.
Europe: Could suffer if industrial tariffs expand, but may benefit if U.S. CAPEX increases from European firms. We think it’s likely that European manufacturers will invest into the U.S.

Key Industries for CAPEX Investment to Watch

Semiconductors & Electronics: U.S. chip fab expansion reduces dependence on China/Taiwan.
Advanced Manufacturing & Automation: Robotics and AI-driven automation improve efficiency.
EVs & Battery Supply Chains: U.S. battery production growth offsets potential Chinese tariffs.
Infrastructure & Energy: Investments in domestic steel, aluminum, and clean energy projects prevent cost spikes.
Nearshoring & Logistics: Expansion of supply chain infrastructure strengthens trade with Mexico as long as they meet Fentanyl interdiction and immigration requirements.

Indicators of Success

Rising CAPEX in Targeted Sectors – This infers higher productivity into future
Stable or Falling Core Inflation – Allows the Fed to ease rates
Growth in High-Value Exports – U.S. manufacturers and high-tech sales are multiplicative
Shift in Trade Deficit – Even small trends make a difference
Private Investment Following Public Incentives – Credit expansion reduces need for U.S. deficit spending

Bottom Line

Tariffs create short- and medium-term fears of volatility. But as can be seen, there is the possibility that a well-designed tariff policy could bring resilience to the U.S. economy. A successful investment response requires targeted CAPEX that enhances productivity and trade resilience. Without it, tariffs will remain a pure tax burden rather than a catalyst for economic advantage. This makes the continuation of the Trump tax cuts a non-negotiable for the administration. While it’s still unclear whether the administration will be able to execute tariffs successfully, we should expect volatility to be a base case, but with the potential that a rationalization of the U.S. fiscal process, tariff and investment developments could bring longer term relief. As a result, we think outright selling or trimming of U.S. equities on what could be a premature flattening of the yield curve seems to be based in fear. We continue to think that participating in equity growth while defending against potential downside declines provides the best path for investor success.

Sources

¹ Year-over-year change in CPI from Q4 2024 to Q4 2025. Source: FED, SEP, and Bloomberg
² U.S. Census Bureau
³ The White House Fact Sheet

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