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The second presidency of Donald Trump began in January with global markets concerned about trade wars and the level of U.S. government debt, while also hoping for tax cuts and deregulation. The market’s working assumption is that there will be some tariffs, but primarily they will be used as a weapon or bargaining tool to achieve other objectives. Ultimately, as ever, it all comes down to the impact on U.S. inflation, interest rates and consequently, economic activity. With such an unpredictable President, it is very hard for markets to accurately price in any tariff move, especially as the promised offsetting tax cuts have yet to be announced. Therefore, we must expect increased volatility. In fact, recent levels of market volatility have been very low by historical standards, in this respect, Trump represents a return to normal. While tariffs are dominating the headlines, there are other economic implications taking place. Mass deportation and restrictions on the supply of cheap, undocumented labour are already starting to impact some areas, such as construction and agriculture, which will be inflationary. Elon Musk seems to have been handed control of the US government chequebook with many services under threat, indeed all foreign aid appears to have been cancelled. How far this goes is again impossible to tell at this stage, nevertheless the bond markets will be pleased. When the world’s dominant economy undergoes such dramatic political change there will be global implications, especially in Germany where an election is under way. It depends whether these initial measures are perceived to be successful or not. The ultimate arbiter will be inflation.
Trump Tariffs Impact on USA Growth
Trump has unleashed what economists term “animal spirits,” prompting many businesses to jump on the growth bandwagon. However, as shown in these charts from Goldman Sachs, Trump’s policies are likely to be detrimental to growth. These charts assume a 10% across-the-board tariff. While the headline numbers might be higher, the majority of U.S. imports will probably end up below that threshold, suggesting that these projections may be pessimistic. The projections indicate that by April 2026, tariffs could impact the U.S. GDP growth rate by as much as 1.25%. The immigration impact is relatively small and likely to be industryspecific, particularly affecting sectors that rely heavily on large numbers of low-cost undocumented labor. There will be some offsets due to promised tax cuts, which are highlighted in the second chart. While these tax cuts would provide some relief, depending on their timing, they will not fully compensate for the negative impact of tariffs on growth. The key economic message from these charts is that the cost of tariffs is, as previously mentioned, temporary. The negative period will pass, as seen during the in the first Trump Presidency.
Tariff impact on US Inflation
Tariffs impact consumers by causing higher prices. Suppliers typically do not absorb the full cost, so the burden ultimately falls on the U.S. consumer, much like Value Added Tax (VAT). As prices increase, consumer demand tends to decrease, we saw this during the last Trump administration, where consumer spending effectively “went on strike.” A key concern in this scenario is that inflation numbers are likely to rise. So, what actions will the Federal Reserve take in response?
Trump has begun to pressure the U.S. Federal Reserve, arguing that interest rates are too high. However, whether the Fed can implement cuts depends significantly on the inflation rate. This chart from Goldman Sachs attempts to illustrate the potential impact of 10% tariffs applied across the board (indicated by the red line) compared to targeted tariffs on China and the auto industry (shown in light blue). In a worst-case scenario, a blanket 10% tariff could temporarily push inflation above 3%. In contrast, targeted tariffs would likely have a much smaller impact. These estimates are currently speculative, as the effects will depend on whether the tariffs are a one-time measure or part of an ongoing strategy. The Federal Reserve’s ability to overlook these effects will ultimately depend on the specific tariffs that are enacted. Presently, tariffs are primarily being used as a bargaining tool, but this situation may evolve.
DeepSeek and Artificial Intelligence
In January, Artificial Intelligence (AI) appears to have reached a critical inflection point. The Chinese program DeepSeek AI received acclaim from several influential Silicon Valley executives. While tests indicated that it might not be as advanced as OpenAI’s software, DeepSeek AI has two significant advantages that could revolutionise AI adoption. Firstly, its open-source nature allows any developer to access and customize the software for their specific needs, reducing reliance on the likes of Microsoft. Secondly, it operates on less electricity, using more affordable microchips instead of Nvidia’s expensive, power-hungry Blackwall range. This development shifts the focus from building AI infrastructure toward enhancing the end-user experience. The current emphasis in AI now revolves around what is termed Software 2.0 rather than semiconductors and data centres. Software 2.0 utilises machine learning to create autonomous systems capable of learning and evolving without human oversight. This concept, popularized by Andrej Karpathy, the former AI director at Tesla, contrasts with traditional programming, referred to as Software 1.0, where developers write explicit code within a “binary structure” to accomplish tasks. In contrast, Software 2.0 utilizes “datasets and neural network architectures” as its source code. The details are filled in by the machine learning process, allowing systems to adapt and learn. Crucially, it automates software writing and can generate code without human input, thereby eliminating unnecessary layers as it continuously rewrites and improves itself 24/7, 365 days a year. Consequently, businesses can create more efficient and adaptive systems. If this is the case, AI will evolve from being merely an enhanced spell checker and a better search engine to becoming genuinely transformational for business.
Markets
January has proven to be an immensely complex period for the investment markets. Bond yields initially rose due to fears over tariffs and increased issuance, but subsequently rallied as current inflation numbers remained subdued. Bargain hunters turned their attention to European stocks, particularly as it became evident that the European Central Bank (ECB) will need to cut interest rates. Meanwhile the Fed seems to be “on hold”, it will need to examine what tariffs are actually implemented rather than threatened. Meanwhile, Nvidia, which has dominated the AI-driven stock market and was for a time the largest and most expensive stock in the S&P 500 index, suffered setback following the DeepSeek news. While this may not impact the current order backlog, it raises questions about the future necessity of ongoing heavy capital expenditure on data centres. The AI “arms race” has now shifted toward software, similar to the evolution of the internet. Thus, the AI narrative is not over, rather, it is evolving much more rapidly than anticipated into its next phase. The dominant factor for the markets now is Trump and his regular announcements. Can a full trade war be avoided? If not, what will be the implications for inflation? Will the Fed choose to overlook it? Can Elon Musk identify all the cost savings he has promised? Lots of questions that will add to the volatility this year. What is certain though is that corporate profits globally are going up and ultimately that supports the markets and will drive prices higher
