Yesterday, President Trump announced his long-awaited tariffs on U.S. trading partners that will raise the effective tariff rate to levels not seen since the 1930s. Markets are reacting sharply to the news as the import duties are more onerous than broadly anticipated, and the announcement created more questions than answers as investors gauge the responses from trading partners and consider the longer-term implications. The S&P 500 is tracking towards its worst decline since June of 2020 and the 10-year Treasury yield has fallen to 4.00%. We’re writing to summarize the key details of this announcement and address the understandable concerns you may have about what it means for the economy and your portfolio. Rest assured, while the economic backdrop has become more uncertain, our fundamental approach to your portfolio remains unchanged. We build client portfolios to withstand shocks and achieve long-term goals under a variety of scenarios.

In what the White House calls a “Liberation Day” for U.S. trade, the administration enacted two main types of tariffs: (1) a 10% blanket tariff on all U.S. imports, and (2) “Discounted Reciprocal” Tariffs on about 60 nations deemed “unfair traders.” The latter are set at roughly half of each country’s alleged tariffs and non-tariff barriers on U.S. exports, resulting in higher levies for certain regions including: 34% for China (totaling 54% with the blanket rate), 32% for Taiwan, 46% for Vietnam, 20% for the EU, and 24% for Japan. Canada and Mexico are technically excluded but still face a 25% tariff unless goods meet updated USMCA standards.

In aggregate, these trade duties are estimated to bring the effective U.S. tariff rate to just below 30%, according to Oxford Economics, up from 2.3% last year. In announcing these measures, the administration claimed it is rectifying long-standing imbalances. The new duties are set to phase in quickly (the tailored rates take effect April 9), with no clear end date, underscoring a hardline approach to trade negotiations.

Such a dramatic policy shift understandably raises worries about the economic outlook. Many of you have asked whether these tariffs increase the risk of recession, how they might impact inflation in the near term, and what this means for the investment outlook. We want to address each of these concerns directly:

Recession Risks:

Trade tensions of this magnitude do introduce material headwinds to growth, with economists across Wall Street dialing back growth expectations. Oxford Economics believes the U.S. will avoid recession but has become dangerously vulnerable to slipping into one, depending on the extent of retaliatory responses. Similarly, Bank of America Global Research warned that if the full slate of tariffs remains in place, it could push the U.S. economy to the precipice of an economic downturn. Their economists estimate the tariffs might subtract on the order of 1.0–1.5 percentage points from GDP (while adding a similar amount to inflation), potentially stalling growth. The weight of tariff impacts will be felt very unevenly across the economy with some sectors, especially manufacturing, feeling the pain most acutely, while service sectors fare better. The impact will also vary across consumers with lower income consumers bearing the brunt as a larger portion of their spending goes toward necessities that are often subject to tariffs.

It’s important to remember, however, that these are precautionary forecasts assuming no mitigation of the tariffs. There is still the possibility of negotiations or exemptions that could soften the impact. Additionally, should growth deteriorate sharply, the Fed may respond with interest rate cuts to help cushion the economy.

 Our investment team continues to watch economic data and Fed policy signals to gauge the true recession risk, rather than the headlines alone. To this point, labor market readings have softened but don’t yet point toward imminent recession, which was further indicated by today’s lower than expected initial jobless claims and yesterday’s better than expected ADP payroll gains for March. High yield credit spreads, another important indicator of distress, are on the rise and have hit 6-month highs but remain below levels signaling an imminent default wave. The U.S. economy still has underlying momentum and other policy responses (monetary and fiscal) can help offset some trade-related drags.

Inflation Pressures:

The significant rise in import taxes will trigger a short-term jump in prices over the next few quarters as company’s pass on higher input costs on to consumers. With so much unknown at this point, economists are publishing a wide range of forecasted inflation impacts from a 0.5% increase to core PCE on the low end to 1.7%+ on the high end.

The silver lining is that the Federal Reserve is aware of this dynamic and has indicated it sees tariff-driven inflation as likely transitory. Fed Chair Jerome Powell recently suggested that one-off import taxes won’t necessarily cause sustained inflation over the long run – especially if demand softens in response. This gives the Fed some leeway to eventually resume interest rate cuts if needed, once they judge the inflationary effect to be passing. Due to this flexibility alongside rising recession fears, market expectations for rate cuts are increasing (the market now reflects closer to four 0.25% rate cuts in 2025 compared to 2- 3 cuts a week ago), despite the higher inflation outlook.

Implications for Investment Strategy

As we wrote in the 2025 Long View outlook report at the start of the year, our investment team believes being disciplined on diversification is now more critical than ever with market concentration near historical record levels after several years of dominant performance from U.S. stocks. While these trade tensions will weigh on the global economic picture, there have been offsets to this year’s drawdown in U.S. stocks including resilience in high quality fixed income and international financial markets. In both equity and fixed income markets, we continue to maintain a bias toward high-quality companies with defensive profitability and shy away from areas more vulnerable to economic shocks, like high yield bonds.

The new tariffs have introduced real challenges and we expect continued market volatility in the near term, but we have navigated volatility before and will do so again with discipline. We will continue to analyze incoming data and policy responses (from both the U.S. and its trade partners) and will keep you informed of any meaningful shifts in our outlook. Our team is working hard to anticipate risks and position your portfolio optimally.

Thank you for your trust and the opportunity to guide you through these complex times. If you have any specific questions about your portfolio or the impact of these tariffs, please do not hesitate to reach out to us. Our priority is to help you stay confident, focused, and on track toward your long-term financial goals, despite the headlines.

2025 The Long View | First Merchants Bank