A Resilient U.S. Economy Amid Trade Wars—But Consumers Are the Wildcard

The Real Impact of Trump’s Tariffs and What Record-High S&P 500 Levels Really Mean

Worst Case Scenario Averted For Now...

The S&P 500 index has been repeatedly breaking record highs, even as Trump’s tariff threats continue, geopolitical tensions in the Middle East rise, and consumer spending slows. So, what’s behind the rally?

First, the worst-case scenario feared by investors earlier this year didn’t materialize. Trump’s initial threat to impose tariffs of up to 145% on China and 50% on other key trade partners has been significantly watered down. While tariffs were indeed imposed on China, Canada, and Mexico specifically targeting cars, steel, and aluminum, since February, the inflationary impact has been much more limited than initially feared.

Macroeconomic conditions remain fairly healthy. More importantly, the market has come to believe that Trump will back down if needed. This has been dubbed the “TACO” phenomenon (Trump Always Chickens Out). While in April investors feared he might press ahead at all costs, they now believe he will not push through if it risks major damage.

Falling Business Confidence, but Different Corporate Behavior

While business sentiment has declined amid tariff uncertainty, this hasn’t translated into reduced action. Companies have continued investing in equipment, factories, and technology—albeit at a slower pace than last year, and are still creating jobs.

At the beginning of the year, the University of Michigan’s Consumer Sentiment Index dropped due to Trump’s aggressive and unpredictable policy messaging. Americans feared that steep tariffs and policy volatility could result in severe consequences. But those worst fears have since eased, and the index rebounded 16% in June compared to May (though it still remains 18% lower than last December).

Reduced Policy Uncertainty Boosts Confidence

The reduced unpredictability in the policy environment has also helped calm investor nerves. While major tax and spending legislation from the Republican party remains unclear, these risks are more manageable than the early threats during Trump’s term such as Elon Musk’s “DOGE” initiative to drastically shrink the federal bureaucracy.

Consumers, Emerge as the Biggest Risk

However, the largest threat now appears to be the consumer. This week, the U.S. Department of Commerce sharply revised Q1 real consumption growth (adjusted for inflation) from 1.8% to just 0.5% on an annualized basis. This weakness persisted into Q2, with May consumption falling 0.3% from April after adjusting for inflation, still below December levels.

Discretionary spending on items like air travel and hotels, which are sensitive to the economic outlook has been particularly weak. Research firm FactSet now expects Q2 earnings for S&P 500 consumer discretionary companies (including retailers, restaurant chains, and automakers) to decline 5.1% year-over-year, a sharp downgrade from the 2.2% growth forecast in late March.

Fed’s Dovish Tilt and the Bond Market

Federal Reserve Chair Jerome Powell has acknowledged that there is little evidence tariffs have broadly driven inflation higher. Some Fed officials have even said rate cuts should be considered as early as next month, highlighting internal divisions. This has contributed to falling bond yields, which in turn supported stock prices.

Lingering Risks from Tariffs

Still, the full impact of tariffs may not yet be felt. Trump’s 90-day tariff grace period ends July 9. While some officials suggest this deadline may be extended due to progress in talks with some trade partners, Trump announced on Friday that negotiations with Canada had stalled and new tariffs would soon be imposed.

According to Morningstar’s chief U.S. economist Preston Caldwell, even with some rollbacks, the average U.S. tariff rate now stands at 18.8%, the highest since the 1930s. That’s up from just 2.4% in 2024. He estimates this will push PCE inflation from its current 2.3% to 3.2% by early 2026.

Conclusion: Optimism with Caution

So far, the U.S. economy has absorbed the trade war shocks better than expected. While GDP growth is projected to slow sharply to an average annualized rate of 0.8% in the first half of 2025 (down from 2.5% in 2024, per S&P Global Market Intelligence), this is not expected to trigger a recession.

However, weakening consumer spending remains the key downside risk. Although Trump’s administration has become more predictable, the full effects of tariff policy may still be playing out. Investors are understandably relieved that the worst-case scenario hasn’t come to pass, but the real test lies ahead: how consumers respond to lingering economic uncertainty will ultimately shape the trajectory of the U.S. economy.