The Big Idea

The early play-by-play in the tariff game

Steven Abrahams | April 25, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Some of the fog of tariff war has started to clear, marginally improving conditions for taking risk. Markets have set initial boundaries around the US, the US has signaled interest in de-escalating, China has shown a little softening in its hard stand. Other countries have started signaling their positions. But the chances of getting everything wrapped up by July 8 when the 90-day US tariff pause ends and avoiding years of ongoing negotiation looks close to zero. The chances of continuing to de-escalate after July 8 nevertheless look better than the chances of re-escalating. And that allows some cautious optimism on risk.

Return of the market vigilantes

The White House has allowed markets to put implicit limits on the US approach. Markets punished US assets from Liberation Day through April 9, when the US paused tariffs. Levels on that date likely set a floor that the administration will hesitate to breech (Exhibit 1). That eliminates some extreme outcomes, such as escalating with other trading partners as the US did with China. Unlike Churchill, the US seems unwilling to pay any price in this war.

Exhibit 1: The floor on trade policy implied by markets before the tariff pause

Source: Bloomberg, Santander US Capital Markets

The administration continues to test market opinion about de-escalating the fight with China. US Treasury Secretary Scott Bessent described current tariff rates with China as “unsustainable” and suggested the US and China had an opportunity for a “big trade deal.” The Financial Times has reported US plans to exempt car parts from tariffs imposed on imports from China to counter fentanyl production, as well as tariffs imposed on steel and aluminum.

The US has also started to provide more conventional details of bilateral negotiations. The Wall Street Journal recently reported US terms for negotiating with the UK, including a drop in UK auto tariffs from 10% to 2.5%, relaxed rules on agricultural imports, including beef, and changes to country-of-origin rules. These details make the negotiations and their potential impact much more concrete. The US has also described “big progress” with Japan and an imminent agreement of understanding with South Korea, although without any detail.

Markets still show signs of rotation out of US assets, the most obvious being a widening yield gap to other global markets and a falling US dollar. But public description of negotiations and details of proposed term should slowly give markets a picture of the US negotiating goals and strategy.

Markets for risk assets have improved as these and other signals come out of Washington. After dropping 11.5% from April 1 through April 8, the S&P on Friday traded only 2.2% below its April 1 close. The cumulative details of US negotiations should reduce some of the uncertainty around the US approach steadily improve conditions for accurately pricing risk.

China’s strategy

China has shown no indication so far of making the first public move to de-escalate. China has asked the US to cancel “unilateral” tariffs, to show the country “respect”, to appoint a US point person for negotiations, has campaigned to hold onto existing trade relationships with other countries and warned other countries not to align against it in negotiations with the US. It has also canceled a deal with Boeing and started to bring concerns about US sanctions and Taiwan into the discussion. The US claims it is in trade talks with China, but China denies it.

China may be calculating that it can stay in the fight longer than the US. In 2022, China exported $582.8 billion to the US, according to the World Bank, more than 16% of China’s total exports. That was equivalent to 3.3% of its GDP and 2.2% of US GDP. The United States that year exported $153.8 billion to China, only 7.5% of US exports. That was equivalent to 0.6% of US GDP and 0.9% of China’s GDP. China’s exports to the US clearly are the bigger and more important flow for both countries. Cutting off that flow hurts China’s manufacturers and US consumers. The New York Times reports that China is considering tariff exemptions on imports from the US if the import is crucial to the manufacturer’s supply chain. China may be assuming that US consumers and their votes pose more of a challenge to the US administration than its own manufacturers pose to China.

Other countries’ strategies

Japan has reportedly hesitated to align with the US, preferring to stay non-aligned and maintain its strong trade relationships with both the US and China. Japan in 2022 exported $145 billion to China and $140 billion to the US.

South Korea reportedly is working on a deal that would involve tariffs, non-tariff measures, economic security, investment cooperation and monetary policy. Korea in 2022 exported $156 billion to China and $110 billion to the US.

News about negotiations with the European Union have been sparse, although the EU on April 10 paused tariffs on some US goods originally imposed to counter US tariffs on aluminum and steel.

Expectations for July 8

Even though senior counselor to the president for trade and manufacturing Peter Navarro has said “we’ve got 90 deals in 90 days pending here,” that looks impossible if taken literally. A 2016 Peterson Institute study of 20 US trade deals found the average one took 18 months from launch to signing, and 45 months to implementation (Exhibit 2). The shortest deal took four months from launch to signing, and 18 months to implementation.

Exhibit 2: The average US trade deal has taken 18 months to negotiate

Source: Peterson Institute, Santander US Capital Markets

With multiple bilateral trade negotiations happening between now and July 8, a good outcome would probably have the US reporting a few agreements done and the rest still underway. Under those conditions, the US presumably would keep Liberation Day tariffs on pause or withdraw them. That would substantially reduce market uncertainty.

A middling outcome would have no deals concluded, most still underway and some not even started. The risk of re-instating some Liberation Day tariffs would go up.

A bad outcome would have no deals concluded, some underway and some starting to re-escalate. Presumably some Liberation Day tariffs would come back under those conditions with some trade partners countering. Uncertainty could return to April 8 levels.

Playing the pause

At this point, the good, middling and bad outcomes look equally likely. None of them entirely resolve the details of the potential tariffs and all of them involve negotiations that could stretch on for years, leaving a risk premium in the market. The good outcome means at least all parties are engaged. The middling outcome involves some risk of re-escalation, but lower risk than the market saw between April 2 and April 8. And the bad outcome involves active re-escalation, which could involve re-testing the market levels of April 8.

The prudent strategy seems to stay relatively safe and liquid and reallocate to risk to the extent we move toward a good or middling outcome. Since April 8, we have moved away from a bad outcome and risk assets have rallied. If we continue to get more disclosure of negotiations and their details and see other signs of de-escalation, adding risk should get rewarded.

* * *

The view in rates

The market closed on Friday pricing fed funds at 3.44% to end the year, just under 44 bp below the Fed’s March dots. The market has a first 25 bp cut priced for June or July, a second cut by September, another in October and a final cut in December. That will likely require the Fed to look through the inflationary impact of the administration’s remaining tariffs, assuming that they hold, and focus on the risks to growth.

Other key market levels:

Fed RRP balances closed at $94 billion as of Friday, down $4 billion in the last two weeks.
Setting on 3-month term SOFR closed Friday at 428 bp, up 4 bp in the last two weeks
Further out the curve, the 2-year note traded Friday at 3.66%, down 20 bp in the last two weeks. The 10-year note traded at 4.27%, down 21 bp in the last two weeks.
The Treasury yield curve traded Friday with 2s10s at 51 bp, flatter by 1 bp in the last two weeks. The 5s30s traded Friday at 85 bp, steeper by 14 bp over the same period
Breakeven 10-year inflation traded Friday at 227 bp, up 4 bp in the last two weeks. The 10-year real rate finished the week at 200 bp, down 26 bp in the last two weeks.

The view in spreads

Bearish on credit spreads with US trade policy in flux. The Bloomberg US investment grade corporate bond index OAS traded on Friday at 102 bp, tighter by 12 bp in the last two weeks. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 155 bp, tighter by 1 bp in the last two weeks. Par 30-year MBS TOAS closed Friday at 37 bp, tighter by 4 bp in the last two weeks.

The view in credit

Tariffs should weaken most credits assuming slower growth, and hit specific credits hard based on exposure to cross-border trade flows. Excess returns from the first week of tariff war point to the specific sectors more or less exposed to tariff. We have been watching cracks in credit quality at the weaker end of the credit distribution for months. Fundamentals for the average of the distribution continue to look stable. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. Consumer debt service coverage is roughly at 2019 levels. However, serious delinquencies in FHA mortgages and in credit cards held by consumers with the lowest credit scores have been accelerating. Consumers in the lowest tier of income look vulnerable. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks. If the Fed only eases slowly this year, fewer leveraged companies will be able to outrun interest rates, and signs of stress should increase. LMEs are very opaque transactions, so a material increase could make important parts of the leveraged loan market hard to evaluate.

Steven Abrahams
steven.abrahams@santander.us
1 (646) 776-7864

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.