Can Investors Keep Counting on the TACO Trade?

Despite renewed tariff pressures from the Trump administration on various trade partners, market impact has remained modest, driven by investor expectations of an eventual policy easing. While direct economic headwinds have yet to fully materialize, companies anticipate price increases in the coming months as existing inventory is absorbed. Analysts identify tariffs as a key risk to corporate profits in the second half of the year, with effective U.S. tariff rates potentially reaching 14-15%, underscoring trade policy uncertainty as a continued market driver.

Analysis

The market is currently exhibiting a notable divergence between escalating trade policy risks and a relatively muted equity response. This dynamic is largely sustained by investor expectations of an eventual policy reversal from the Trump administration, a sentiment captured by Deutsche Bank's "TACO Trade" thesis. Despite this optimism, the underlying economic threat remains significant, with analysts at ClearBridge Investments identifying tariffs as the primary risk to corporate profits in the second half of the year and forecasting a potential effective U.S. tariff rate of 14-15%. The anticipated economic headwinds have not yet manifested in macroeconomic data, an effect attributed to companies absorbing costs by drawing down pre-tariff inventory. However, corporate management commentary indicates this is a temporary buffer, with price increases likely in the coming months. Consequently, upcoming data releases, including the June CPI report and second-quarter earnings, will be critical inflection points, potentially validating or challenging the market's current complacent stance on trade risks.

Key Decisions for Investors

• Investors should closely monitor upcoming economic data, particularly the June CPI and U.S. retail sales figures, for the first concrete evidence of tariff-related price inflation or a slowdown in consumer spending.
• During the upcoming Q2 earnings season, focus on management commentary regarding margin compression, supply chain adjustments, and the ability to pass on higher costs, as this will provide a leading indicator of the impact on corporate profitability.
• Consider the risk that the market's expectation of an eventual trade policy de-escalation may be overly optimistic, and evaluate positions for their vulnerability to a scenario where high tariffs persist and negatively impact corporate profits in the second half of the year.