Guest Post: Michael Drury on Markets and Economics

Trump is negotiating his tariff objectives with the markets, Drury concludes, offering an excellent assessment of the current economic outlook.

Michael Drury is the Chief Economist at McVean Trading (https://www.mcvean.com) and a friend and colleague of many years. We serve on the GIC College of Central Bankers Advisory Board together and have been organizational colleagues at several national and international forums. He is a regular guest at our Maine gathering and contributor to the panel discussions and dialogue. I have admired Michael’s work since we first met at a conference in Singapore many years ago. Mike published this narrative on July 13th in his Weekly Economic Outlook missive published each Sunday. It is an extraordinary and succinct summary of the current outlook for economics and markets. He covers issues including an analysis of the tariffs as we know them. I asked Mike for permission to share this with my readers, and I thank him for saying “yes.”

Here are Michael Drury’s July 13th comments:

President Trump, fresh off the success of the Iran bombing and the passage of the One Big Beautiful Bill, is again testing the limits to executive power with a new round of tariff threats. So far, the financial markets have shown little reaction in equities, fixed income or currencies, as they continue to view these moves as negotiating ploys to drive quicker settlement of better trade deals for the US. We believe the President will continue to escalate his demands – not only for tariffs, but on immigration, deregulation, US security measures, and a wide range of his America First policies – until they are challenged by market concern. In our view, the true negotiations are not between Trump and foreign powers or domestic politicians, but rather with investors (billionaires), whose approval is measured every day in the markets.

True, Trump has stated that he does not care what markets think, but his reactions to declining equities, rising interest rates, and even a weaker dollar (given he has advocated for that to improve US manufacturing) have created the Trump Always Chickens Out strategy – which help lead to the rebound to new highs in the S&P 500. That TACO trade, and its insulting name, have emboldened the President to increase his demands – knowing that his shock and awe strategy in Iran and on the budget have generated significant victories, including the market rebound.

Bottom line, as long as the markets continue to give him leeway to advocate for more aggressive positions, the President is likely to take up the challenge. We have noted many times that his earliest successes in 2018 – with the 21% corporate tax rate and China’s acceptance of the Phase One agreements – show that his extreme demands are often not negotiating points, but rather final destinations. This is not an analysis of whether his policies are good for the economy or the US more broadly, but rather an observation that he will push his agenda further than markets expect by taking advantage of their expectation that he will moderate his demands, despite a lot of history that shows he will not. Every success then leads to an even more aggressive positioning in another round of negotiations, as apparently no deal is ever final.

The wave of 21 new tariff letters released Monday and Tuesday was targeted at ASEAN and Asian trade partners, who were meeting last week with Secretary of State Marco Rubio in attendance. Of the ten ASEAN members, all but Singapore received a letter, as did Japan and South Korea – who were in attendance as observers. The letters effectively reiterated that April 2nd levels for tariffs, with all higher than the 20% touted by Trump in Truth Social for Vietnam – although that agreement has not yet been signed. Many nations were given rates higher than the 30% for China – with even allies like Japan and South Korea (which has a trade agreement with the US) getting 25% tariff rates.

Once again, this clouds the ultimate goal of higher tariffs. Is it simply to raise more revenues to offset the continuation of the Trump tax cuts? Or are they to ring-fence China and reduce its manufacturing clout? Or to force manufacturers back to the US with ever higher barriers to foreign production? Or to improve the US defensive position in an increasingly isolationist world? Our view is that Trump’s goal is all of the above – and that markets hope he will only institute the parts that benefit them most. That friction is likely to keep the US economy on the edge of stagflation, with growth underperforming, but not awful, and inflation higher than target, but not crippling.

The risk to US growth is that the higher tariffs will offset the fiscal stimulus that comes in FY 2026 from the One Big Beautiful Bill. Moreover, higher tariffs may cause enough inflation that the Federal Reserve remains on hold as they, like the markets, try and decipher whether this is a one-time adjustment, or if the effects may be longer lasting – as this may not be the final round of tariffs. The OBBB was projected to lift the FY2026 deficit to 7.5% of GDP from 6.9% this fiscal year. That roughly $200 billion in fresh fiscal stimulus would be snuffed out by a universal 20% tariff, instead of the widely analyzed 10% baseline. More likely, that 20% level for tariffs may not come from a universal level but rather from the hodge-podge of different tariffs directed at particular countries and products. The 10% tariff was expected to lift inflation by 0.6%, so at 20% we would double that – but we are far from sure that 20% is the ultimate goal.

In the letters that went out this week, only the Philippines received a 20% tariff, with others as high as 40%. Threats later in the week were for 50% on copper, 50% on Brazil, 35% for Canadian goods not covered by USMCA (already at 25%), and 30% for the EU and Mexico. How real these figures will be is unclear. Trump raised tariffs on China to over 150% in response to their initial intransigence. In Truth Social, he indicated that an 80% rate looked right ahead of the Geneva negotiations – but left it up to Bessent, Lutnick, and Greer, who set the rate at 30%. This week, Rubio indicated that he felt ASEAN nations would ultimately get better rates than many others. However, articles suggest that Vietnam thought it was getting 11%, until Trump unilaterally set the rate (again on Truth Social) at 20%.

More important is the question of whether any rate is ever permanent. Canada and Mexico were faced with 25% rates excluding USMCA – but now those appear to be creeping higher as pressure mounts to open negotiations on the larger agreement next year. As noted, South Korea has a trade agreement with the US for very low tariffs – unlike Japan, which has relatively high barriers both tariff and non-tariff on American goods. They were effectively lumped together – with the ASEAN and Bangladesh – in a sweep of higher tariffs across Asia. Tariffs on steel and aluminum have already been raised from 25% to 50% – and the threat is even higher.

For businesses trying to decide how to leave China, the only solution appears to be to return to the US – or stay and pay the 30% tariff. Why move to another Asian venue – or even Mexico – if the tariff will be roughly in the same ballpark as the Chinese 30%? A 10% tariff on Chinese goods after 2018 moved very little production to other countries, with the exception of Vietnam – where it is unclear how much is just trans-shipping and how much is true value added. The swelling Vietnamese trade surplus with the US has not grown as fast as their trade deficit with China. That may be pure trans-shipping but also reflects the fact that initial investments from capital relocation are larger than the subsequent flows from those investments. Regardless, if Vietnam holds at 20%, it will become the new base for many who want out of China. However, with only a 10% advantage, they may not attract a much wider flow – especially given that the river is already pretty high as a $19 trillion economy with an 18% of GDP trade sector tries to pour into a less than $500 billion economy. Note the flow through Vietnam from China to the US exceeds $100 billion already.

Last week, we were in Jackson Hole at the Global Interdependence Center’s Teton Economic Outlook. Our main take away – other than the confusion and frustration about tariffs – was that there is a lot of liquidity floating around. The most obvious sign is the rush of Bitcoin to $118,000 – but analysts from the equity and fixed income markets both indicated that funds are currently plentiful as many are still moving back off the sidelines from earlier cautious positions. Few felt that we were in the endgame, although many felt the market may be moving into an oversold position.

We have argued that the stimulus left over from the Biden Administration plus the expectation of fresh money from the OBBB has helped keep US nominal growth stronger than most had expected. The stall in the real economy early in 2025 freed liquidity to flow back into financial markets as hope sprung eternal that the Fed would lower rates. Even without that help, markets are back to new highs (in dollars). Bottom line, we read the current market as similar to early 2022, when a stall in the economy plus a lot of stimulus led to higher prices – first in asset values, and with a long and variable lag to prices of goods and services. We initially expected Covid-related inflation would be high – maybe 4%!!! Well, we went a lot higher than that with a very limited effect to the real economy. Thus, our present call for a return to 4% inflation may be low – and may not matter much. The second bite of the apple is never as sweet or sour as the first.

Thank you again, Michael. See you in Maine.