The recent market turmoil has felt a lot like an amusement park ride – chaotic and out of control, but ultimately, it’s over, and things return to normal. This unpredictable period is a reminder of how fragile sentiment can be when external shocks hit. President Trump’s announcement of new tariff rates in early April set off a cascade of reactions in the market, and now, with more clarity on the tariff details, we must reassess the potential risks, including the growing chance of a recession.

Markets React to Tariff News

The capital markets’ response to the announced tariff increases was swift and dramatic. On April 2, the first round of tariffs was revealed, and the stock markets reacted immediately, with the S&P 500 experiencing wild price swings. Over the course of just a few days, the index’s daily high/low range averaged a staggering 7.7%. This volatility was a signal of growing concern, as investors tried to gauge the potential impact on global growth and inflation.

The uncertainty wasn’t confined to the stock market. The bond and currency markets also felt the effects of the tariff news. The U.S. 10-year Treasury yield initially dropped from 4.18% to 4.01%, then spiked to 4.48% just a few days later, reflecting the rapid shift in investor sentiment. Similarly, the U.S. Dollar index dropped by over 12% before rebounding by 9.5% once the administration announced a 90-day delay in the tariffs. Gold, traditionally seen as a safe haven during times of uncertainty, surged by 9% during the same period.

While markets were clearly rattled, the administration responded by temporarily putting the new tariff plans on hold, which helped to stabilize market reactions. This back-and-forth suggests that even the most aggressive policies can be adjusted when markets start to show signs of distress.

Rising Inflation and Economic Risks

As a result of these developments, I have revised my inflation forecast for 2025 from 2.5% to 3.0%. The additional tariffs are likely to exert upward pressure on inflation, particularly on imported goods. Beyond the immediate financial market reactions, these tariff increases raise questions about the broader economic impact, including potential disruptions in global trade and financial stability.

Another critical factor is the government’s significant debt obligations. The U.S. is set to refinance $9.2 trillion in Treasury debt in 2025, with a large portion due by the middle of the year. Every small increase in interest rates adds substantial costs to this debt, which could exacerbate the pressure on government finances.

The Growing Risk of Recession

As we assess the economic landscape, I’ve raised the probability of a recession this year from 25% to 40%. This shift is largely driven by changes in sentiment. Both consumer and business confidence have taken a hit in response to the tariff uncertainty, leading to a slowdown in willingness to spend and invest. While there is no immediate sign of a recession based on hard economic data, the growing uncertainty in sentiment points to a higher likelihood of slower growth in the months ahead.

Recent surveys show that consumer confidence has weakened, with inflation expectations climbing. Small business owners, who account for a significant portion of employment in the U.S., are also more cautious. The National Federation of Independent Business reported record-high uncertainty among small business owners, reflecting the strain of unpredictable policy changes.

Balancing the Data

Despite the growing risks, the data doesn’t yet point to an imminent recession. Job growth remains strong, and unemployment claims have not spiked. The March employment report showed a healthy gain of 228,000 jobs, well above the 12-month average. Additionally, weekly unemployment claims have remained steady, signaling that the labor market is still relatively stable.

However, historical trends suggest that job creation often peaks several months before a recession begins. If a downturn were to occur this year, it would likely be deeper into the second half. This provides some breathing room for policymakers to respond.

The Road Ahead

Looking forward, it’s clear that the economic outlook is uncertain. My core economic theme, which I’ve termed “Three Yards and a Cloud of Dust,” still holds, with a 60% probability of this scenario. We maintain a forecast of GDP growth between 1.5% and 2.0%, and our inflation forecast is 3.0% or higher.

The critical question is how policymakers will respond. If the tariff-driven slowdown intensifies, will the Federal Reserve step in to provide more liquidity? And will Congress enact a tax reduction package to offset the economic impact of the tariffs? These are questions that will shape the outlook in the coming months, but for now, it’s clear that the ride isn’t over yet.