ORLANDO, Florida, April 2 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

New reality about to dawn

U.S. markets on Wednesday were determined to put on a brave face

ahead of U.S. President Donald Trump's announcement of sweeping

tariffs that will escalate a global trade war and threaten to

upend the entire international trading system.

Stocks rose sharply and Treasuries and the dollar ended

notably weaker. Buoyed by hope or expectation that the tariffs

wouldn't be as draconian as feared, U.S. indices closed in the

green. The deeper analysis of the tariff fallout - lower growth

and higher inflation - will be for tomorrow and beyond.

Fed policymakers and other central bankers are in a bind -

do they respond to the weaker growth impulse, or higher

inflation? More on that below, but first, a round up of today's

main market moves.

I'd love to hear from you, so please reach out to me with

comments at . You can also follow me at @ReutersJamie and

@reutersjamie.bsky.social.

Today's Key Market Moves

* The S&P 500 rises 0.7% and the Nasdaq climbs 0.9%.

* Tesla shares leap 5.3% after Politico reports that Trump

has

told members of his Cabinet that Tesla CEO Elon Musk will soon

step back from his government role. Shares had been down as much

as 6.4% after quarterly sales plunged 13% to the weakest in

nearly three years.

* U.S. stock futures sink as much as 2.5%, pointing to a

bleak

open on Thursday.

* Global stocks are mixed. China's benchmark indexes are

essentially flat, Chinese tech rises 0.35%, and Japan is up

0.2%, while European benchmark indexes fall as much as 0.5%.

* Japanese equity futures point to a fall of 2% at the open

on

Thursday.

* The euro hits a two-week high of $1.0870, rising 0.5% for

its

best day in three weeks. Technicals remain bullish - that's

almost a month above the 200-day moving average.

* It's an exact mirror image for the dollar index - at a

two-week

low, biggest fall in three weeks, and now almost a month below

its 200-day moving average.

T-Day arrives, markets rise

So, 'Tariff Man' has shown his hand, and now markets

nervously await the response from the rest of the world. Most

countries will probably play their cards cautiously and

carefully, which is what Britain's finance minister Rachel

Reeves and Mexican President Claudia Sheinbaum on Wednesday

indicated they will do.

Trump's tariff salvo adds to the long list of protectionist

shots fired since his inauguration in January. The extent of the

pain and damage remains to be seen, and earlier on Wednesday

European Central Bank President Christine Lagarde said it will

be "negative the world over" while Bank of Japan Governor Kazuo

Ueda said the hit to global trade could be huge.

Few would argue, although the latest global readout points

to a mixed picture in the first quarter as economies grappled

with historically high levels of uncertainty and braced for

impact - factory activity in India expanded at the fastest pace

in eight months, while industrial production in Brazil

unexpectedly fell; Mexico's government on Tuesday lowered its

2025 GDP growth forecast, but to a still rosy 1.5%-2.3%.

The most recent U.S. economic indicators suggest activity

and the labor market have held up pretty well ahead of "T-Day" -

durable goods orders rose solidly in February and ADP private

sector payrolls growth in March beat expectations.

Although the economist consensus is still for GDP expansion

in the first quarter and beyond, forecasts are being cut across

the board - JP Morgan's Michael Feroli, for example, slashed his

Q1 forecast to 0.0% from 1.0% and his 2025 call to 1.3% from

1.6%.

Still, these and most forecasts are significantly brighter

than the Atlanta Fed GDPNow model's gloomy estimate of 1.4% GDP

contraction in the first quarter when adjusted for outsized gold

imports.

Thursday is the first day in the new world of Trump's

tariffs, and there's huge uncertainty and risk for investors to

navigate. Let's see if their optimism from the previous day

spills over.

Optimal Fed response to tariffs? Ease policy

Focus on the "stag". Ride out the "flation". That may be the

Federal Reserve's optimal plan for handling the new wave of

tariffs coming from the Trump administration.

With details of U.S. President Donald Trump's sweeping

tariffs now emerging, all eyes will soon turn to the Fed's and

other central banks' response to the president's "liberation

day" duties that could leave them in quite a bind.

It's generally agreed that tariffs are damaging to growth

and inflationary, initially at least. So how should central

bankers react? Do they cut interest rates to prop up a

stagnating economy or raise them to cool fiery price pressures?

According to a Minneapolis Fed working paper published last

month, the answer is clearly the former. The authors find that

the "optimal" policy response to tariffs is not just to look

through the inflationary impact and keep rates steady, but to go

even further and ease policy.

"The optimal monetary response is to stimulate the economy,

raising aggregate income and boosting demand for imported

goods," wrote Minneapolis Fed economist Javier Bianchi and

University of Wisconsin-Madison assistant professor Louphou

Coulibaly.

The optimal response, they argue, "is expansionary, letting

inflation rise above and beyond the direct effects of tariffs.

This result holds regardless of whether tariffs apply to

consumption goods or intermediate inputs, whether the shock is

temporary or permanent."

ADVERSE EFFECTS

This all runs counter to the commonly held belief that

pouring fuel on an inflationary fire is essentially the most

dangerous thing a central banker can do, as it risks

"unanchoring" inflation expectations.

But the authors argue that history simply doesn't show this

to be the case. Instead, the data suggests that to mitigate the

slump in imports as tariffs bite, the central bank must

stimulate economic activity, lift employment and boost income.

Policymakers must be prepared to "tolerate some overheating,"

the authors contend.

This conclusion reflects another important lesson from

economic history: tariffs are pretty bad for growth.

A 2020 study using aggregated data for 151 countries from

1963 through 2014 found that tariffs have "economically- and

statistically-significant adverse effects" on growth.

The impact is "persistent" and increases over time, the

researchers found. Their baseline model suggests that a 3.6

percentage points increase in tariffs results in a 0.4% decline

in economic output five years later.

They actually found that the projected longer-term effect of

tariffs on GDP was higher than the estimated medium-term

impacts, but they limited their study to a five-year time

horizon "in an effort to be conservative."

PROCEED WITH CAUTION

Right now, Fed officials are also erring on the side of

caution. In their revised economic projections released last

month, they maintained their forecast for two quarter-point rate

cuts this year, although a hawkish underlying shift in the "dot

plot" of officials' individual projections moved the median

closer to one cut.

And Fed Chair Jerome Powell has been at pains to be neutral

and non-committal on the question of tariffs, insisting that,

before acting, he and his colleagues must wait and see what the

actual impact is on activity, prices and employment.

Fed Governor Chris Waller, however, was a bit bolder in a

speech to the OECD in Paris in January, stating: "If, as I

expect, tariffs do not have a significant or persistent effect

on inflation, they are unlikely to affect my view of appropriate

monetary policy."

The market is certainly focusing on the "stag" more than the

"flation". U.S. businesses are reporting the highest factory

gate prices in years and consumer inflation expectations are the

highest in decades, according to some measures, yet bond yields

are falling and interest rate futures are pricing in multiple

cuts this year and into 2026.

Investors appear to be betting that, if the tariff push

comes to the recession shove, the Fed will focus on stimulating

growth. History suggests they're right.

What could move markets tomorrow?

* Japan services PMI (March)

* China 'Caixin' services PMI (March)

* UK services PMI (March)

* ECB board member Isabel Schnabel speaks

* U.S. weekly jobless claims

* U.S. services ISM (March)

If you have more time to read today, here are a few articles

I recommend to help you make sense of what happened in markets

today.

1. Tariff shock less worrying than slow burn: Mike

Dolan

2. Trump uses power against foes unlike any other

modern US

president

3. Tesla quarterly sales plunge as Musk backlash

grows

4. Trump fireworks risk sparking equity contagion:

Pelosky

5. The Aussie is losing its way as markets' risk

compass

Opinions expressed are those of the author. They do not

reflect the views of Reuters News, which, under the Trust

Principles, is committed to integrity, independence, and freedom

from bias.

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