Market whiplash after the 2025 tariff shock: an event-targeted VAR approach

Summary

Focus

On 2 April 2025, the US administration announced sweeping tariff measures that triggered a sharp sell-off in global markets. Yet within weeks, equities, volatility and inflation expectations had largely recovered. We investigate the underlying forces behind that rapid reversal. Our analysis aims to disentangle the contribution of (i) the transitory nature of the initial shock, (ii) subsequent policy reversals and (iii) unrelated macroeconomic news.

Contribution

We develop a flexible, high-frequency framework – event-targeted vector autoregressions (ETVAR) – that identifies the dominant shock based on its ability to explain the joint movement of variables within a narrowly defined time period. The method offers a structured yet agnostic alternative to standard event studies and difference-in-differences approaches.

Findings

We find that more than 60% of the equity market recovery can be traced to tariff-related shocks, including the transitory nature of the initial shock and offsetting policy signals such as the 90-day implementation pause. The remaining recovery is explained by unrelated macroeconomic surprises, such as CPI and labour market news. In contrast, movements in Treasury yields and the US dollar are primarily driven by other shocks, coinciding with a spike in Treasury market stress. These results highlight the limits of attributing all market movements to trade policy and demonstrate the value of a flexible, event-driven empirical strategy.

Abstract

On 2 April 2025, the U.S. President announced one of the largest tariff packages in history, triggering sharp financial market reactions. Yet within six weeks, markets had largely recovered. This paper develops an event-targeted vector autoregression (ETVAR) framework to disentangle three potential explanations for the recovery: the transitory nature of the initial shock, offsetting tariff announcements, and other macroeconomic surprises. Our orthogonalisation method isolates a dominant shock from the "Liberation Day" window and tracks its dynamic impact. Realisations of this orthogonalised shock explain 60–80% of the recovery in equities, copper prices, the VIX, and short-term inflation expectations. In contrast, the dollar's persistent depreciation and movements in government bond yields largely stem from other orthogonal shocks, coinciding with a sudden deterioration in Treasury market liquidity. The findings highlight the limits of attributing all market movements to trade policy and demonstrate the value of a flexible, event-driven orthogonalisation strategy.

JEL classification: C18, C32, F10, F40, G12

Keywords: VAR, event-study, orthogonalisation, tariff announcements