Bracing for the Air Pocket

With markets digesting a surge in tariffs and shifting fiscal rhetoric, we sat down with Olga Bitel, partner and strategist on our global equity team, to revisit her views on the global economy. In this wide-ranging conversation, Olga offers a candid assessment of growth prospects in the United States, Europe, and emerging markets (EMs)—and explains why the global economy may be headed for an “air pocket”—a period when the drag from tariffs sets in before any potential policy offsets, such as tax cuts or deregulation, have time to take effect. The coming months, she argues, will test the resilience of the post-pandemic expansion.

Last fall, you discussed how the United States and much of the world had achieved a soft economic landing in the first half of 2022, and since then the U.S. economy has been in expansion. Has that expansion been upended by trade tensions?

Olga: The current administration’s economic policies—particularly on trade—appear to be worsening the growth/inflation trade-off. In other words, U.S. gross domestic product (GDP) growth is likely to slow materially by the end of this year, even as inflation becomes more volatile and potentially moves higher. As a result, the trade-off between growth and inflation has deteriorated.

What do you expect in the second quarter?

Olga: To answer that, it’s helpful to first look at what actually happened in the first quarter. Private domestic demand held up reasonably well. Consumption contributed 1.2% to GDP growth, and investment added another 1.3%, bringing total private domestic demand growth to 2.5%. That represents only a modest deceleration from the pace of the prior three quarters (but seasonal adjustments in the United States have been problematic for years, so first-quarter data tends to look weak on a seasonally adjusted basis). What made the first quarter different this time was the drag from inventories, which essentially offset the entirety of private domestic demand growth. The key question is, what caused the run-up in inventories? Many have claimed that businesses were front-loading goods ahead of expected tariffs, but there is little evidence of broad-based stockpiling. Specifically, two factors drove the inventory buildup. First, there was a significant surge in gold imports. Whether this was government-directed, or linked to financial hedging, it wasn’t related to productive economic activity. Second, manufacturers appear to be anticipating Section 232 reviews—which are likely to affect semiconductors, autos, drugs, and potentially steel—and responded by building inventory. Roughly 40% of the inventory buildup came from pharmaceutical stockpiling. Additionally, there was a small, volatile uptick in auto registrations and some computer-related equipment purchases (mostly tied to data center buildouts). The bottom line: domestic demand in the first quarter was healthy, and any headline weakness came from nonproductive inventory distortions.

I expect to start seeing the impact of tariffs between late May and early July.

I expect to start seeing the impact of tariffs between late May and early July, given shipping timelines of 45 to 60 days from port to consumer, and the fact that some ships bound for the U.S. were delayed or stalled in early April. This will likely create price volatility, even if no new tariffs are implemented. There’s also uncertainty about the de minimis exception, which could further disrupt small package flows and raise prices. So, we’re entering a period where GDP growth may slow, and inflation volatility may rise. I expect to see the first signs of the deterioration in the growth/inflation trade-off this quarter.

Markets have stabilized after that initial surge in early April. How would you describe this moment? Is it an air pocket?

Olga: We’re not in the air pocket yet—but we’re heading toward it. The “air pocket” refers to the gap between the negative economic impact of tariffs and any potential boost from tax cuts or deregulation, assuming those materialize. Tariff disruptions are already happening. Even though we don’t know where policy will ultimately land, the uncertainty alone is affecting supply chains and pricing. Meanwhile, any fiscal offsets—such as tax cuts—likely won’t be enacted until late summer or early fall. By that point, most of the year will already be behind us. As for deregulation, the timeline is even more uncertain, and any effects would take time to filter through. So, this moment is more like the lead-up to the air pocket: disruptions have begun, but policy support hasn’t arrived yet.

How does the recent interim deal with China change your thinking—and what do you take from China’s strong first-quarter growth?

Olga: The United States effectively blinked. It conceded to nearly all of China’s preconditions just to begin discussions—and those discussions will take place on China’s terms. So the headline might say “interim deal,” but what it really signals is a broader shift: the United States is backing away from its more aggressive posture, likely because it recognizes it won’t win meaningful concessions. Markets rallied because of the direction of travel. The perception now is that the administration will walk back tariff threats if it believes there’s no payoff. That shift in tone is what buoyed markets.

Is the latest U.S. trade deal with the United Kingdom a sign of things to come regarding bilateral agreements?

Olga: Not really. Calling what was agreed upon between the United States and the United Kingdom a “trade agreement” is a stretch. It’s not a comprehensive, legally binding document with clear rules and enforcement mechanisms; it’s a series of carveouts from the existing framework. Even these carveouts will take at least a year to finalize, leaving businesses in limbo in the meantime. And if this is what it takes to revise a preexisting structure with a close ally, imagine the difficulty of negotiating simultaneous bilateral deals with dozens of countries.

If you’re looking for a sign of where global trade might be headed, the U.K.-India deal is the better indicator.

Contrast that with what else happened the same week: the United Kingdom signed a full-scale trade agreement with India. That deal took three years to negotiate and includes goods and services. While current U.K.-India trade flows are modest, the real significance is that India—one of the world’s most protected economies—is dismantling its trade barriers. India is also accelerating trade talks with the European Union (EU), suggesting a broader shift. If this trajectory continues, India could become far more open to global trade by the end of the decade. So, if you’re looking for a sign of where global trade might be headed, the U.K.-India deal—not the U.S.-U.K. one—is the better indicator.

Bullish predictions about the economy under Trump were often based on hopes for deregulation and tax policy. Given what you’ve seen so far, are those predictions bearing out?

Olga: It’s hard to say, because nothing has actually been enacted yet. The most commonly discussed tax proposal is 100% expensing for equipment, factory structures, and installations—a supposed boost for capital investment. There are also more populist elements being considered, such as eliminating taxes on tips and overtime pay. But those would likely be temporary. We might also see softer deductions—perhaps something like a tax break on auto loans for U.S.-made cars. Until something is signed into law, though, it’s all speculative.

Do you think that combination will lead to economic growth?

Olga: No. If the goal is to drive long-term economic growth, this approach falls short. It may boost personal disposable income in the short term and provide a temporary lift to consumption, essentially acting as a mild offset to the loss of purchasing power from tariffs. But these effects are fleeting. At the same time, the package would significantly increase fiscal deficits without meaningfully improving productivity or investment incentives. So, while there may be a short-term bump in demand, it doesn’t lay the groundwork for durable, supply-side growth.

What does the outlook look like for EMs? For example, from a tariff perspective, are EMs somewhat shielded?

Olga: Not really. A 10% base tariff, applied across the board; it is the floor, not the exception. There’s no special carveout for emerging markets. Countries such as Costa Rica or Madagascar, which don’t have leverage and aren’t major trade partners in politically sensitive sectors, are simply exposed. There’s no protection if you’re not producing what the United States wants—or can’t retaliate. If there’s any relative “shield,” it would come from potential downward pressure on the U.S. dollar, which could ease external debt burdens or make EM exports more competitive. Broadly speaking, the response to tariffs is about who can generate enough domestic demand to cushion the blow. Stronger consumption growth in China or increased investment in the EU are the more relevant macro offsets.

You recently noted transformative changes in Europe and how growth there is accelerating, making it an attractive investment destination in the near term. What is the biggest reason for caution when it comes to Europe?

Olga: The biggest reason for caution is governance. You’re dealing with more than 20 countries that have to agree, democratically, on spending priorities. That’s not exactly a formula for speed or efficiency. That said, the recent shift in Germany is telling. A country long resistant to fiscal spending suddenly committing €500 billion—and likely more—shows a sense of urgency that shouldn’t be ignored. Still, structurally, Europe (and to a lesser extent Japan) tends to move slowly. Decisions take time. So while the direction of change is encouraging, the pace and coordination risks remain significant.

Olga Bitel, partner, is a global strategist on William Blair’s global equity team.