On his self-proclaimed “Liberation Day”, President Trump announced a much larger tariff package than was broadly anticipated. The following Q&A provides details of what was announced and discusses a few potential implications.
Q. What has been announced?
- A minimum 10% tariff on imports from all countries
- An array of “reciprocal” higher tariff rates for those countries with which the US has the largest goods trade deficit
- Both of the above exclude Canada and Mexico
- Reciprocal tariff rate highlights include China at 34% (plus the existing 20%, taking the total to 54%), the EU at 20% and the UK at the 10% minimum level
- There are currently exemptions for various materials and sectors which total about a third of imports. Some of these sectors remain under separate sectoral trade investigations
- The reciprocal tariffs only apply to the non-US content of an import provided that at least 20% of the value of the import originates in the US
- The exemption for de minimus value shipments ($800 or less) remains in place until there are systems in place to be able to collect tariffs efficiently for them
Q. Are tariffs a new phenomenon?
Tariffs have been around for centuries and they act as a trade barrier for a country’s domestic industries. By levying a tariff on imports, it makes it easier for a domestic company to compete against importers. There is an economic argument for using tariffs to protect industries at the beginning or end of their lifecycle, but received wisdom is that all other tariffs are an impediment to global growth. The US effective tariff rate had steadily reduced after the second world war until President Trump’s first term in office.
Q. What will the US effective tariff rate be?
For all the talk of fine tuning the reciprocal tariffs, a simple formulaic process seems to have been followed by taking the percentage of the trade difference between the US and each country/region and dividing by two. The sum of these, plus existing tariffs, leads to a blended US import tariff rate in the 23%-26% vicinity (with Canda and Mexico still to be finalised). This tariff rate is even bigger than the Smoot-Hawley tariffs of 1930; the international retaliation at that time was large, which helped to worsen the Great Depression. The final effective rate of the new tariffs will depend on the extent of negotiations and retaliation by other countries over the coming weeks.
To contextualise this another way, the 2025 additional tariff hikes on the $3.3 trillion of goods imports is effectively a tax increase of $650-$700 billion or a little over 2% of US GDP. Two quick reminders here. First, tariffs are paid domestically so are mainly a tax on the US consumer. Second, even though the US is a relatively closed economy when it comes to trade, the US consumer is so important to global GDP that this does have serious implications for global growth.
Q. How will this impact economic growth?
In the US, it has been initially estimated that this tariff package will hit real GDP growth in the 1.0%-1.5% region this year, with inflation rising by the same amount. A similar pattern of growth decreasing and inflation increasing is likely to be seen across the world but with varying magnitudes. Most countries should avoid an outright recession, except for some of the smaller export-orientated Asian countries, but a lot of this will depend on fiscal and monetary policy responses.
The changes to economic forecasts are fluid as uncertainty remains rife. The tariff announcements are just the opening salvo; there will be negotiations, retaliation and counter-retaliation to come. US Treasury Secretary Bessent has stated “…this is the high end of the number barring retaliation”. It will be an interesting next few weeks, and we expect some retaliation will be in the form of on non-tariff barriers targeting US service economy companies.
Q. Will this cause another inflation shock?
The tariffs can be viewed as mainly being a supply shock for goods; with services exempt for now, barring retaliation. At current tariff levels, assuming partial pass through and some substitution effect in goods, US inflation will increase by 1.0%-1.5%. Cyclically, this is likely to be a one-off jump in the level of prices, not an inflation impulse that persists; or in Fed Chair Powell’s lexicon :“transitory”.
The transmission mechanism from a supply shock boost to prices into a broader inflationary wave is via the labour market. If the labour market is strong, such that people can push for higher wages to rebuild spending power following the goods price hikes, then inflation permeates more into the services sectors and creates a feedback loop. The US labour market witnessed exceptionally tight conditions following the Covid disruptions but has slowly softened since. Even excluding Musk’s DOGE based job cuts, the labour market has fragility due to the low level of hiring; a small increase in the layoffs rate would rapidly feed through to higher unemployment. All the policy uncertainty has hit business confidence (and therefore investment and hiring), consumer confidence and spending.
Q. How will the US Federal Reserve react?
The problem is that central bank inflation-fighting credibility is still being rebuilt after the farce of previously referring to inflation as transitory post Covid, when it clearly wasn’t. Therefore, the Federal Reserve will want to be confident that the secondary impact of tariff hikes (via the labour market) on inflation is not happening before it commits to cutting rates. If the Federal Reserve does wait too long to cut rates, then the cumulative cuts will have to be larger once they restart. A similar dilemma faces the Bank of England and European Central Bank.
Q. Will tariffs rebuild an American manufacturing base?
Longer term, the tariffs have the potential to hugely disrupt supply chains, which is the raison d’etre behind them. We are not convinced they will lead to a massive repatriation of manufacturing activity away from cheaper labour economies back on to US soil. At the margin, there might be more production but we don’t believe the US consumer is yet ready to pay the price for clothes and trainers made using the cost of domestic labour. On the flip side, the excess supply from, for example, some Southeast Asian economies could flood other markets causing a deflationary impulse.
Q. Are there other consequences for the US?
There is the loss of reputation as a reliable trading partner and a reduction in influence, sometimes referred to as “soft power.” From an economic perspective, on a much longer-term basis, if the US dramatically shrinks its current account deficit, this has ramifications for capital flows from the rest of the world. These help fund the US fiscal deficit and provide capital for investment. We think Trump does want a weaker US Dollar to help close the current account deficit, but sometimes you need to be careful what you wish for. Also, on a structural basis, tariffs, whilst sometimes having their uses, do mostly lower the comparative advantage gains from trade and thus reduce the growth potential of the global economy.
Q. What do the tariffs mean for investors?
The immediate equity market reaction to the larger than expected tariff package has been very negative. Companies with a supply chain that involves production in high-tariff countries have fared particularly badly. The impact per regional equity market has varied significantly, with the US and Japan bearing the brunt among major developed markets and the UK’s FTSE 100 index holding up reasonably well. Government bond markets have rallied, with concerns about growth dominating the temporarily higher inflation. All this shows the benefits of diversification during periods when shocks to the financial markets occur.
Times of heightened volatility like this tend to create great investment opportunities for the long-term investor. Governments create the rules for the playing field but they do not compete; it is companies that compete. Supply chains will have to be adapted, some companies will thrive while others whither. Most well run companies will adapt to the new rules and continue competing to generate strong returns.
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