Early Thoughts On Historic Hike In US Tariffs

Key points:

1. The latest US tariffs/trade protectionist policies, announced on April 2, have greatly exceeded market expectations.
2. A 54% effective tariff rate toward China is arguably an act of economic war.
3. Market implications are grim — near-term growth/inflation trade-offs are likely to worsen dramatically, and we’ll likely see an immediate US recession and a significant short-term spike in US inflation

Before I unpack the economic and market implications of the sweeping tariffs the Trump administration introduced on April 2 (which have raised the effective tariff rate to the highest level since the 1930s), I want to acknowledge that this is an early response* to a nascent policy. The situation will very likely.

The tariffs

As part of this new policy, a universal 10% tariff on all countries will take effect on April 5. Additional, “reciprocal” tariffs will be implemented on April 9. These are a purported response to tariffs imposed by other nations toward the US. The presidential administration asserts these tariffs represent half the rate of the tariffs imposed toward the US by other countries and positions this halving as a kindness on the part of the US.

There are a few particularly notable aspects of the new policies I’d like to point out. First, the tariff rate for China appears to be “stacking,” meaning that while the new, “reciprocal” tariff is 34%, the effective rate is 54% given 20% was imposed earlier this year. It also ends duty-free de minimis treatment for covered goods. Next, exemptions to future Section 232 tariffs — applied to gold, autos, and energy/critical materials — were mentioned. Investigations into pharma and semiconductors are expected, as well. Finally, on a relative basis, Canada and Mexico will continue to receive no tariffs on USMCA-compliant goods, a 25% tariff on non-USMCA compliant goods, and a 10% tariff on non-USMCA-compliant energy and potash.

Let’s turn our attention back to timing. In theory, because the “reciprocal” tariffs are meant to be enacted a week after the announcement was made, there is room for negotiation. In my view, the administration is likely calculating that using an aggressive starting point increases the probability that other countries make concessions, which the US could accept before/immediately following implementation. I suspect the administration would view such concessions as both a testament to US strength and a means of retaining some revenue from a fiscal perspective. The latter point is important — a reconciliation process may lead to higher debt levels over the medium term with a current policy baseline and the addition of further tax cuts beyond the extension of the Tax Cuts and Jobs Act (TCJA).

As part of this conversation, it’s worth noting the April 2 judicial election results revealed that voters are souring on the Trump administration. This type of feedback can be a disciplinarian, but President Trump is steadfast in his conviction in the efficacy of tariffs, which he seems to view as a solution to structural issues around labor share of income and income inequality. It remains to be seen whether they will achieve the desired outcome over time.

The economic implications

The magnitude of the tariffs will erode, if not destroy, trust among US allies. A loss of trust may make allies less likely to engage in negotiations than the administration bargains on — a dynamic that is likely to become clearer in the coming days. What’s more, a decline in institutional integrity undermines the status of the US dollar as reserve currency. This risk has now accelerated, and even if the administration walks the tariffs back before implementation, this is unlikely to dissipate. In the short and medium term, these actions:

• Increase the probability of a more sustained rise in inflation volatility
• Bode poorly for short- and medium-term growth prospects
• Heighten the probability of the business/economic cycle engaging with negative signals from policy uncertainty
• Raise the likelihood of economic nationalism and repatriation

This all said, I’ll be surprised if all these tariffs go into effect as announced, which makes analysis of the situation difficult. Uncertainty multiplier effects can be large — especially when bilateral negotiations with 60 countries may be looming large and potential shifts in tariff rates by the day/week are likely.

Source: Wellington Management