Key Takeaways
- President Trump has announced big tariffs on US trading partners. 10% has been levied on China which is well short of the 25% announced for Canada and Mexico.
- A weaker Canadian dollar and Mexican peso will blunt the impact, but they will still likely suffer trade loss. A boost in domestic demand for both countries is likely but the net impact will be negative.
- If the tariffs go ahead both Canada and Mexico could be nudged into recession. US growth will also suffer but its economy should remain in expansion territory.
- Europe is vulnerable to future announcements, but the UK could escape lightly in relative terms.
- There will be some upward inflationary pressure for the US, but we would expect the Federal Reserve to look through the one-off effects.
- Tariffs apply to goods so service industries aren’t exposed to the same extent. We still view the US stock market as attractive.
A possible trade war is upon us, and it threatens to upend the established world order. There will be winners and losers but, like all wars, the net effect is a big loss in economic terms.
We knew President Trump would be radical, we heard him promise to put big tariffs on US trading partners. But the consensus in the markets was that this was largely a negotiating ploy, and that actual tariffs would be much smaller. Most of the pre-election rhetoric was directed at China but they get 10% extra tariffs which is well short of the 25% tariffs on Canada and Mexico. This all adds up to a big shock. The average US tariff currently stands at a tiny 2.3%. That would rise fourfold under President Trump’s plan.
Of course, it’s possible that these tariffs are negotiated away in the next few days – we’ll discuss that later – but let’s start with the assumption that they go ahead.
Canada and Mexico are likely to go into recession and Europe will follow suit assuming he imposes tariffs there too. The UK will also suffer but in relative terms could escape lightly. US growth will also suffer but modestly so and will remain well clear of recession.
Canada and Mexico do not have to raise their export prices by 25%. The Canadian dollar has fallen 8% versus the US dollar in the second half of 2024. The Mexican peso is down 17% on the same basis. This will blunt the impact on their exports though they will still suffer in terms of trade loss. Anti US sentiment plus retaliatory tariffs will boost domestic demand at the expense of US exports but the net effect is still distinctly negative.
US inflation will go up but only a little, perhaps half a per cent or so. The market assumes that this will keep the Federal Reserve on hold and some analysts are even suggesting a rate hike is in the offing. We are less concerned on this front. The Fed can easily look through one-off effects like this. And central banks in the ‘victim countries’ are more likely to ease rates. That would benefit the US dollar but again, we wouldn’t overestimate the impact.
Beyond these immediate effects, Trump’s policies threaten to seriously damage strategic and economic relationships, giving a firm kick to a trend that was already underway. Offshoring and sophisticated supply chains had taken several hits in the last decade or so and world trade has stagnated. Trump threatens to accelerate this process with a negative economic impact everywhere.
Even if the threatened tariffs are negotiated down or away in the next few days, there is nothing to stop President Trump doing it again.
Before I get too carried away, it’s worth noting that all this applies to goods. Services are the bulk of employment and GDP in developed economies, and they are not exposed to tariffs. The US stock market, with its focus on tech and services still looks attractive on a relative basis. That was our view before the tariff turmoil and it’s still our view now.
