Why US tariffs are the talk of the town

Chinese exports into the US have reached record highs and exports to the US have reached their highest level in two years as businesses look to front-load inventory prior to the expected tariffs early in 2025.

But, are businesses right to be concerned? And, what could these potential tariffs mean for global trade and markets?

What tariffs are expected to be announced?

There are two types of tariffs that could be implemented under the Trump Presidency, which are:

Targeted Tariffs – this type of tariff often used as a tool for negotiating policy concessions from other countries. By imposing tariffs on specific goods, the US aims to pressure trading partners into making favourable policy changes. This tactic can lead to short-term disruptions in trade but may result in long-term benefits if successful in achieving policy goals.

General tariffs – as the name suggests, they are broader in scope and aim to rebalance trade relationships. These tariffs can redistribute economic activity by making imported goods more expensive, thereby encouraging domestic production. However, the effectiveness of general tariffs in addressing trade imbalances and their impact on the economy remains a topic of debate.

Trump has said that, once he takes office in January, he will introduce tariffs, both targeted and general, ranging from 10% to 60%. As the President, he has broad authority to implement these tariffs without congressional approval.

Could US tariffs be inflationary?

Tariffs are effectively a sales tax on imports. When foreign goods arrive at US customs a tariff charge is applied, usually as a percentage of the value. All else being equal, tariffs raise the cost of imported goods relative to those produced domestically.

This cost can be “paid for” in a few ways: The importer could accept lower margins and pay for the cost itself. The importer could also pass this cost onto consumers and defend their margin. Or, the exporter (original producer) could lower their selling price to such a level as to offset the increase in the cost of goods from tariffs from the importer’s perspective.

While all three effects always play a part, empirical evidence shows that most of the tariff cost is passed on to consumers which increases the price level and, by extension, inflation.

Core goods have been a major detractor for over a year now, but this has turned recently. When we consider tariffs, it is likely goods inflation will reaccelerate over the next two years, pending on the size and scale of the tariffs.

Tariffs are coming off a low base of around 2-3% so a modest broad-brush increase may not have significant impact on inflation. However, the risk of retaliation from other countries remains a concern. Retaliatory tariffs can escalate and lead to a cycle of increasing tariffs, which can have a bigger impact on inflation and disrupt global trade.

Will tariffs boost growth?

Many questions remain about President Trump’s tariff policy in terms of size, countries and industries affected, and timeline of implementation. For this reason, we are holding off from making any knee-jerk reactions until the announcements are made in the new year.

We are probably going to end up with some adverse impact on prices and overall world trade, but not on a scale to derail US growth or to threaten materially higher inflation. There will be some offsetting policies, such as the increase in oil production which should lower energy prices. Furthermore, President Trump campaigned strongly against inflation, so he and his advisers will be aware of the dangers of excessive tariff-induced price rises.

In the short term, the anticipation of tariffs can lead to a buildup of inventories as businesses front-run the tariffs to avoid higher costs later. This inventory buildup can temporarily boost economic growth. However, once the tariffs are in place, the subsequent reduction in inventory purchases can act as a drag on growth.

What tariffs are unlikely to do , at least in the short term, is narrow the US trade deficit and boost American manufacturing. The overall Trump policy mix implies a stronger US dollar which will erode international competitiveness of American manufactures. Furthermore, increasing industrial capacity takes time as factories need to be built, machines bought and assembled, workers trained and hired, and production scaled up to an economically efficient level.

What tariffs could mean for markets?

The overall impact of tariffs on markets is uncertain. There are two key factors for equities. Firstly, what will be the tariffs levied against countries which supply intermediate goods for US industries. Excessive tariffs for these products may significantly raise their cost to American final goods producers or even halt their operations if there are no economical alternatives available. Secondly, what will be the retaliatory measures from trading partners that may cutoff market access to American companies.

Overall, we believe that there will be more important factors driving the equity markets over the coming year than tariffs, but the unpredictability of announcements (and eventual follow through) of measures at President Trump’s whim, will likely increase levels of volatility going forwards.

More concerning is what the expected mix of trade and fiscal policy means for fixed income markets. President Trump intends to extend TCJA package of tax cuts due to expire in 2025 with possible further cuts. This will not only increase the increasingly problematic federal deficits, but also provide a demand boost to economy.

Trumps’ hope is that tariffs will provide an alternative source of income to the government and pay for the tax cuts, despite empirical evidence mostly going against this notion. Furthermore, tariffs will be a negative supply shock to the economy, as discussed above.

Since the policy mix is conductive to the economy running hotter than expected and with the longer-term fiscal position deteriorating, this will likely lead to the repricing of the US sovereign curve towards higher yields, with knock on effects in other sovereign markets and credit.