Finally we have arrived at Liberation Day when we will find out in full what US President Donald Trump plans on the tariff front. The Financial Times is presenting it in relatively apocalyptic terms.
Investors are on edge ahead of Donald Trump’s plan to hit imports to the US with new tariffs “immediately” on Wednesday, sharply escalating a trade war that has already rattled markets and trading partners.
Investors are always considering a range of things and of course are never one group as in fact markets require opposites as some buy and others sell.
“The investor community is universally anxious,” said Robert Tipp, head of global bonds at asset manager PGIM, pointing to “people reducing risk and backing away from credit, backing away from the dollar, backing away from stocks” in recent weeks.
I am not so sure about backing away from credit because the US bond market has rallied with the ten-year at 4.17% this morning. Whilst the US equity market has indeed fallen we see that actually uncertainty measures are reasonably calm.
Gauges of expected market volatility have risen in recent days, with the Vix index of projected equity market turbulence up 4.6 points over the past week to 22, above the long-term average of 20.
Anyway there is of course uncertainty as to exactly what will be applied as we saw something of a hokey cokey dance around the early tariffs on Canada and Mexico. One thing we do know is that the official view on equity markets has changed between Trump 1.0 and 2.0.
The US stock exchange was a “snapshot in time”, said Leavitt, echoing comments from other Trump officials that the White House would look past market turbulence stemming from the tariffs.
Let us move onto expected economic impacts.
The White House View
The first point is that the US is in a relatively strong position.
While trade accounts for 67% of Canada’s GDP, 73% of Mexico’s GDP, and 37% of China’s GDP, it accounts for only 24% of U.S. GDP. However, in 2023 the U.S. trade deficit in goods was the world’s largest at over $1 trillion.
That was from the original statement on the 1st of February and since then we have seen this.
The United States imposes fewer barriers to imports than other major world economies, including those with similar political and economic systems. For many years, the United States has been treated unfairly by trading partners, both friend and foe. This lack of reciprocity is one source of our country’s large and persistent annual trade deficit in goods — closed markets abroad reduce United States exports and open markets at home result in significant imports.
This moves in a direction that we have been noting for some years which is that the conventional view that it is good to be a net exporter is seeing some challenges. The US is essentially leveraging the fact that it is a large net importer with the implication that it will be effected by a tariff war less than net exporters will be. There is an immediate irony because as I noted in yesterday’s article the January trade figures were much worse as importers raced to beat the tariffs.
Also whilst this will obviously increase American tariffs and have a shock effect much of the media seems to be ignoring the tariffs applied already by other countries.
50% tariff from the EU on American dairy
700% tariff from Japan on American rice
100% tariff from India on American ag products
300% tariff from Canada on American butter & cheese ( White House)
Of course the White House is going to list the most extreme cases but I also note that the response from the European Commission us rather defensive.
For technical reasons, there is not one “absolute” figure for the average tariffs on EU-US trade, as this calculation can be done in a variety of ways which produce quite varied results.
Also there has been inconsistency in the presentation as in the UK much of the media has told us that tariffs from the European Union on the UK are a sign of its economic strength. Now suddenly we are told tariffs are a bad idea.
The reality is that it is happening now or as David Bowie would put it we are seeing ch-ch-changes. So let us move to likely impacts.
Inflation
This is the clearest impact as we will see price rises.Some areas will be able to compress margins but I cannot see that happening much in one of the headline areas which is the automobile industry. There I expect a pass through approaching 100% if not 100% itself. The Budget Lab has crunched some numbers for the US economy based on a rumour/hint in the Wall Street Journal about likely tariffs.
Average aggregate price impact. A 20% broad tariff would raise consumer prices by between 2.1% (no retaliation from other countries) and 2.6% (full tit-for-tat retaliation) in the short-run, assuming no policy reaction from the Federal Reserve. This is equivalent to a loss of purchasing power of $3,400-4,200 per household on average in 2024 dollars.
As you can see it would be very inflationary for the US and there would be price rises and inflation across the world.
Deflation
Just as a reminder I define this as lower aggregate demand not lower inflation. Here is the Budget Lab again.
US real GDP effects. The tariffs reduce the size of the US economy in both the short- and the long-run. US real GDP growth is -0.9pp to -1.0pp lower in calendar year 2025 and -0.1pp to -0.2pp lower in calendar year 2026 under the no-retaliation and full-retaliation scenarios, respectively. After 2026, the level of GDP begins to recover modestly as production and supply chains reoptimize. But in the long-run, US output is still -0.3% to -0.6% lower. That’s the equivalent of the US economy being permanently smaller by $90-$180 billion annually in 2024 dollars.
As you can see at this point it is a case of economic self-harm with inflation higher and economic output weaker. One way of looking at it is that it would wipe out economic growth for this year if the US grows in line with present forecasts of around 0.3% per quarter.
The UK
The Office for Budget Responsibility has crunched some numbers. From the original tariffs on Canada, China and Mexico it did not find much of an effect.
In this scenario, the lasting effects on the UK’s output and public finances are limited.
Then a scenario based on an announcement of 20% tariffs today.
In this case, the UK experiences a larger and more lasting loss of output, peaking at just over ½ a per cent in 2026-27.
And the corresponding loss of tax revenue and increase in inflation-linked spending virtually eliminates the headroom against the Chancellor’s current balance target by 2029-30.
Then a scenario based on retaliation in kind.
In this scenario, the UK experiences a larger loss of output which peaks at around 1 per cent in 2026-27.
And while the Exchequer gains around £9 billion a year in additional tariff revenue, this is more than offset by the loss in revenue from other taxes on domestic income, consumption, and profits.
And the net result is that the Chancellor’s fiscal headroom is also almost wiped out by the fifth year of the forecast.
The first rule of OBR Club that the OBR is always wrong still applies but it gives us a general idea.
Comment
One of the factors that gets forgotten in the Ivory Tower analysis is time. What I mean by that is they assume that the tariffs will be permanent whereas they are just as likely to be temporary because of their role as a negotiating tactic. Negotiations could backfire and the tariffs become permanent but that as Oasis put it is a definitely maybe. But the immediate impact will be both inflationary and deflationary. Oh and let me add something that much of the analysis skirts trade flows will be weaker.
So as they used to say on Hill Street Blues “let’s be careful out there.”