Trump's tariffs: Is free trade a thing of the past?

Liberation day

All imports to the US affected by tariffs

 

President of United States, Donald Trump, announced Tuesday night a series of
«reciprocal tariffs». All the imports to the US. will be subject to a 10% tariff.
However, much higher rates will apply to major trading partners: Union
European, 20%; China, 54%; Japan, 24%; Taiwán, 32%; Cambodia, 49%; South Africa, 30%; Vietnam , 46%; Thailand, 36%, etc. The calculation of these tariffs is not easy to understand. Roughly speaking, the announced tariffs are equivalent to 50% of the assumed tariff rate of the partner country. This assumed tariff rate is calculated by dividing the trade deficit with that country by imports from that country.

The tariffs are scheduled to take effect on April 9, but the 25% tariffs on
automobiles and their parts will come into effect immediately. Semiconductors,
Critical minerals and pharmaceuticals are currently exempt, but are likely to be
that will be subject to tariffs in the future.

Canada and Mexico are not mentioned in the new tariff announcements; what has already been decided will continue to apply. The White House said it would deal with these two countries based on a framework established in previous executive orders imposing tariffs on Canada and Mexico, as part of the US government's efforts to combat fentanyl and border issues. Trump had previously set these tariffs at 25%, before announcing some delays and exemptions. However, the debate over tariffs on Canada has also shown that Trump's measures have met with some resistance, even from the Republican side. The push by Democratic senators to avoid tariffs on Canada was also supported by some Republican lawmakers, who then faced verbal attacks from the president.

It should be noted that the announced tariffs are higher than most observers and markets expected. However, we expect bilateral negotiations to be held in the coming days and weeks to agree on some relief. However, the conditions for such negotiations are difficult, first, because many talks must be held simultaneously, and second, and almost more importantly, because the logic behind tariffs is not the same as that of bilateral negotiations. This means, for example, that a reduction in existing tariffs on US products cannot simply be used as a concession. These points could mean that the tariffs announced yesterday will remain in place for some time, with their full impact unfolding in the coming months and years.

Possible retaliatory measures

It is expected that the European Union (EU) initiate negotiations as a first step, and only if these fail are tariff countermeasures likely. However, the EU has a trade surplus, which will likely weaken its negotiating position. Retaliation against the US could include non-tariff measures, such as excluding US companies from government procurement.

And yes?

Yesterday's announcements constitute an unprecedented shock to free trade. For this reason, analysis based on historical data to classify them may have limited accuracy. However, to give an idea, we estimate that all tariffs combined would increase the effective tariff rate on US imports from around 2,5% to more than 20% if maintained. We estimate that this direct trade effect would reduce US gross domestic product (GDP) growth by about 60 basis points. Inflation could increase by up to one percentage point.

 

Major trading partners will also be affected by the announced measures. In nominal terms, GDP growth would be around 40 basis points lower in the eurozone, 60 basis points lower in Japan, and 130 basis points lower in the rest of the world. ChinaThanks to the agreement still in place between Canada and Mexico, these countries have been excluded from the wave. If tariffs were to increase by 10% in the future, GDP growth would be reduced by about 150 basis points in Canada and 180 basis points in Mexico. Some of this has already been factored into our most recent forecasts. However, as mentioned, these calculations should be treated with considerable caution, as there will be a significant amount of negotiation, and the current approach is unprecedented.

Uncertainty about future US trade policy and potential countermeasures remains high, as the risk of a further escalation in the trade war persists. Even assuming the United States applies a blanket 10% tariff, further rounds of tariffs cannot be ruled out. However, it should also be emphasized that we cannot underestimate the ability of global businesses to adapt to changing conditions. However, the back-and-forth of recent weeks has had a very negative impact on confidence in the US administration's statements. Even relaxed language from the US would not really help alleviate market participants' uncertainty about the future. We find ourselves in an environment in which companies are finding it increasingly difficult to invest, as there is currently no logical way to prepare for what might come. And the situation worsens with each passing day of uncertainty. But the clock is ticking not only against the (free) world trade, but also against Trump and his administration. If agreements aren't reached quickly in bilateral negotiations, it could be difficult to repair the damage Trump is causing. At some point, it will no longer be up to the United States alone to turn back the clock.

The question therefore arises as to whether one will be convinced Donald Trump that he will reverse course and prevent further damage to the United States and global trade, and when. Or whether, after all, the American president will be restrained by the American courts. At the very least, the situation has deteriorated much further than previously feared. Yesterday's events were merely another step on the path from a globalized world to a much more protectionist one.

In short, we do not expect the tariffs announced yesterday to remain at these levels for long. However, given the large number of parties involved and the lack of logic underlying the tariffs, negotiations over potential relief will be very difficult and therefore protracted. Furthermore, the mere implementation of the plans may reach its limits due to the US administration's lack of capacity or simply logistical problems. Finally, it remains to be seen whether the political headwinds emerging for Trump will also be reflected in a significant drop in his approval ratings, potentially leading to a change in the president's way of thinking. However, these are all hopeful signs that may take time to materialize. In the short term, the situation remains tense, and uncertainty is likely to remain the dominant sentiment.

Implications for asset classes

The market's initial reaction to the tariff announcements was clear. With stock prices falling sharply around the world and government bond yields also declining, a scenario was clearly emerging in which fears of a sharp economic slowdown outweighed inflation fears. The latter, in particular, is likely a consequence of what Trump presented Wednesday night. The dollar lost ground across the board, a sign that in this case, the United States is part of the problem, not a potential solution.

Shortly after the announcement, gold rose to record highs, but then retreated relatively sharply. Since last night, Brent crude oil prices have lost about $4 per barrel.

 

Fixed income and currencies:
 

USA Types:

U.S. Treasury bonds opened higher immediately after Donald Trump's tariff announcement, with yields falling significantly. The move continued into early trading yesterday. New YorkTrading volume rose to 247% of the recent average as markets remain risk-averse. With the intentions of yesterday's announcement still unclear—whether it provides a basis for negotiations or a permanent shift in tariff policy—Treasury bonds are likely to remain volatile for the time being. The market appears to be overwhelmingly long, so it wouldn't be surprising to see a sell-off if tariffs are reduced slightly as a result of the negotiations. However, volatility could be exacerbated by upcoming data releases, such as Friday's jobs report, as the market appears increasingly concerned about the labor market.

EUR rates:

As expected, eurozone government debt has reacted positively. If implemented as announced, the tariffs could have a negative impact on growth. If they remain in place, we believe a negative impact on global trade is inevitable. Countermeasures by the EU, China, and other countries are likely to exacerbate this drag. This is positive for interest rates, although the impact on inflation is less clear.

 

Furthermore, the typical movement away from "risky assets" favors safe-haven flows. The effect on non-core government bonds, government-related bonds, and covered bonds is less evident. A moderate widening of spreads versus Bunds is plausible in a risk-averse environment, but we do not expect a substantial widening of spreads. Expectations of further rate cuts by the European Central Bank (ECB) support the view of a steep yield curve.

Variable income

Diversification, more important than ever in the face of increasing uncertainty

The measures unveiled at the Rose Garden are likely to have long-term and potentially painful consequences for global growth. As a result of the unilaterally announced global trade war, frightened consumers and policymakers will only do one thing: wait and do nothing. The cost of uncertainty is expected to be enormous and could grow daily. Uncertainty about job security could increase; uncertainty about where and when to invest, whether and when to consume or travel. Diversifying portfolios across asset classes, sectors, and geographies could be a potential way for investors to manage risk.

Risk scenario – recession

If none of the announced tariffs are reversed through agreements in the next four weeks or so, the global economy risks entering an "oil price shock"-type crisis by mid-year. Our previous earnings estimates and index targets would have to be revised significantly downward.

In our view, only the most defensive equity sectors (telecoms, utilities, consumer staples, healthcare) could perform relatively strongly in such a negative scenario. Sectors that have generated the highest returns for investors in recent years could be at greatest risk of being sold off. Valuations are likely to fall, although we expect earnings cuts to be less pronounced. Cyclical sectors, such as consumer discretionary, capital goods, and enterprise software, are likely to experience the largest negative earnings revisions. Although the US has raised the possibility of a trade conflict with the rest of the world, all countries are focused on one: the US. This could mitigate some of the economic damage in the rest of the world. Markets outside the US could continue to fall somewhat less than US equity markets.

 

European small- and mid-cap companies are more sensitive to the economy and are unlikely to fare better in such a scenario. In Asia, equity markets have been hit hard by the announced tariff, which exceeded market expectations. Export-oriented Japan and Vietnam may continue to experience sell-offs due to unexpected tariffs. Domestically oriented markets, such as China, India, and Indonesia, could show relative resilience compared to other regional markets. So far, Australia and Singapore have been less directly affected by tariffs, with the lowest tariff rate in APAC. Defensive and domestically focused sectors in both Australia and Singapore are likely holding up better than other sectors.

 

 

Author: Vincenzo Vedda, Chief Investment Officer (DWS)