Unforeseen consequences: How far reaching will US tariffs be?

At a glance:

• The recent tariff news wasn’t wholly unexpected, but the scale caught markets by surprise.
• Tariffs will see costs passed on to consumers, and will impact interest rates decisions.

The moves by the US to implement tariffs on key trading partners is likely to have many unforeseen impacts, according to investment experts at SJP. Even if now temporarily on hold, the surprise element alone of the Canada/Mexico (and their restrictive retaliations) announcement certainly impacted market sentiment.For reference, Canada and Mexico make up 30% of US goods imports and are highly integrated in terms of supply chains. For example, more than 50% of auto parts come from Canada and Mexico, and goods cross the border several times as part of the production process.

Hetal Mehta, head of economic research at SJP, says that while it was well known President Trump may turn to tariffs, the scale and the initial targets caught many off guard. While the US has large trade deficits with both countries (meaning the US imports more than it exports to them), they are also its closest neighbours. They have also all been part of “free” trade agreements with the US for decades.

Trump is reneging on deals he himself signed (when he was first president in 2016), Hetal explains. And now, even as some actions may be paused, other countries are being targeted – such as China. Where next? Consequently, how will this affect trade relationships – and supply chains - around the world?

While Hetal points out it is unlikely to be as disruptive to supply chains as the pandemic, it will likely change relationships between countries. But it isn’t just a matter of switching suppliers to other countries or even emphasising buying domestically, Hetal notes. For one, it takes time to build supply capacity from other regions and areas to fill current demand. For another, there are also non-tariff barriers with other countries – such as regulation. “You can’t just jump to another supplier that easily. So, will these non-tariff barriers get watered down? Where will the trade get re-rerouted to?”

Already the US consumer buys more than the US can supply, which is why it imports more goods than it exports, she highlights.

Hetal comments: “One way or another the US consumer will pay for tariffs – they are on the hook. The impact could be 1. Higher inflation. 2. Higher interest rates to combat that inflation and 3. Higher taxes for households. The latter is because the intention is to funnel the profits of the imposed tariffs to lower US corporate taxes. If the US were to reverse this action in the future, they may find it difficult and have to turn to consumers to pay that bill.”

UK impact?

The UK may have escaped the opening salvo of Trump’s trade war for now, but it may still get caught in other ways. For one, Trump has also spoken about potential tariffs on the EU, which is the UK’s most significant trade partner. As such, tariffs imposed on EU goods may have a knock-on impact for the UK, Hetal points out.

Hetal says: “It will inevitably raise questions on how central banks - especially the European Central Bank (ECB) but also the Bank of England (BoE)– should respond should they also be subject to such protectionist measures. Any further weakness in the euro area economy will likely spillover to the UK. This could result in an increased willingness to cut interest rates in the UK."

A 10% tariff could reduce euro area GDP by up to 0.5%, Hetal explains, adding: “With growth already so fragile in Europe, there is little scope for it to avoid recession if such a tariff was to be imposed. As such, we believe the ECB is likely to carry on cutting rates.”

There is also the fact it raises global uncertainty. We know that in periods of uncertainty, extreme outcomes known as ‘fat tails’ become more likely. The first day markets opened after Trump’s Mexico/Canada announcement already saw increased volatility.

Joe Wiggins, investment research director at SJP, says this initial volatility spike was a result of investors attempting to understand the potential responses and economic consequences. “Periods of heightened uncertainty and market noise are incredibly challenging for long-term investors often not because of the issue that is the focus of attention but rather our behavioural response to it. When under stress investors have a tendency to make decisions that relieve short-term anxiety often at the expense of their long-run objectives.

“Attempting to make prudent investment decisions related to the recent announcement of US tariffs is fraught with difficulty. Untangling the economic and market consequences of an incredibly complex, and still nascent, situation is extremely unlikely to be a productive activity.”

What’s next?

This is one to watch from a political and economic standpoint. Questions around US – Canada/Mexico trade – and other countries - remain. What other countries will be targeted and what retaliation will be taken? While Hetal doesn’t expect the tariffs will have any direct impact on UK inflation, other knock-on impacts are hard to foresee given how unpredictable Trump’s policies have been so far.

With respect to markets, according to SJP’s investment experts, volatility will likely persist throughout 2025 as such policy uncertainties play out. However, analysis from the investment team suggests strong underlying business fundamentals, technological innovation, and structural growth trends continue to provide compelling investment opportunities.

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