The road to hell is famously paved with good intentions. The wide-ranging tariffs announced by the US administration overnight should be viewed in that context. Tariffs were applied to a broader range of countries, including historic US allies, and at higher rates than had been expected. The good intent in this instance relies on the assumption that tariffs will raise government revenues – thereby reducing the size of the budget deficit and potentially allowing room for tax cuts elsewhere – whilst at the same time encouraging more domestic investment and production. Whilst these might be worthy aims, history strongly suggests that such a naive approach to trade policy does not end well.
Challenges for central banks
The risk of a US and global recession has increased directly as a result of the US tariffs, as has the likelihood that inflation stays higher for longer. In turn, the possibility of stagflation makes life very difficult for central banks. Immediately following the tariff announcement, Treasuries rallied as part of the risk-off trade. However, the medium-term path for Treasuries is far more uncertain due to the upward pressure on prices that is expected to follow tariff implementation. As was seen in 2022 and 2023, when faced with a choice between fighting inflation and supporting the economy, central bankers place greater weight on the former, at least in the short term, for fear that if inflation becomes embedded the longer-term consequences are even more painful.
The market’s interpretation of the tariffs speaks volumes. Asian markets have experienced significant declines overnight while European markets declined this morning and US equity index futures are meaningfully lower. The S&P 500 futures index is down around 3% at the time of writing.
Tit-for-tat
Some countries and regions have already indicated that they will, unsurprisingly, be forced to implement retaliatory tariffs on the US. While US Treasury Secretary Scott Bessent indicated that tariffs would peak following this announcement, at the same time the US authorities have said that if any countries retaliate the US will impose yet more tariffs. This suggests that we are not done yet and should expect further rounds of tit-for-tat measures in a potentially damaging cycle of mistrust. Some countries, such as India and Vietnam, have tentatively suggested that they may be open to reducing the trade restrictions they place on US goods if there is some reciprocation, although no detail is available.
If there are any positives, one is that Canada and Mexico were excluded from the latest round, though will continue to be subject to the tariffs that have already been announced. A second positive is that product specific tariffs such as on autos and steel will not be added on to country specific tariffs. However, these are very small offsets to a policy announcement that otherwise contains much to be cautious about.
Volatility ahead
The next few months are therefore likely to be volatile as:
- The tariffs start to impact global activity and inflation
- Other countries impose retaliatory measures on the US, potentially stoking a long drawn out phase of deglobalisation
- The international political order re-aligns and countries reassess the nature of their relationship with the US, not just with regard to trade but more broadly including the implications for defence and the existing world order.