Quick Bite: The Trouble with Tariffs
With the arrival of the second Trump Administration, tariffs are back, and back with a vengeance. The new Administration has imposed a series of trade taxes but has been unpredictable and capricious in their application, creating global trade uncertainty. In recent weeks, tariff policy has been the primary cause of market volatility and the 10% correction in share markets.
Goldman Sachs’ Equity Sentiment Indicator (see below) is now at its lowest level since early 2023. A few months ago, it was at record highs.
Source: Goldman Sachs
While the US has been the driver of this tariff war, other countries have responded with their own trade taxes and other retaliatory measures. Tariffs or trade taxes act as a sales tax on domestic consumers, and so tariffs tend to increase inflation. But no one really knows how bad the inflation shock will be.
How much have tariffs increased? Two measures are commonly used – average tariff rates, and effective tariffs. The average tariff rate simply takes the average of every tariff rate that is being applied, whereas the effective tariff is the total trade tax revenue received as a percentage of the total imports into a country. Effective tariffs are the focus.
US average tariff rate and effective tariffs.
Source: UBS
Tariffs have long been a burden for consumers, pushing up prices as money is paid to the government. Today’s trade is a lot more complex than it was in the past, and this makes the relationship between taxing trade and inflation more complicated than previously. Complexity drives trade ratios.
Global real GDP and real exports, 1981 = 100
Source: UBS
There are numerous ways in which tariffs can impact inflation. In assessing the extent of the inflation damage, investors need to ask:
- How visible are the effects of the tax to the consumer, and how likely is it that the tariffs will stay in place?
- How much of the tariff change will be passed directly to the consumer?
- How significant will the second-round effects of the tax be?
- How quickly can exporters adapt to help their overseas customers avoid paying the tax?
Tariffs typically result in higher prices for consumers. However, the complexity of global trade introduces uncertainty about the extent of these price increases
The Organisation for Economic Co-operation and Development (OECD) recently published its latest economic projections and commentary. It explicitly states:
“The high level of geopolitical and policy uncertainty at present brings with it substantial risks to the baseline projections. One possible risk is the escalation of trade restrictive measures. An illustrative exercise, where bilateral tariffs are raised further on all non-commodity imports into the United States with corresponding increases in tariffs applied to non-commodity imports from the United States in all other countries, shows that global output could fall by around 0.3% by the third year, and global inflation could rise by 0.4 percentage points per annum on average over the first three years. The impact of these shocks would be magnified if policy uncertainty were to increase further or there was widespread risk repricing in financial markets. These would add to the downward pressures on corporate and household spending around the world.”
The OECD’s largest downgrades were reserved for the two economies that trade most heavily with the US and face significantly higher barriers to their exports, namely Mexico and Canada. The OECD now expects Mexico’s economy to contract by 1.3% this year and 0.6% in 2026 (previously forecast growth of 1.2% and 2.8%). For Canada, it now expects growth of 0.7% in both 2025 and 2026 (previously forecast expansions of 2%).
The OECD said the US economy will now likely grow by 2.2% this year and 1.6% next (previously forecast growth of 2.4% and 2.1%). The global economy is now forecast to grow by 3.1% in 2025 and 3% in 2026 (previously projected to expand by 3.3% each year).
Source: Financial Times
These forecasts assume that tariffs on nearly all imports to the US from its North American neighbours will rise by 25%, while a 20% increase in tariffs on Chinese imports and higher duties on aluminium and steel imports will remain in place. However, further tariff increases are likely.
President Trump has threatened to impose so-called reciprocal duties on any trading partner that charges tariffs or imposes other trade barriers on US products, with further announcements anticipated. The reciprocal tariff plan is expected to be introduced on 2 April, along with additional 25% duties on a handful of industries, such as autos, semiconductors, and pharmaceuticals.
While the tariffs would raise additional revenue for the US government, the OECD warned that would be more than offset by lower revenues from other taxes as the economy slows, “implying that additional tax increases or lower fiscal expenditure are needed to keep the overall budget deficit unchanged.”
Even without further increases, the OECD forecast that inflation across the world’s largest economies will be 0.3% higher this year and next because of higher tariffs. That could lead central banks to cut borrowing costs more gradually than would otherwise have been the case, another headwind for growth.
The OECD now expects the US Federal Reserve (Fed) to keep its key interest rate at current levels of 4.5% until “well into 2026.” It had previously expected the Fed to lower its key rate to between 3.25% and 3.5% by the first quarter of 2026.
In the meantime, the tariff war is starting to impact consumer and business confidence. A recent survey of consumers showed a dramatic decline in “expected change in financial situation in a year” reflecting some of these pressures.
Source: Edge and Odds
