Friends and colleagues typically send me sensational-sounding economic stories on April Fool’s Day, just as a joke. There was a sensational-sounding economic story that came out this week. But it arrived on April 2nd, and it was no joke. The White House announced another round of tariffs that left businesses and the financial markets reeling.
Here are the main messages we would share at the end of a tumultuous week.
- The 10% across-the-board (ad valorem) tariff and specific reciprocal tariffs on most U.S. trading partners went well beyond what most were expecting. It wasn’t just the size of the levies that surprised, but also the manner in which they were calculated and applied. Several countries that would not be considered major transgressors are facing penalties that are well out of proportion with their trade positions.
- Things could still get worse before they get better. As of this writing, China has already retaliated with additional 34% tariffs, with the European Union (among others) likely to hit back soon. The President has promised to escalate further in that event. Uncertainty is still very high.
- This round of measures and counter-measures will do substantial damage to the economies involved. Odds of recession in many markets have risen sharply. Inflation pressures and inflation expectations are rising.
- Some analysts argue this week’s policies are temporary, expecting negotiations to begin soon, proceed productively, and result in amelioration. We are not so sure. Little in the first 10 weeks of the Trump Administration suggests a willingness to de-escalate. Trump’s comments accompanying the tariff revelation characterized the global trading system as a series of mistakes working against the nation’s interests. Minor concessions will not overcome an intent to rebuild the global trade order.
- The goal of reshoring massive amounts of production to the U.S. will take an immense amount of time and capital. Given automation within the manufacturing sector, this will not be a powerful engine of job creation. Past episodes like the washing machine market intervention raise difficult questions about the efficacy of tariffs.
- Permanent damage has been done to the American brand overseas. Boycotts are starting, and new trading arrangements excluding the U.S. are being discussed.
- The discomfort produced by this posture is becoming more acute. World equity markets are slumping, as is the U.S. dollar. For now, the President seems unmoved. Some Senate Republicans have crossed party lines to oppose the use of emergency powers to prosecute a trade war, but the House has held firm.
- Congressional Republicans working on the budget bill are attracted to the prospective increase in tariff revenue, as it can be used to offset deeper tax cuts. The need for a steady stream of import duties may make concessions more costly in trade negotiations. Forecasting tariff income is difficult: Products made more expensive by tariffs will lose favor with consumers, diminishing tax revenue. If the policy succeeds in its objective of restoring domestic production, the tariff is moot.
- Many of you have been anxious for a forecast update reflecting this week’s developments. This is no easy task. We offer some thoughts below, and we are at work on revised forecasts.
Domestic Disarray
This week has been circled for a long while. Investigations of trade improprieties began immediately upon Trump’s inauguration and were to be completed around this time, forming the basis for corrective action.
At the center were rumors of reciprocal tariffs. The design seemed simple: the United States would match the rates charged by each of its trading partners on imported goods. But the new measures announced this week were derived without any reference at all to current tariff levels. The bilateral deficit the United States runs with each country was divided by total imports from that country, and then arbitrarily divided by two. This resulted in rates that were unusually low for some trading partners, and unusually high for others. The administration implicitly believes that all trade deficits are a bad outcome and should be minimized. The larger the deficit, the greater the intervention.
As a standalone event, this week’s news would have represented a tremendous shock. However, the action comes on the heels of new levies on the auto sector, steel and aluminum, and Canada and Mexico. Each of those efforts will carry on separately.
Markets held out hope that trade uncertainty would reach its peak on April 2, and decline as policy becomes clearer and negotiations commence. Treasury Secretary Scott Bessent characterized the reciprocal rates as a ceiling, which can be brought down as trade comes into better alignment (crucially, assuming no retaliation). But negotiations feel a long way off. The U.S.’ metric for trade fairness is bilateral trade deficits. Even foreign policymakers eager to strike a deal will have limited ability to steer their nation’s private consumption and investment preferences. And negotiations will only bring down the reciprocal tariffs; the President has said that the 10% baseline is here to stay.
Official pushback is underway but may be a dead letter. The Constitution vests the “Power To lay and collect Taxes, Duties, Imposts and Excises” with Congress, which has passed laws to empower the Executive branch with tariff authority. That delegation can be rescinded. This week, a bill to revoke the president’s tariffs on Canada found some bipartisan support in the Senate; this movement could grow if economic ramifications become more severe. The scope of this week’s actions may exceed the president’s authority under the International Emergency Economic Powers Act, a question to be settled in the courts. None of these challenges will proceed quickly.
Ramifications of the new policy will take time to appear in official statistics. Tariffs are a new tax on imports, paid by the importer. That cost must be absorbed at some point in the value chain, most likely in the form of higher final prices. Import orders were front-loaded this year to allow inventories to build in advance of changes to trade policy; these will offer a cushion before prices rise, but rise they will. Even if trade policy ultimately succeeds in restoring domestic production, U.S.-made goods are unlikely to offer a cost advantage.
Higher prices will weigh on demand. Households will be squeezed, across income strata. Consumption and business investment are poised to slow as budgets are stretched, spending plans get reevaluated, and uncertainty reigns. Sectors exposed to international trade will be at risk of job losses as demand cools. Hospitality and tourism firms will be the first to feel the U.S. boycott as foreign visitors choose to travel to other destinations.
To be fair, the U.S. economy did just perform well through an interval of very high inflation, but circumstances do not compare. Today, the tariffs hit amid no fiscal stimulus, a push to reduce government spending, and a cooler labor market. While some retaliatory tariffs may be reduced, we do not foresee a return to free trade. Risks to inflation and unemployment will remain elevated.
As a result, the Federal Reserve's job just got more complicated. Expectations of rate cuts had been pushed out, as inflation has remained above the Fed's 2% target. But if layoffs gather momentum, cuts may resume sooner.
Tariff Typhoon
Elsewhere in the world, Asian nations will be the hardest hit by the new tariffs. The tariff rate on trade-dependent regional economies is set to increase ten-fold, to 42%. Chinese goods now face total import taxes of 65%. The U.S. administration is also seeking to choke shipments from markets that have helped Chinese exporters reroute their products and avoid punitive penalties.
Countries like Vietnam, Thailand, Japan, South Korea and Taiwan will also be subject to much higher rates ranging from 24% to 47%; “China Plus One” sourcing strategies will lose their hedging value. The move ignores the free trade agreements that the U.S. has with several Asian economies, notably Korea and Japan. India, which has the world’s highest tariffs among major markets, now faces an additional 26% duty on exports to the United States.
The magnitude of the hit will also be determined by the size and scale of the individual country’s retaliation. Tit-for-tat measures will only draw the ire of the U.S. administration, and these nations’ trade surpluses limit their potential to retaliate. Barring China, most from the region will likely opt for no retaliation or even lower their tariffs, with a hope of securing some form or relief or progress toward a broader trade deal.
The Japanese Prime Minister has warned of a significant impact from auto taxes on the industry, but the overall impact on the economy will likely be manageable. We expect the external backdrop to become a bigger drag on Japan’s growth, but not enough to push the economy into a recession. India is not dependent on U.S. goods exports and is unlikely to retaliate as it seeks to negotiate a bilateral trade deal.
Weaker growth prospects and currency volatility will drive the region's policymakers to make economic conditions more supportive. The crisis could present an opportunity to invest in greater resiliency and broader trade alliances.
Europe Spots A Weakness
Modern history provides many instances of strategic tensions between Europeans and Americans. When Egypt nationalized the Suez Canal in 1956, America opposed Europe’s military intervention. Germany pushed back on President Carter’s plan to deploy ballistic missiles in Europe in the 1970s to pressure the Soviets. The case for a war in Iraq in 2003 was poorly received by Europeans. And we may never come to an accord as to whether the sport is called “football” or “soccer.”
The cycle of tension is again on the rise, this time over America’s trade policies. Brussels has promised to respond decisively to U.S. tariffs. The European Commission has already unveiled duties on up to €26 billion of American goods. But recent comments from the European Commission have raised the risk of the bloc going after American services exports.
While President Trump has been fixated on closing goods trade deficits, he has overlooked the unevenness in services. While the EU has a significant goods surplus with the U.S., America holds a persistent and increasing services surplus of over €100 billion with the bloc. This is spread across a variety of sectors, including finance, travel and technology.
The EU’s Anti-Coercion Instrument (ACI) gives Brussels the authority to restrict U.S. firms’ access to European markets. The European Commission could impose substantial fines on social media platforms for failure to comply with local regulations. It could restrict the activities of American banks, prevent tech companies from receiving revenues through subscription services, limit their intellectual property rights and exclude them from government contracts.
Any retaliatory measures under the ACI would require approval from 15 out of 27 member states, potentially leading to delays in the EU’s response. While this seemed like a high barrier when the ACI was designed, this week’s developments could convince a majority of member states to take action.
If Brussels drags the U.S. tech sector into the trade war, it would represent a substantial rise in tensions. The dominance of major U.S. technology firms is one of the key factors behind the large trade imbalance in services, and they have avoided conflict thus far.
The Irish economy has the most to lose. U.S. technology firms are particularly important for Ireland, which hosts the European headquarters of several of the big tech companies. This sector generates enormous revenues from their business in Europe, paying a large chunk of their taxes in Ireland (which is a low-tax jurisdiction). In 2023, more than half of Ireland’s corporate tax receipts came from just ten corporations, primarily U.S.-based technology and pharmaceutical firms. The strike against American businesses could lead to an exodus of U.S. multinationals and drive the Trump administration to pressure companies to move profits back to the United States.
Those who were raised on typical American sports need time to come around to soccer/football. The game’s pace is unpredictable, and it feels unusual for matches to end with a tied score. As the U.S. and Europe enter a frenzied interval, a draw may be the best outcome the world can root for.
Information is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Under no circumstances should you rely upon this information as a substitute for obtaining specific legal or tax advice from your own professional legal or tax advisors. Information is subject to change based on market or other conditions and is not intended to influence your investment decisions.
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