Insight Investment

"Risk assets are not clearly pricing in the likely impact on growth, and the policy response so far has been insufficient to counter the negative headwinds facing the global economy"

The new US trade regime is reshaping global economic and market outlooks. Tariffs are being used as leverage in negotiations, to address trade deficits and to encourage domestic manufacturing. Additionally, tariffs are now viewed as a means to generate fiscal revenue and to counter China's economic ascent.

After taking office, the new US administration initially focused on Canada, Mexico, and China. It began with a 10% tariff on Chinese goods, which shortly increased to 20%, and declaring a national emergency to impose 25% levies on Mexico and Canada despite the USMCA agreement. On 2 April, the administration announced a base tariff of 10% on most imported goods and "reciprocal tariffs" on 57 countries, aiming to rebalance trade deficits. Auto tariffs of 25% were also implemented immediately.

Amid market turmoil and economic forecast downgrades after the announcement, the US paused the rollout of reciprocal tariffs for 90 days, with China being a notable exception. On 12 May, the US and China then agreed to reduce tariffs temporarily, providing some relief. However, many tariffs remain in force, with more expected on products like pharmaceuticals and semiconductors.

There remains significant uncertainty about what happens after the initial pause comes to an end, and also whether sectoral tariffs will be introduced on items like copper, lumber, pharmaceuticals, and semiconductors. It even appears that tariffs could be introduced on specific companies to force domestic production.

Smaller, open economies like Vietnam face potentially huge economic headwinds without tariff relief. Sectoral tariffs, such as those on autos, semiconductors, and pharmaceuticals, further exacerbate the impact, especially for countries in Southeast Asia.

Tariffs are likely to be a significant headwind for growth, for both the US and its trading partners. This is driven by the direct trade impact and via confidence. Even if reciprocal tariffs remain paused and the confidence impact dissipates, there is likely to be a long-term impairment of growth.

It is not clear that risk assets are pricing in this scenario, and the policy response so far appears insufficient. To see a significant change to the economic impact, we need one of the following:

• significant Fed cuts, which are unlikely before unemployment rises given the current inflation outlook;
• a significant change of policy on tariffs, which seems very unlikely before we see real economic pain; or
• an offsetting fiscal impulse, such as tax cuts, subsidies, or other support for affected industries, which seems the most likely scenario.

In the meantime, we see downside risks to risk assets as the economic impact feeds through over the summer.