Tariffs ranging from 10% to 50% were announced on the countries with which the US has the largest trade deficits. For all other countries that were not designated specific tariffs, a 10% universal tariff was also announced. Additionally, there was confirmation of a 25% tariff on all auto imports. These tariffs will be added to those already implemented by the US administration. By our estimates, this takes the effective tariff rate* to 25%, levels not seen in over 100 years (Exhibit 1). 

Who are the tariffs aimed at helping? What are the risks?

It is increasingly clear that restoring its industrial base is the core priority for the US administration. It has long been known that globalisation did not benefit all segments of society equally and President Trump is speaking directly to the cohort that has often been referred to as ‘those left behind’. 

The administration has repeatedly mentioned that this is about Main Street, not Wall Street, and therefore perceptions that falling stock prices would limit policies have so far been mistaken. 

In the absence of the stock market being the signal to change course the question is how and when the economic data might prompt a rethink. Unpicking US trade relationships and the fabric of the US economy to restore its industrial base is likely to challenge growth in the near term. The data already show that uncertainty has put companies into a ‘wait and see’ mode, limiting capex and hiring plans. The extent to which firms shift from not hiring to firing to protect margins will determine the extent of the growth hit. What is also yet to be seen is whether uncertainty causes companies to absorb the import cost pressures or pass them on to consumers in the form of higher prices.

Slowing growth, rising unemployment and potentially higher prices, might pressure the administration to switch to a more moderate trade agenda, particularly if Republican members of congress start to fear for their reappointment at next year’s mid-term elections. The University of Michigan consumer survey, split out by voter persuasion (Exhibit 2), will be one of the key things to watch to see how quickly the pressure is building.

Reasons not to panic 

With such a historic change, it’s tempting to run for the hills and cut risk asset exposure. There are two reasons to question whether this is the right strategy.

First, it is yet possible that market moves, and the sheer practical realities of being able to implement these policies within a matter of days, lead to them being scaled back. Avoiding being top and tailed by news flow is critical.

Second, it’s important not to underestimate the prospect for positive news flow to follow in respect of monetary and fiscal policy. While retaliation is likely to come first, governments across the world may yet choose to react to the likely growth hit of tariffs via increased spending or tax cuts, to support domestic businesses and consumers. In this scenario, the market focus may shift to inflationary risks, rather than growth downside. Supply chain disruption and less efficient global trade patterns could also push inflation higher, as could exchange rate moves.

The reaction to US tariffs will also likely hasten the de-regulation agenda that is underway to support growth. For example, in response to the US’s auto tariffs, the UK is reportedly considering changing its regulations around electric vehicles (EVs) to ease the pace at which manufacturers must shift their sales away from conventional cars and towards EVs. This type of regulatory easing could also play a role in the rest of Europe as a channel through which to support industry.

The economic and market importance of potential counter-stimulus should not be overlooked – it has often played a role in supporting diversified portfolio returns after shocks, as Exhibit 3 shows. Thus, investors should avoid being buffeted by headlines, and instead ensure their portfolios are set up to be adequately resilient across a range of potential outcomes.

How should investors respond?

It is somewhat early to assess the market response to the US’s tariff announcements. However, it appears that as investors digest the likely hit to global growth caused by higher trade barriers, bonds are playing their traditional diversifying role against equity downside. US Treasury yields have fallen sharply, as expectations for near-term interest rate cuts by the Federal Reserve increased. However, while fixed income is a critical component of a resilient portfolio, investors must also look elsewhere to truly insulate their portfolios against today’s elevated uncertainty.  Here are some other considerations: 

1. An active approach is crucial. All passive strategies – including those tracking the MSCI World index or the Bloomberg Global Aggregate index – are highly exposed to US risk given the way in which the weight of the US has grown in benchmarks in the past decade. 
2. Geographical diversification is important in a period of economic fragmentation, and that will require an active approach to investing. Selectivity allows investors to avoid markets or sectors more exposed to trade uncertainty, as well as to lean into segments of the market that may have overcorrected in response to the recent trade news. Income-oriented strategies may also prove to be relatively defensive.
3. Think about currency exposure within these geographical considerations. The decline in the dollar since the announcements is noteworthy. Prior tariff announcements, or more generally risk-off days, have historically coincided with dollar strength. In our view, the dollar’s strength has been built on the foundations of macroeconomic growth outperformance, interest rate differentials and stock market outperformance which saw the world’s capital increasingly gravitate towards US assets. These foundations are now being challenged and the prospects for the dollar depend on how much these differentials change in the coming months. Our foreign exchange team have for some time argued that the US dollar smile (where the dollar strengthens in both extreme good and bad times) has become a dollar smirk (where the downside protection can no longer be relied upon).
4. Have adequate inflation protection in a portfolio. The record high level of the gold price tells us that investors are looking for assets limited in supply and for those able to access real assets, these alternatives have often proved best able to outperform during inflationary periods. Elsewhere, investors can look to commodity strategies, as well as macro hedge funds, which tend to outperform when volatility is elevated. Some regional equity markets are less exposed to inflation risk than others – for example, the UK’s FTSE 100 and FTSE All-Share were among the very few markets to post positive total returns in 2022 as inflation spiked, thanks to their large energy weight and defensive tilt.

* The effective tariff rate is a weighted average of the tariffs applied to all US goods imports, reflecting the various tariffs applied to different products and countries.