• On April 2nd, the U.S. President issued an Executive Order based on a “national emergency” including two main tariff announcements: 1) 10% universal tariff on U.S. imports with the goal of raising revenue (effective April 5th) and 2) Higher “reciprocal” tariffs on more than 25 of the country’s biggest trading partners based on the size of their trade deficit with the U.S. (effective April 9th).
• These “reciprocal” tariffs were much higher than expected. China saw an additional 34% (for a total tariff increase of 54 ppts this year), 20% on the European Union (EU), 24% on Japan, 25% on South Korea, 26% on India, 32% on Taiwan and higher tariffs on Southeast Asia (e.g. 36% on Thailand; 46% on Vietnam). Canada and Mexico were spared this round, as a separate United States-Mexico-Canada Agreement (USMCA) discussion continues. Within Asia, Australia and Singapore were not subject to reciprocal tariffs as the U.S. has a trade surplus with these markets.
• These announcements added to previous tariffs: 25% on non-USMCA compliant goods from Mexico and Canada (10% on Canadian energy and 10% on potash), additional 20% on China, 25% on steel and aluminum and 25% on imported autos and auto parts.
• As seen in Exhibit 1, we estimate that this brings the average effective tariff rate to around 25% , the highest since the early 1900s.

What happens now?

• Additional sector-specific tariffs may still be forthcoming (on semiconductors, pharmaceuticals and certain critical minerals). These sectors were exempted from the tariffs announced on April 2nd but have been mentioned by the U.S. President in prior tariff announcements as areas of focus.
• The duration of these tariffs will matter for the growth outlook. The 10% universal tariffs are likely to be permanent given the revenue raising goal, but the additional tariffs may be the start of negotiations with individual trading partners, leading to their reassessment over time.
• Trading partners may decide to retaliate with their own tariffs on U.S. exports and U.S. companies (including services like technology). At the time of writing, China announced a 34% tariff on all U.S. imports starting April 10th. Canada has also retaliated, announcing their own tariffs against U.S. auto imports. Both Canada and the EU have stated they are planning additional countermeasures against the U.S.
• Fiscal and monetary policy responses will be key. U.S. additional tax cut discussions are likely to be accelerated, and fiscal stimulus overseas can increase further (especially in Europe and China). Central banks (including the Federal Reserve) are likely to focus on responding to the growth hit by lowering rates,  rather than the supply driven inflationary impact. Some emerging market (EM) central banks may decide to devalue their currencies to maintain export competitiveness (led by China).

What are the economic impacts?

The tariff announcement has raised market pricing for a recession, but there is still a large degree of uncertainty regarding the duration and depth of any recession that may eventuate. What is more certain is that the short-term economic impacts of tariffs tend to be stagflationary.

Some of the one-time increase in tariffs may hit U.S. businesses’ bottom line, while some may be passed on to the end consumer, raising prices. Important business decisions (investment and hiring) may be postponed or canceled, and consumers’ spending habits may change by pulling back on bigger purchases. 1Q growth was already looking soft and further softening in 2Q will depend on the duration of tariffs.

The extent to which global companies and economies are impacted will depend on their policy responses and the external vs. domestic focus of specific companies.

Investing implications

Since April 2nd, risk markets have pulled back significantly. The S&P 500 fell more than 10% in the subsequent two days following the announcement, while the NASDAQ and the Russell 2000 have fallen into bear market territory (more than 20% from the recent peak). Within U.S. equity indices, multinationals with significant overseas production have suffered disproportionately. Asian and European stocks also fell. Bonds rallied on growth concerns, with U.S. Treasury yields falling over 20 basis points (bps), and being 80bps lower than their January peak. Safe haven assets such as gold and the Japanese Yen strengthened. Commodity markets weakened on softer demand outlook, especially oil prices.

How should investors be positioned?

• Multiple defenders needed to cushion portfolios from shocks: Core bonds can help during growth shocks, with the U.S. Aggregate index up 3% year-to-date. Other diversifiers are needed when inflation and fiscal concerns take the lead again, with real assets (infrastructure, real estate), gold, certain hedge funds and hedging strategies are top of the mind.
• Diversify equity exposure: After two years of concentrated U.S. equity performance, expectations are high, and portfolios are concentrated exactly in the previous winners. So far this year, investors have been rewarded for being diversified, with value outperforming growth by 1,000bps and international markets outperforming the U.S. by 1,100bps (the biggest since 1989). Companies with lofty valuations and low quality continue to be the most vulnerable.
• Active management to separate winners and losers: Companies and sectors will be impacted unevenly. Companies that are domestically oriented, services-oriented and have higher pricing power are likely to fare better.
• Role of income remains key, whether from high quality fixed income, stock dividends, alternative assets or strategies with option overlays. A consistent income stream is important when asset prices go through policy-induced volatilities.

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