To conclude the year, tariffs have once again become a focal point, with Google searches for the term spiking in November and December. The Federal Reserve is also paying close attention, as Chair Powell mentioned the potential inflationary effects of tariffs as a reason some FOMC members might have raised their inflation forecasts for the coming year and increased the perceived upside risks to prices. The lessons from the "Trade War 1.0" of 2018 and 2019 remain relevant. There is much more tariff talk than tariff action, which does not mean that markets don’t react negatively in the short-term, but does mean that investors need to separate the signal from the noise. In 2025, as tariffs fluctuate in the headlines, market opportunities may arise when tariff implementation and consequences are mispriced.

The "Trade War" of 2018 and 2019 serves as a template for a potential "Trade War 2.0," offering four key lessons:

1. Tariff talk noise rises but eventually subsides: We may see a repeat of escalating tariff threats, but the likelihood of most being implemented is low. In 2018-2019, many tariffs were threatened on major trading partners, with estimates suggesting the average tariff rate on all U.S. imports could rise from 1.4% to over 11% if all were implemented. Some tariffs were enacted (on washing machines, solar panels, steel, aluminum and Chinese goods), raising the average tariff rate by 2020 but only to 2.8%. Negotiations around immigration and defense spending granted many countries a reprieve. Investors should moderate their fears of significant tariff increases, currently projected to reach 17.7% by the Tax Foundation (assuming 20% universal tariffs and 60% tariffs on all Chinese goods).
2. Even tariff threats can rock markets – in the short-term: Likely to see a repeat of the “stronger dollar for longer” move. In 2018, the U.S. dollar index appreciated a maximum 10% around tariff announcement windows and almost 5% again in 2019. Given the forward looking nature of markets, global equities (including the U.S.) had a negative year in 2018, with multiples contracting at least 20% that year.
3. There is an important signal from the Trade War: Despite limited surface changes, there was a significant shift in tariffs on Chinese imports: from 2.7% in 2017 to 9.8% in 2020. Supply chains have been dramatically restructured since the first Trade War, with the percentage of total U.S. imports from China dropping from 21% in 2017 to 14% today, while imports from Mexico and Southeast Asia have surged. Despite the U.S.-China Phase I trade deal of 2020, China has shifted its imports, with U.S. imports decreasing in representation and those of agriculture-producing Emerging Markets surging. Tariffs on Chinese goods are likely to increase further, turbocharging this reorganization of supply chains.
4. Investment opportunities arise amidst tariff-related volatility: After a challenging 2018, global equities rebounded impressively in 2019, with the U.S. +32%, Europe +26% and emerging markets +19%, led by multiple expansion. As reality proves less harsh than feared, short-term sell-offs tend to be short-lived. This includes international markets that may face tariff threats early next year but could eventually see a reprieve. This includes Europe and Mexico, which were under fire previously but saw no tariff changes and Southeast Asia, a significant beneficiary of "friendshoring." While fears about tariffs boosting U.S. inflation may exert upward pressure on yields, the scale and scope of tariffs are unlikely to alter the U.S. inflation normalization theme.

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