Monday Digest
Posted 3 February 2025
Trump has not been gradualist about imposition of tariffs on Canada and Mexico. From February 4th, tariffs will be 25% on everything (including e-commerce low value postal package forwarding) except for energy imports from Canada which will be 10%.
The 10% rate imposed on China is not the full 60% he mentioned in his election campaign, but the punishment meted out to the USA’s neighbours and erstwhile friends was not tempered by deal-seeking first.
All have signalled the likelihood of retaliation which, says Trump, will probably attract greater tariffs.
All this may still turn out to be a short-term upset be part of Trump’s infamous ‘Art of the Deal’ to press concessions on border controls from his neighbours. Goldman Sachs currently estimates that the economic effects will be to raise core inflation by about 0.7% and cut growth by 0.4% – which may sound fairly small, but would indeed be a considerable setback against his growth promises (although the lower 10% tariff on oil should reduce those impacts somewhat). They think the impacts will persuade the US administration to unwind the action.
For some time, investors have generally expected that Trump really held fairly orthodox economic view on tariffs and that, ultimately, he would use them to seek deals. That view is still probably held by investors, even if it appears that Trump is playing harder hardball than expected.
However, clearly, markets are having to increase the probability of a scenario where Trump wants tariffs more than he wants deals.
Trump appears to have hardened his position in recent days. He has said he is “tariff-man”, and that appears to be a policy goal rather than an attempt to gain bilateral deals. The strategy is to raise revenues from foreigners to pay for tax cuts and tax relief extension. Scott Bessent gave an estimate for how the balancing act might go during his confirmation hearing; over 10 years, the tax cuts will probably cost $4.6 trillion and tariff revenues might generate up to $3 trillion, and spending cuts/efficiencies are put in place to drive the federal deficit down towards Bessent’s target of 3% of GDP.
If that is the case, we should not expect that deals will be forthcoming. While Trump used immigration and drugs to declare an economic emergency as a justification for the executive order, they are a sideshow – if Trump gets Canada and Mexico to act on these issues, all well and good but it probably won’t mean reduced tariffs. Rather, he said plainly that he seeks bilateral trade balances; export values should be the same as import values.
In this scenario, we should expect that tariffs will be forthcoming on Europe. On Sunday night, Trump said tariffs will “definitely happen” with the European Union and possibly with the United Kingdom as well.
Still, there may be differences applied to individual nations. “The UK is out of line, but I think that one can be worked out, but the European Union is an atrocity what they’ve done.”
Starmer appears to be taking him seriously, approaching the US President with care. Reuters reports that Trump, asked on UK tariffs, said “I think that one can be worked out”. Perhaps this is because the UK has a net deficit in goods and services trading with the US.
The President’s relationship with Congressional Republicans may also be under strain, affecting his ability to enact his agenda. The Budget Reconciliation process begins next week and that is likely to throw up all sorts of potential points of conflict. They usually try to wrap it up by May but it’s highly likely to head to the wire in August.
Trump will also probably have to deal with the Supreme Court shortly over the other executive orders which breach both the constitution and US government contracts made with overseas governments.
But perhaps of biggest interest will be the effect on consumer confidence. On Sunday, Trump posted the following:
“WILL THERE BE SOME PAIN? YES, MAYBE (AND MAYBE NOT!)”… “BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID.”
Given that the cost of living was a decisive issue in the election, this may not be as easily swallowed by his base as he seems to assume. From February 4th, the tariffs will be all-encompassing, including food, energy and raw materials. Consumers face imminent price rises, especially in the more northerly states.
The media have been surprised with some Trump-supporting outlets expressing disquiet, even outrage. The Wall Street Journal published an Op-Ed calling the tariffs on neighbours “the dumbest trade war in history.” Trump retaliated saying that the WSJ was leading the “Tariff Lobby” and saying their reporting was fake news, controlled by China. Meanwhile, maybe not so remarkably, Fox News has only two articles which allude to the tariffs and nothing in its opinion section.
The first opinion polls since the imposition of executive orders and tariffs will be available by the end of this week.
Since the news last Friday, equity markets have reacted sharply, down about 1.5 – 2.5% generally. While the impact is broader, it is not dissimilar to last week’s AI news from Chinese DeepSeek. So, it’s notable that there is so far less panic than one might have
expected, given the economic damage potential his actions entail. At least there was a late session in the US for US investors to trade after the announcement.
Meanwhile the Chinese New Year makes domestic investor reaction difficult to gauge. Currencies have generally shifted lower against the US Dollar, with Sterling -1%, the Canadian Dollar and the Euro -2% and the Mexican Peso -3%.
For markets, the underlying tone is not yet negative but this combative and disruptive phase is eating into the positivity. Liquidity was abundant but broad market declines can reduce that liquidity quite quickly.
In terms of US monetary policy offsets, it is difficult for the Fed to loosen given the effect that tariffs might have on inflation.
Potentially however, the disinflationary impacts on other nations could mean policy action, and that possibility is causing investors to buy bonds. German 10-year bond yields have fallen 0.10% to 2.40%, with the inflation-linked 10-year yield now at -0.20%. UK 10-year gilt yields have also fallen 0.10% below 4.50%, and a similar fall in 10-year inflation-linked bonds to a real yield of 0.85%.
Bond gains do help to stabilise the liquidity situation in markets, but the sense that risks are rising may mean more volatile assets may remain under pressure. Investors are likely to remain wary.