Over the last few weeks markets have been whipsawed by tariffs. In February Trump announced 25% tariffs on goods from Canada and Mexico, but then reversed course, delaying the implementation for one month. The tariffs to the two countries became effective on March 4th, but then billions in exemptions were put into effect while the countries negotiate. Meanwhile, a 10% tariff on China went into effect on February 4th, and was increased to 20% on March 4th. A tariff on the European Union of 25% was announced on February 26th. Multiple countries have retaliated with tariffs of their own, risking an all-out trade war, and creating a high degree of uncertainty. Whether you agree or disagree with politics, we as investors need to be aware of the impact tariffs can have on global markets. Here is an overview.
What is a tariff?
A tariff is essentially a tax on goods that are imported into a country, similar to a sales tax but charged when goods cross into a country through customs. Tariffs are often used to protect domestic industries by making imported goods more expensive, thus encouraging consumers to buy local products.
Do tariffs increase costs?
Tariffs increase costs by creating ‘friction’ in the marketplace. What I mean is that manufacturers can no longer readily and easily use the lowest cost supplier globally. For example, an auto manufacturer may have an increase in the cost of steel to make cars, a cost that they may or may not be able to pass along to their customers. This can be particularly painful for US manufacturers, such as Caterpillar and Boeing, that export globally and compete with global competitors. These global competitors may be able to take advantage of lower costs in the global marketplace not subject to the tariff.
Sometimes foreign countries can fully or partially offset the cost of the tariff by reducing prices or devaluing their currency.
Will tariffs cause a recession?
Economic data is still strong, and we continue to believe that the US economy is resilient enough to withstand the tariffs, but tariff uncertainty is one of the biggest risks for 2025. Even the possibility of retaliatory tariffs can impact future investment. Consider for example, a company that is trying to decide where to locate a factory. If future costs are unknown, the company may pause on the investment. A good rule is that businesses like stability since stability increases confidence and allows further expansion.Â
The United States has historically been one of the least protectionist countries in the world. Ironically, some of the countries that criticize the new tariffs, including Europe and China, are much more protectionist of their own markets. One of Trump’s stated goals is to end this type of unfair trading practice. If these countries negotiate to lower tariffs on US goods in order to avoid tariffs on goods coming into the US, the ultimate outcome could be very positive for the global economy. On the other hand, if we see a trade war with continued escalation on both sides, this could damage global trade and risk a recession. Given these unknowns we believe it is appropriate to remain defensive, but diversified, including diversification in foreign markets, and bonds.