Trending
Written by: Len Reininger | Advisor Asset Management
We are hearing from virtually all segments of the media that we are about to enter a new inflationary period based on pending tariffs proposed by President Trump. To summarize, most recent tariffs include:
- A 25% tariff and steel and aluminum imports (aluminum tariffs will rise from 10% to 25%)
- A 25% tariff on Canadian imports except for energy, where a new 10% tariff will be imposed
- A 25% tariff on Mexican imports
- An additional 10% tariff on Chinese imports, on top of the existing 10% tariff
Note that of this writing, there has been a one-month delay on the tariffs on automakers, and on Canada and Mexico, but the ultimate effects mentioned herein once the tariffs go into effect remain unchanged. Additionally, reciprocal tariffs (see below) are still scheduled to take effect.
In addition, the president indicated more to come with the announcement of his "Reciprocal Trade and Tariffs” Executive Memorandum that provides the basis for additional tariffs with the goal of addressing “unfair and unbalanced” trade practices. These practices are defined as follows:
- Tariffs imposed on U.S. goods
- "Unfair, discriminatory or extraterritorial taxes" including value-added taxes (VAT)
- "Non-tariff barriers" and "burdensome regulatory requirements"
- Policies that "cause exchange rates to deviate from their market value"
- "Wage suppression;" and "Any other practice that…imposes any unfair limitation on market access or any structural impediment to fair competition" for the U.S.
This week, President Trump announced that he is prepared to impose 250% reciprocal tariffs on Canadian lumber and dairy products, the same tariffs as Canada had been charging the U.S. on those products.
In addition, partner economies that run a goods trade surplus with the U.S. are likely to draw attention for potential trade measures. According to the policy, economies that have sizeable bilateral tariff differentials with the U.S. (i.e., India, Argentina, Brazil) and those with high non-tariff barriers (i.e., Canada, China, EU) are additionally at risk of trade restrictions.
The U.S. is the world's largest goods importer: in 2024, it absorbed $3.3 trillion of foreign goods (11.3% of U.S. GDP). Consequently, the administration sees the U.S.' $1.2 trillion goods trade deficit (4.1% of U.S. GDP) as a problem to be addressed bilaterally by making deals with trading partners that want access to the U.S. market to also buy more U.S.-made goods in return, or levying tariffs on goods imported by the U.S. An increase in U.S. manufacturing production and raising revenues appear to be additional objectives behind the administration's emphasis on examining all trade.
As noted below, U.S. tariff rates are among the lowest in the world when looking at the top 10 trading partners, which helps provide the rationale of the president’s view of the U.S. trade policy not being balanced. The average U.S. tariff rate is about 3% (trade-weighted average of 2.2%), among the lowest in the world. In fact, by product group, the U.S. falls near the bottom of almost every category, specifically agricultural products for which it maintains the lowest simple and trade-weighted averages across 10 major trading partners. If all tariff threats are implemented, the U.S. tariff rate would rise to 10.7%.
Taken by itself, tariffs will have both positive and negative impacts on various industries — positive for steel and negative for autos and auto parts. Most analyses talk about a negative impact on employment, inflation, and economic growth. However, the U.S. federal government is taking a more holistic approach to tariff impacts beyond the direct impact of the tariff itself. And, as it turns out, the imposition of tariffs is not the doomsday some business articles and some rating agencies are making it out to be, in our view.
At the same time the tariffs are going into effect, there are growing disinflationary forces at play. For example, the U.S. Energy Information Administration (EIA) is forecasting that beginning in the 2nd half of 2025, gradual increases in energy production combined with relatively weak global oil demand growth will increase global oil inventories, placing downward pressure on prices through at least 2026. Oil price drops have already started to begin as over the past month, WTI crude oil futures are down 5.2%. The EIA expects prices to continue falling. This is highly disinflationary and has the potential to counter any inflationary impact due to increased tariffs. And the EIA forecast does not account for the pending deregulation and expansion of the U.S. domestic energy industry, which have already begun. Per Treasury Secretary Scott Bessent, “…there will be tariffs, there will be cuts in regulation, there will be cheaper energy. So, I would expect that very quickly we will be down to the Fed's 2% target. So, I'm expecting inflation to continue dropping over the year.”
Past performance is not indicative of future results.
And while projections assume that in net U.S. jobs will be lost, that analysis ignores the impact of companies expanding domestically, or even relocating to avoid the tariffs, even at this early stage. Note that in the last few days, a foreign auto manufacturer announced that it is moving the production of one of its models from Mexico to Indiana, and a foreign semiconductor manufacturing company will be expanding its manufacturing facilities in the U.S. to the tune of $100 billion primarily due to the threat of tariffs on semiconductor imports.
Another factor to consider is that, according to Moody’s, the pass-through of tariffs to U.S. consumer prices will be gradual and incomplete because firms' ability to pass on additional price increases is severely impaired today due to high prices and inflation, unlike in 2018, when inflation was around 1% in the prior three years and was not a serious issue. According to Moody’s, more companies will absorb the increases and are already looking at increasing savings and cost cuts so as to not pass it on to the consumer. However, this could have a negative impact on corporate margins for companies most vulnerable to tariffs. In other words, already-high prices leave companies with only limited power to protect their margins from inflation and a dampening in consumer demand resulting from U.S. tariffs. This acts as a deterrent for passing prices on to the increasingly cautious consumer. Current high prices leave retailers with limited pricing power to offset tariffs.
Additionally, only a fraction of imported goods' retail prices will be subject to a tariff because domestic content, such as design, sales, logistics and retail, comprises about half the cost of a product, lessening the impact of tariffs. In other words, tariffs will only apply to a portion of a finished product. Meanwhile, imported consumer goods make up only around 8% of total personal consumption expenditures and imported intermediate and capital goods make up around 6% of the value added in U.S.-produced goods and services. We do not believe these factors are a recipe for devastating price increases resulting from tariffs.
On another note, the Atlanta Fed GDPNow graph, which is making the rounds, looks very disinflationary as GDP growth goes below 0%. It is noted that this view is not shared. The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2025 is -2.4% on March 6, down from -1.5% on February 28, and certainly not inflationary, if the estimate is correct.
Finally, last week’s data showed that the Personal Consumption Expenditures (PCE) index increased 0.3% in January and showed a 2.5% annual rate. Excluding food and energy, core PCE also rose 0.3% for the month and was at 2.6% annually. The 12-month core measure showed a step down from the upwardly revised 2.9% level in December in an apparent easing of inflation.
If the goal of the imposition of tariffs is to prevent an unbalanced transfer of wealth while at the same time stimulate domestic growth which in turn, stimulates GDP, this can be done without a serious inflationary impact on the U.S. consumer. This also occurs at an opportune time as there are deflationary pressures brewing in the economy. Increasing domestic growth by attracting new companies and encouraging the expansion of others within the U.S. to avoid tariffs (which we are already starting to see), without a serious inflationary impact, would obviously strengthen the domestic economy and spill down to improving corporate credit quality.