Trump, tariffs and a big dose of policy uncertainty

Trump, tariffs and a big dose of policy uncertainty

At the weekend, US President Donald Trump announced 25% tariffs on goods from Mexico and Canada (10% on energy products). These countries send around 80% of their exports to the US. He imposed an extra 10% tariff on Chinese imports. After last minute negotiations, Mexico and Canada tariffs have been delayed a month while further discussions continue. Further climbdowns are possible. However, Trump has given clear indications that tariffs are also incoming on the EU (but not necessarily on the UK where he suggested things could be worked out).

Why is Trump threatening/imposing tariffs? According to the White House the weekend tariff announcements were a reaction to illegal immigration and a desire to stop fentanyl and other drugs from flowing into the US.

However, Trump has outlined a broader agenda with tariffs including revenue raising (which could help offset the cost of planned tax cuts) and pressuring businesses to bring manufacturing back to the US. The president stated “As tariffs on other countries go up, taxes on American workers and businesses will come down and massive numbers of jobs and factories will come home...”

Will the tariffs ever be imposed? It is possible that in a month’s time Trump goes ahead with the tariffs anyway. Without imposing significant tariffs, he is unlikely to raise much in the way of revenue. It seems likely that we will get some kind of EU tariff announcement. I still think there is a relatively high probability he goes ahead with his universal across-the-board tariff plan in some form.

Legal challenges are possible, and some confusion/disruption seems likely in any event. The tariffs/threatened tariffs on Mexico and Canada follow decades of tariff free trade – currently under the USMCA trade agreement. Canada and Mexico form key parts of supply chains for some industries (notably autos) and a large percentage of US imports for some specific goods.

Higher uncertainty about the policy environment may lead firms to hold back on investment decisions.

Even if most tariff threats are retracted = policy uncertainty. President Trump is engaging in fast and substantial policy change on several fronts, not only tariffs. This is likely to generate substantial policy uncertainty for businesses (and households). That itself of course can be seen as a negative for economic activity. For example, higher uncertainty about the policy environment may lead firms to hold back on investment decisions.

Economic impact (negative for growth, while pushing up prices): Economists disagree on the likely impact of tariffs on inflation and his original tariff pronouncements during his election campaign included across-the-board tariffs on all trading partners, giving rise to some of the larger estimates in terms of inflationary impact.

Focusing on the announcements this weekend (Mexico, Canada, China), raising barriers to trade with your biggest trading partners is not normally seen by economists as a recipe for growth. Estimates of the impact on US GDP seem to range from around -0.2% to -1.2%. On inflation they seem to range from around +0.1% to +1.0%. Estimates of the impact on the Canadian and Mexican economies are generally larger than this. See for example estimates from the Peterson Institute for International Economics ( Trump’s threatened tariffs projected to damage economies of US, Canada, Mexico and China).

The impact of these or any tariffs depends on several factors – including whether there is retaliation, moves in exchange rates and how far tariff moves are absorbed in profit margins (let alone how long they were to last):

• How far we see offsetting currency moves (note that we have already seen some significant currency movement into- and post-election)
• How much of the impact is absorbed by importer or exporter margins – likely itself to vary depending on whether domestically produced substitutes for goods are available and how large and permanent the tariff hikes are or are expected to be.
• Whether competing domestic producers and other exporters take the opportunity to raise their prices.

If I take Trump’s main policy promises together (fiscal, deportations, regulatory, tariffs), I see them as likely to be inflationary. However, there are big questions around scale and timing in terms of how far he will, and will be able to, pursue those agendas and that goes for tariffs too.

Implications for interest rates: A Fed hike (not my central case) is not a far-fetched scenario for 2025/6 if Trump’s tax, immigration and tariff agenda is rapidly enacted and proves inflationary in combination (potentially offset somewhat by deregulation and a stronger dollar). However, the timing of different strands will also be important. We could get most of the growth-negative bits of the Trump agenda for example, before the growth-positive bits. The Fed has a dual mandate and, as above, economists see a negative impact on activity from tariffs if they are imposed (presumably feeding through to labour demand) and an upward impact on inflation over the next year or so.

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