Be careful what you wish for

The Trump administration has doubled down on a hardline trade agenda with bold aims: to generate revenue to fund tax cuts, eliminate bilateral trade deficits and thereby increase domestic production and reduce foreign demand for US reserve assets by lowering the financial account surplus. To pursue these objectives, it has announced a sweeping 10% tariff on all goods imports, alongside targeted tariffs capriciously calibrated to “match” trade deficits with specific countries. This aggressive strategy is rooted in the belief that the US can produce much of what it imports domestically, reducing the need for imports and the corresponding trade deficit. This would in turn suppress imports and shrink the financial account surplus and, by extension, demand for US dollars. 

As history warns, such actions come with a steep economic price, something that most global stock investors are now acutely aware of. With weighted average tariff rates (WATR) now rising above 25%, a ten-fold increase, they are above the calamitous levels of the Smoot-Hawley tariffs of the 1930s when tariffs reached 20%. The weighted average tariff rate on China is now 62.5%, which risks plunging the Chinese economy into a bigger slump than during the early months of the pandemic.  Vietnam, a so-called connector country whose exports to the US grew as manufacturers relocated there after Trump imposed tariffs on China during his first term, now faces tariffs of nearly 49%. Indonesia, another country with a high trade deficit with the US, exports manufacturing goods, which could arguably be made in the US, but also goods such as palm oil, which will never be produced in the US.

The outcome of these actions will tip the US, and very possibly the global economy, into recession. On a static basis, a 25.5% WATR would impose a cost to the US economy of about US$830bn, or 2.9% of GDP (in 2024 nominal terms). If the majority of tariff costs are fully passed on to consumers (a reasonable assumption), the rise in tariffs would increase US personal consumption expenditures (PCE) inflation this year by about 2.3 percentage points, taking the rate well above the 2% target of the Federal Reserve (Fed, the central bank) to closer to 4.5%. 

Ultimately, we believe that the Fed will be forced to cut rates four times this year, consistent with our January estimates. In addition, we believe the Bank of Japan will indefinitely pause its rate normalisation programme, as the governor hinted in a September 2024 speech when explaining the contingencies of the future rate path. Meanwhile, we expect the Bank of England and the European Central Bank to continue cutting rates. 

In the short term, the tariffs will achieve their intended effect: US imports will fall, and the financial account surplus will contract. But this outcome will be delivered not by productive rebalancing, but by recession. A less dynamic global economy, weighed down by inefficiency and protectionism, will be the new normal for the near future. Inflation will rise, growth will falter and productivity will stagnate. Central banks may soften the blow, but monetary policy alone cannot undo the structural damage. Be careful what you wish for—because when trade shrinks and recession takes hold, you may get far more than you bargained for. 

Find details about our forecasts for lower growth, lower rates, temporarily higher inflation and lower potential GDP.

Constance Hunter C-Suite Executive| Board Member | Strategy | Economics | Risk |…

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