Weekly Market Recap

Last week saw dramatic escalation and then de-escalation in U.S. President Donald Trump’s global trade war.

After the imposition of 25% tariffs on steel and aluminium import, measures that will severely hurt Canada’s metal production sector and mean higher metals prices for American manufacturer, Canada’s Ontario premier Doug Ford announced he would impose a 25% surcharge on electricity supplied by Canada to America’s northern states.

The response?

President Trump declared he would double the tariff on Canadian steel. Both sides have since withdrawn. The 25% tariffs remain in place. The European Union announced its retaliatory tariffs, which will come into effect in April should the U.S. import taxes remain in place.

President Trump again signalled he would retaliate if the EU implemented these tariffs. By April, there may be more tariffs on EU exports to the U.S. This will depend on U.S. investigations into the need for reciprocal tariffs to counter any trade restrictions that other countries are deemed to have put in place, including value added tax (VAT).

There have been two distinct phases to the market action since last year’s U.S. election. The first was a repeat of the ‘Trump bump’ experienced in his first term. This took place after the election result confirmed there would be a second Trump term. Investors reacted to the prospect of a Trump presidency, anticipating benefits such as reduced regulation and the possibility of tax cuts.

However, even during the last stages of the Trump bump, European equities had begun to pick up steam and following his inauguration, the Trump bump has become a Trump slump! European equities have broadly managed to continue rising despite a sharp sell-off for global equities, which is almost entirely driven by the U.S.

‘American exceptionalism’ has flourished over the era of global trade

U.S. exceptionalism has been a remarkable trend over a long period. The U.S. began outperforming following the great financial crisis in 2007-2008. Several stars had aligned for this. The U.S. tech sector finally emerged from the shadow of the tech bubble.

Meanwhile, Europe suffered from a debilitating debt crisis and saw a slowdown in China and other emerging markets, which had been strong markets for European exports for many years. As the economy continued to digitise, America’s economy outperformed.

It was aided by more favourable demographics, fortuitous natural resource wealth, a dynamic business environment, and capital inflows from other countries, which kept borrowing costs low despite constant budget deficits.

Many of the conditions that have allowed the U.S. to rise to the top of the pack are being challenged by the Trump administration’s unironic pledge to Make America Great Again.

Could populism force the world’s biggest economic success story to give up its crown? The odds still seem strong for America to remain exceptional.

Its geographic benefits are outstanding from a geopolitical and economic perspective because it’s easily defensible and accessible to trade, with incredible natural resource wealth. Europe, on the other hand, is fragmented, with a Russian aggressor on its doorstep.

The largest U.S. companies have remarkable monopoly power and an unrivalled position in the coming artificial intelligence revolution. There’s controversy about how highly their leadership position should be valued, but the fact they’re the leaders is beyond debate.

How are tariffs affecting business sentiment?

Small business owners usually appreciate a Republican president, but Trump 2.0 is testing their patience.

There has been a meaningful sell-off in U.S. equities despite there being little evidence of economic weakness from companies and economic statistics. However, surveys hinted that change is afoot.

A couple of weeks ago, anecdotal comments within the purchasing managers indices (PMIs) indicated a more nervous business community. Last week, this sentiment was reflected by the National Federation of Independent Businesses (NFIB), which had originally cheered the arrival of a new Republican administration.

It still considers now a better time to expand its businesses than at most points during Joe Biden’s presidency, but it’s noticeably less ebullient about it now than just weeks ago. That’s because the threat of tariffs is likely to mean higher costs, with the risk of disrupted supply chains and, for those who export, the possible imposition of retaliatory tariffs.

For many companies, there’s no choice but to pass those additional costs on to clients. In the long term, some companies have pledged to move manufacturing into the U.S. as President Trump wants. But building new plants for manufactured goods typically takes years, so there’s no quick fix to this threat if the tariff is going to remain until companies have genuinely shifted their production.

The potential impact of tariffs is difficult to quantify, especially as the specific targets, levels and duration of the measures remain uncertain, but we shouldn’t be too concerned by dramatic shifts in survey data.

There have been instances of surveys suggesting very pessimistic economic outcomes only to rebound when respondents have a better idea of what the new business environment is going to be like.

Brexit would be a good example of this. The immediate impact of these tariffs will be far more material than the years of inaction over Brexit, but that doesn’t prevent people from overreacting in surveys.

Peak bearishness – prime buying opportunities?

The American Association of Individual Investors (AAII) business sentiment survey has been a terrific barometer of stock market overreaction in the past. It has now risen to levels that have been associated with some of the most timely ‘bottoms’ in the stock market over recent decades.

Peaks in bearishness, as per this measure, that were recorded in March 2003, March 2009 and September 2022, were all tremendous buying opportunities for the coming years.

In each of those instances, the market was considerably more depressed than it is at the moment, so we probably can’t expect the dramatic gains they offered. But it does indicate that the tariff message has hit investors hard, which sets up the potential for a rebound.

Coming up this week

Monetary policy: Major central bank decisions are on the agenda this week. The Bank of England, the Federal Reserve, and the Bank of Japan are all setting monetary policy, although none are expected to change their current stance (for this month at least).

UK growth: High wage growth is holding the UK back from cutting interest rates. Data on Thursday will reveal whether it has slowed at all.

On Tuesday last week (4 March), the U.S. imposed 25% tariffs on most imports from Mexico and Canada. The exceptions to this were potash (a fertiliser used in farming) from both countries and energy products from Canada, which would be tariffed at a reduced rate of 10%.

Canada, however, has been quick to react with retaliatory tariffs, including an export tariff on the electricity it provides to northern U.S. states, which is designed to impose a real cost on U.S. consumers. Over the weekend, former governor of the Bank of Canada Mark Carney successfully contested the leadership of the Liberal party and will soon become prime minister.

Referring to the trade war, Carney said “We didn’t ask for this fight, but Canadians are always ready when someone else drops the gloves.” Earlier today, in response to those retaliatory measures, U.S. President Donald Trump announced that tariffs on Canadian aluminium and steel would be increased to 50% on 12 March.

By last Wednesday (5 March), it seemed there would need to be an exemption for the car industry, because many products cross the border several times during the manufacturing process. Car makers argued that subjecting their crossborder supply chain activity to tariffs that European and Asian carmakers don’t suffer from puts America at a disadvantage.

It’s unclear why this took until Wednesday to recognise because it had been widely discussed during the presidential campaign. An exemption was granted on Thursday for goods traded under the United States-Mexico-Canada Agreement (USMCA), the agreement negotiated by President Trump’s first administration.

Investors are bracing for the impact of President Trump’s erratic trade policy. This U-turn on Mexican and Canadian tariffs follows an eleventh-hour decision last month to defer their implementation until 4 March. The president lauded the progress made in the fight against fentanyl imports since the tariffs were first threatened.

However, he promised there won’t be another deferral in April, when reciprocal tariffs on Mexico and Canada are due to come into effect following a review. The seemingly endless stream of deferrals and modifications to the Canadian and Mexican tariffs follow February’s attempt to end the tariff exemption on small packages (which had to be temporarily halted due to logistical challenges related to enforcement).

It’s surprising that these challenges hadn’t been foreseen. However, the Trump administration has seemed to be in a state of disillusionment over the effect of tariffs and trade. President Trump believes companies in another country selling goods to Americans are effectively ripping America off, and that producers pay tariffs; overwhelmingly, it’s consumers who pay them. This is not a widely held opinion.

The art of the deal war

Perhaps what’s most surprising about his approach is his apparent desire to go after all other countries at once (assuming he follows through with promised reciprocal tariffs in April). Analysts acknowledged ahead of the election that the U.S. would be in a strong position to negotiate with other countries under the threat of tariffs because trade doesn’t actually make up a particularly large share of the U.S. economy.

However, it seems this position of strength is being squandered. Other countries may trade more, but if the U.S. imposes tariffs on all trading partners simultaneously, as President Trump seems to be suggesting, and if those trading partners impose counteracting tariffs, this raises the amount of U.S. trade subject to tariffs relative to peers, who’ll be trading largely tariff free between each other.

Thousands of years of military strategy, dating back to Sun Tzu’s text ‘The Art of War’, contains variations of the idea that the best path to success is to ‘divide and conquer’. Whilst not a warrior, the Trump administration seems more willing to unite its rivals. Perhaps it’s telling that in his negotiating guide ‘The Art of the Deal’, Trump never really addresses the power dynamics that come from collective or individual negotiations (despite this being a tried and trusted path to negotiating success).

The effects seem telling. Business surveys have shown a marked deterioration in confidence. In some cases, this has been reflected in less activity. In others, the shoe seems likely to drop in coming months. Companies struggle to explain how they’ll react to tariffs because they don’t know what these tariffs will be. It seems reasonable to believe that a company might be more willing to invest in a new U.S. plant than a non-U.S. plant given the threat of tariffs.

However, the decision to invest at all might be in question if you don’t know what tariff you’ll pay on imported components, or how much of a tariff advantage there is to invest in the U.S., relative to the much higher labour costs.

The only certainty is uncertainty

Some business surveys include anecdotal comments from submitters. Almost all of them are negative at the moment, and most of them cite tariffs as the reason for anxiety. An example that stands out from the Institute for Supply Management (ISM) manufacturing survey says: “Management now has us running scenarios to project tariff impacts to our business. They want numbers in 24 hours on variables that equate to a wild guess. Interesting times we live in.”

This shows how difficult it is for companies to make decisions when the taxation of imports changes almost by the day. A number of retailers reported earnings last week, and so the topic of tariffs came up with management. Very few companies have anything significant to say in terms of their mitigation strategies.

Commentary tends to make trite references to leveraging global buying power and focusing on value for customers. Very few know exactly what the impact will be or can do much about it in the short term. There has been some evidence of a slowing U.S. economy. The Citigroup Economic Surprise Index edged below zero, suggesting the economy was performing worse than expected.

Perhaps most extraordinarily, the Federal Reserve of Atlanta’s current estimate of gross domestic product (GDP), (‘nowcast’), known as GDPnow, fell sharply at the beginning of last week. The biggest detractor came from the sharp increase in imports.

Imports reduce GDP while exports increase it, but as businesses anticipate an increase in tariffs, they try and buy ahead of the tax increases. That effect should reverse in coming months, notwithstanding the constantly moving tariff environment.

U.S. consumer confidence drops

However, beyond this, there also appears to have been a more pronounced drop in consumption. This seems likely to reflect an increase in economic caution. Reduced retail sales and weaker confidence surveys have been the clearest indications that the economy is turning.

The U.S. labour market broadly held firm. The non-farm payroll report showed employment creation was weaker than expected and the unemployment rate rose unexpectedly. However, some of that impact is due to a higher-than-average number of workers being unable to work due to bad weather.

Government employment will receive lots of scrutiny as the impact of the Department of Government Efficiency builds. So far, federal government employment was only down by 10,000 jobs in February, but next month will be a better test.

There was some reassuring news on inflation, with lower-than-expected wage growth. Given the weak economic data momentum recently, this firmed up bond markets’ expectations of three rate cuts from June this year.

Forget MAGA and get MEGA

Whilst President Trump’s activities may be dampening economic activity in the U.S., they seem to be accelerating it in Europe. An acrimonious meeting between President Trump and Ukrainian President Volodymyr Zelenskyy saw the U.S. halting aid and ending intelligence sharing with Ukraine.

The move was a devastating blow to Ukrainians and a boost to Russia. It had a galvanising effect on Europeans. On Tuesday evening, German leaders announced their intention to reform the constitutional debt brake to essentially allow for open-ended borrowing for defence. It would also allow for the creation of a €500bn special purpose vehicle for infrastructure investment.

The announcement came on the same day that European Commission President Ursula von der Leyen proposed her ‘ReArm Europe’ plan. The plan includes providing loans to member states to buy military equipment and, more importantly, a commitment to trigger the European Union (EU)’s national escape clause.

This would prevent military expenditure from being counted in the bloc’s punishment mechanism for countries breaching EU spending limits. So, while Trump is trying to Make America Great Again, it’s also time to Make Europe’s Guns Again. Hardly a reassuring thought but one that has boosted the equity market and pushed down European bond prices.

There are immense challenges around increasing defence spending at a time when European countries have very stretched public finances. France’s government fell last year after struggling to pass tax increases to try and restore its fiscal poise. Aerospace and defence companies can be challenging investments as they are inherently unpredictable, have complicated accounting, and rely on government orders.

Following the recent rally, European defence stock valuations appear generous and are vulnerable to headline risk, so we’re not inclined to chase this rally. However, stepping back, increased European defence and infrastructure spending may have longer-term benefits for European indices beyond the defence sector, so we’ve raised our allocation to European equities.

We also cut our gold weighting slightly, remaining overweight. The conditions supporting gold remain broadly in place. It could be sensitive to a further rise in bond yields, but recently, gold has been relatively resilient in the face of yield movements. Instead, it seems to be driven more by being bought by central banks seeking to reduce their dependence on U.S. dollars.

There’s little indication of that trend changing, but in recognition of the extremely strong performance from gold, we thought it was prudent to take some profits.

What’s coming in the week ahead

This week, the economic landscape will be filled with key events that will likely shape market expectations and investor sentiment. We’ll see the release of several significant economic indicators, including China’s inflation rate, Germany’s balance of trade, and the U.S. Job Openings and Labor Turnover Survey, inflation rate, and producer price index.

These data points will provide valuable insights into the current state of the global economy and will likely influence monetary policy decisions and market trends. The Bank of Canada’s interest rate decision and the UK’s GDP growth rate will also be closely watched. In terms of corporate earnings, this week will see reports from several major companies, including Oracle, Ferguson, Adobe and Inditex.

Investors will be watching these reports closely for signs of growth and guidance, although for some companies, the tariff confusion will complicate this. If recent weeks are anything to go by, scheduled releases from companies and statisticians will be overshadowed by the latest erratic action from President Trump.

Another week passed and U.S. President Donald Trump was his usual vocal self, but did also signal some decisive action. President Trump sewed some confusion when he said on his app, Truth Social, that trade tariffs on Canada and Mexico would come into effect in April.

It seems likely he was referring to his planned reciprocal tariffs, which are due to be decided in April following investigations. 25% tariffs on Canada and Mexico were imposed today (4 March).

This is due to President Trump stating he wasn’t happy with the efforts made to reduce the inward flow of the addictive substance fentanyl through America’s neighbours. Of course, that could change. However, it’s hard to see how Canada can significantly reduce its share of fentanyl flow into America, it’s estimated that far less than 1% comes in via the northern border.

While tariffs had been threatened against Canada and Mexico, Chinese tariffs were already imposed in February over fentanyl flowing into the U.S. from China. So, it was a shock when President Trump announced that he would increase those Chinese tariffs by an additional 10%. China tends to respond with its own counter measures when tariffs become effective (a wise move given the U.S. president’s tendency to withdraw them at the last minute).

On this occasion, with the Chinese economy still struggling, there’s speculation that this latest challenge could prompt explicit measures to boost economic activity, such as fiscal stimulus or even a currency depreciation. China has recently seen its consumer prices start to pick up, but inflation remains disconcertingly low.

For that reason, China wouldn’t need to worry about the inflationary impact of a currency depreciation. President Trump also discussed potentially selling gold cards to wealthy prospective immigrants. For the sum of $5million (paid to the U.S. Treasury), these would grant the benefits of a green card.

Will Germany loosen its brakes?

The German election results were announced last week. The Christian Democratic Union (CDU) emerged as the largest party, with the previous leaders, the Social Democratic Party (SPD), slipping to third place.

While the results were largely in line with polling predictions, the victory gave the CDU (and its usual electoral partners the Christian Social Union [CSU]) and SPD enough votes to form a governing coalition with a narrow majority of 13 seats. Even if that group worked together with the Greens to relax the debt brake that limits Germany’s ability to borrow, they would fall marginally short of the 66% majority required to achieve the constitutional change.

The importance of this is a matter of debate, because the CDU and Greens would both like to borrow more money, but they would always struggle to agree what it should be spent on. The CDU favours defence, whereas the Greens place more importance on infrastructure.

With constitutional reform seemingly off the table, there are ways to increase spending a little by using loopholes or by declaring an emergency. The looming threat of an antagonistic Russia and/or the weakening of America’s commitment to NATO (without further spending from European peers) under President Trump seem reasonable arguments for an emergency.

Chancellor-elect Friedrich Merz spent the week trying to negotiate for greater defence spending. This was met by howls of protest from other party heads over what they suggested were double standards; Merz has previously held former Chancellor Olaf Scholz to account over borrowing plans and now wants to raise borrowing himself once elections have been concluded.

Nvidia shares its company results

One of the most significant events last week was Nvidia’s earnings results. It’s late in the earnings season but Nvidia’s results have become an important market gauge for the strength of demand for artificial intelligence and its associated infrastructure.

The results were strong, with revenue growth of 78% year-on-year, which was technically well above expectations. The company’s guidance for the next quarter was also positive, with expected revenue growth of 6% to 8%, which was good, but it didn’t inspire the market. 74% of companies have beaten earnings estimates this year, so sometimes just beating estimates isn’t enough, instead, they must far exceed expectations.

Berkshire Hathaway’s recent results showed strong performance, with operating earnings up 45% for the quarter and 25% for the year. The company’s cash position has increased, and while there were no share buybacks, the valuation isn’t seen as particularly demanding. Warren Buffett’s unwillingness to buy back either his own shares or to make further investments in the market provides an indication that valuations aren’t currently wildly attractive.

Looking ahead

This week, investors will be bracing themselves for a slew of economic events that could significantly impact the markets. Key releases, including manufacturing and services purchasing managers indices (PMI) data, inflation rates, gross domestic product (GDP) growth, and employment numbers from major economies are all set to feature.

Chinese indices, the NBS Manufacturing PMI and the Caixin Manufacturing PMI will provide insights into the country’s manufacturing sector, with expectations of a modest recovery. In the U.S., the Institute for Supply Management (ISM) Manufacturing PMI is expected to show a decline in manufacturing activity, while Japan’s Consumer Confidence Index may indicate a slight improvement in consumer sentiment.

In addition to these economic events, several major companies are scheduled to report their earnings this week, including Broadcom Inc, Ashtead Group, Admiral Group, and Costco Wholesale Corporation.

These reports will provide valuable insights into the performance of these companies and their respective industries. Investors will be watching these releases closely for signs of strength or weakness in economic recovery, which could impact market sentiment and direction.

Notably, European equities have performed well following a tough 2024. They were perceived as victims of President Trump’s interventionist economic trade policy and as such, they were unloved and under-owned but have bounced back firmly.

Like all regions, European companies generate a lot of their revenue globally, but unsurprisingly, they’re the most exposed to European economies. Around 30% of the revenue generated by European companies comes from the region, so when a domestic economy struggles, it has a market impact.

Has the outperformance of European equities reflected a less antagonistic stance from the Trump administration?

Far from it. If anything, investors might be more concerned about the challenges posed by President Trump’s actions now than they were before the U.S. election. His tone has been strangely antagonistic towards Europe.

U.S. geopolitical focus adds pressure on Europe

A couple of weeks ago, we discussed the suggestion that the U.S. administration might consider value added tax (VAT) as a barrier to trade, despite logic and research arguing otherwise.

Last week, the pressure on Europe shifted to geopolitics, with Secretary of Defence Pete Hegseth telling the Munich Security Conference that Europe should foot most of the bill for Ukraine’s defence against Russia. Hegseth said returning to pre-2014 Ukrainian borders (when Russia annexed Crimea) was unrealistic, and that NATO membership for Ukraine was also an unrealistic prospect.

To underpin the weakness of Ukraine’s negotiating position, President Trump seemed to parrot Russian propaganda by referring to Ukrainian President Volodymyr Zelenskyy as a “dictator” (Ukraine has not held wartime elections).

The Trump administration continues to emphasise that European defence spending should reach 5% of gross domestic product (GDP), a level above the current NATO pledge of 2%. That may be bluster, but the pressure on European countries to meaningfully increase defence spending is real. The difficulty is that most have very limited fiscal scope to do so.

The economic situation in Europe

Some countries, such as France, were already struggling to rein in their borrowing, after having toppled Michel Barnier’s government due to its attempts to take tough choices and reduce borrowing.

It’s an unwelcome situation for France, which has been struggling economically. France and Germany have substantial manufacturing sectors, which have been experiencing difficulties through a global downturn.

Recently, the services sector has also been looking fragile. Friday’s flash estimate of French economic activity from the purchasing managers indices (PMIs) was strikingly weak, driven by a marked deterioration in the services sector. The data may be anomalous.

Neighbouring Germany’s equivalent results were much less stark, as was the broader Eurozone PMI. France’s political and debt situation is distinctly worse than that of many of its European peers.

This might be unsettling to its shoppers, but consumers are generally insensitive to these things until they feel the cost of them in terms of wages, job losses, or inflation. Economic pressure therefore remains for Europe.

However, the prospect of an end to hostilities in Ukraine does bring potential economic benefits. Moscow could increase the gas flow to Europe if peace talks are successful. That would be welcome because replenishing gas storage for next winter is another worry for European leaders. There should also be huge opportunities for construction and redevelopment activity in Ukraine once the conflict has ended.

Like France, the UK saw an implied contraction in its manufacturing and services sectors but that contrasted with a lot of other data out last week. Employment data, whilst notoriously unreliable, suggested that employment numbers weren’t dropping.

Wage growth was fast and, even though inflation data was strong, the implication was that UK wages are rising faster than inflation, contributing to stronger-than-feared retail sales growth.

Interest rates have been coming down recently, which provides further support, and the shock of high mortgage rates is beginning to ebb. Consumer sentiment edged higher, begging the question: why are the business surveys so weak?

Some of this could simply be temporal. Consumers are enjoying the decline in inflation over the last two years, cuts to National Insurance contribution rates, and rising house prices. Businesses, however, are planning how to address the steep increases in employers’ National Insurance contribution rates.

Europe’s next move

The results of this weekend’s German elections have landed, showing centre-right Christlich Demokratische Union (CDU) and centre-left Sozialdemokratische Partei (SDP) winning a majority of the seats in the Bundestag.

The new coalition will have big implications for the German economy and beyond. It’s likely it will want to reform the strict national debt brake enshrined within the German constitution; however, this requires a two thirds majority, which it didn’t receive.

The results were in line with pre-election polling and suggest that a two-party coalition can be formed. Whilst that will require cooperation from the centre-left and centre-right parties, it’s considerably more manageable than a three-party government including the Greens.

Tariffs a source of uncertainty for U.S. businesses and citizens

The stream of announcements on U.S. trade tariffs, and subsequent delays or amendments, makes for an unusually opaque economic policy environment, which must be weighing on companies to some extent. There’s some limited evidence that it’s also affecting the U.S. public.

President Trump’s approval rating has been dropping since he took office, which isn’t unusual. Although the economy has remained strong, and the President has been proactive, this suggests that some of his actions are jarring with segments of the public.

A majority believe he should have done more to bring down prices. Whilst that’s an unrealistic expectation, it’s one he did little to dispel on the campaign trail and the landmark policies of imposing tariffs and limiting inward migration are inflationary in nature.

Federal employees in particular will be concerned about their futures given the actions of Elon Musk and the Department of Government Efficiency. A recent poll found that just 39% of the public approved of the President’s handling of the economy. This is a decline of 4% from the end of January, after which we’ve had a flurry of confusing announcements on tariffs.

As a reminder, trade tariffs affect many U.S. businesses because they import components, and they affect consumers because ultimately, the cost of import tariffs will typically be paid by U.S. consumers.

At the end of last week, the University of Michigan Consumer Sentiment Survey seemed to underpin this. It showed consumer expectations for inflation in the coming five to 10 years increased to the highest level in nearly 30 years.

Meanwhile, the S&P Global Purchasing Managers Index noted a significant shift in business activity in February from just a couple of months previously, which it attributed to ‘widespread concerns about the impact of federal government policies, ranging from spending cuts to tariffs and geopolitical developments.’

“Tariff is a beautiful word. It’s a great word. It’s a word I like.” Donald Trump U.S. President.

President Trump loves tariffs. Not just that, but in a contrast to standard economic understanding, he described trade wars as “good” and “easy to win.” When he first took power in 2017, the U.S. visible goods deficit was about $770 billion per annum.

When he left office, it was $880 billion, an increase of 3.4% per annum over the duration of his first term (most of which would have related to inflation). At the end of 2024, the deficit had risen to $1.2 trillion.

Understanding tariff economics

Back in 2016, when the suggestion of rolling back decades of progress in reducing tariffs began to be taken seriously, economists pointed out that their research found few long-term links between tariffs and trade balances.

It seems implausible that raising the price of an imported good wouldn’t lead to a drop in demand for that good, and indeed, that’s typically the case in the short term. However, this trend doesn’t hold over the long term.

Why?

Economics is complex and sometimes struggles to conform to scientific analysis. We can’t perform experiments or have control samples on economies and so conclusions should be viewed with scepticism. That complexity means that when you change one thing, many other things may change as a result.

In the case of tariffs, the most obvious resulting change is a retaliatory tariff. There’s also a reaction in the currency market. If Americans buy fewer imported goods because of tariffs, they use less foreign currency, which can make the U.S. dollar stronger.

That stronger dollar makes imports cheaper and exports more expensive. The tariff might apply to a particular good, but the exchange rate adjustment applies to all goods. You would therefore expect to see an improvement in the balance on the tariffed goods but a smaller deterioration in the balance on all other goods.

What’s the point of tariffs?

The point of the tariff might be to encourage consumers to switch suppliers. They may do so, but not necessarily to a domestic supplier. Another reason might be to persuade the supplier to relocate its manufacturing.

Again, it may do so, but not necessarily to within the U.S. Since the U.S. imposed tariffs on Chinese imports, America’s bilateral trade deficit with China has improved. However, America’s overall trade deficit hasn’t improved because non-Chinese imports have taken the place of Chinese imports.

Perhaps this is the reason that President Trump had been discussing imposing tariffs on all imports. That would limit the ability of consumers and suppliers to switch to other non-U.S. jurisdictions to avoid the tariff. However, it’s still unlikely to be beneficial. America has a low rate of unemployment.

It arguably has very little spare capacity. Therefore, for Americans to displace the activities of importers, they would likely need to stop doing other things. Under free trade, America’s educated, and largely skilled workforce produces higher value goods and services than those it imports. So, the effect of the tariffs would be expected to be inflationary, but not necessarily productive.

Indeed, since many imports are components that end up in exported products, there’s widespread belief the tariffs would lead to increased prices and reduced growth. Recent data seemed to support the notion that the U.S. labour force is currently highly employed.

The working age labour force participation rate is relatively high, and inflation has remained persistent. In last week’s Consumer Price Index (CPI) report, most measures of inflation showed some persistence, which makes cutting interest rates very difficult. Federal Reserve Chairman Jay Powell seemed to endorse this message in his testimony to Congress.

EU and UK at risk due to high VAT rates

Last week, President Trump seemingly shifted his stance from imposing universal tariffs on all imports to focus on reciprocal tariffs, those imposed in response to tariffs from other countries on U.S. goods. Most of these countries are emerging markets with higher average tariffs on U.S. imports.

However, last week’s memorandum from President Trump specified that he believes that Value Added Tax (VAT) is effectively a trade restriction. In many countries that have a VAT, imports from the U.S. would be subject to it, while exports to the U.S. would receive a VAT refund.

Despite studies indicating that VAT doesn’t impact trade balances, President Trump and his adviser Peter Navarro don’t subscribe to conventional economic analysis. The Secretary of Commerce has now been tasked with reviewing the effects of tariffs and VAT rates on U.S. trade in order to develop recommendations for U.S. import tariffs by 1 April 2025.

Without knowing exactly how they’ll reach their judgements, it seems likely the EU and UK could appear to be imposing some of the highest tax rates on imports from the U.S. (should they be evaluated by those standards). This is the case despite the UK having a relatively balanced trade relationship with the U.S.

Research indicates that tariffs don’t cause lasting adjustments in trade deficits, which are more influenced by differences in competitiveness. The U.S. has a trade deficit because its wages are much higher than those in other regions, making production more costly.

While tariffs may encourage more domestic manufacturing, this could also lead to less affordable products due to higher production costs. The U.S. already receives significant investment from abroad, which effectively mirrors the trade deficit it runs.

However, as President Trump encourages further investment, he inflates the U.S. dollar and makes its exports less competitive.