Tariffs here to stay

Implications of Trump’s trade policy for investors

U.S. President Donald Trump remains steadfast in his commitment to tariffs despite concessions on the magnitude of some of them over the past few months. Is it wishful thinking to believe that he’ll eventually relent and reduce the level of tariffs he intends to implement?

I believe tariffs are here to stay. The Trump administration has been adamant about their importance since the campaign trail and continues to view them as necessary for reasons such as generating revenue to reduce the U.S. deficit and – at least to its thinking – bringing manufacturing jobs back to the U.S. and raising middle class wages. Moreover, tariffs have also become an important geopolitical horse-trading tool that is not likely to be abandoned anytime soon.

The question is whether this “inevitability” has been priced into financial markets. Perhaps not entirely, but investors do seem more comfortable with the idea of tariffs. At the very least, I don’t believe we’ll experience another market meltdown like we did following Trump’s Liberation Day announcement in April. To me, that represented peak tariff uncertainty because at that time many investors did not believe Trump would actually go through with tariffs.

That doesn’t mean tariffs are no longer significant to investors. In fact, even with some of the recent compromises, the effective rate for them is now higher than at any time since the 1930s. Yet the Trump administration – which often uses the stock market as a barometer for what it can and cannot do – surely understands its limits and the capacity of tariffs to shock financial markets is probably behind us.

The influence of trade policy on markets

If another “shock” seems unlikely going forward, there still seems to be uncertainty regarding the details and validity of U.S. trade policy as it now stands. What influence might that have on financial markets going forward?

As opposed to being considered an existential crisis – as it often has seemed to be this year – U.S. trade policy is more likely to be treated as just one of several factors with the potential to affect financial markets. In fact, the rally to new all-time highs in many global equity indexes over the past few weeks largely reflects that.

Still, there’s no doubt that tariffs continue to breed concern and remain a potential catalyst for heightened volatility to the extent they might weigh on economic activity through consumer prices and/or corporate margins. At best, it could take many months to iron out final details of current “handshake” frameworks with countries and regions like Japan and Europe, while some pre-existing trade agreements such as the United States-Mexico-Canada Agreement (USMCA) are subject to re-negotiation starting next year.

It’s also true that the legitimacy of some tariffs is being challenged in the courts, including reciprocal country-specific levies executed under the International Emergency Economic Powers Act (IEEPA). Ultimately, Trump could achieve similar aims to these types of tariffs through the implementation of more sectoral-style tariffs that are governed under Section 232 of the Trade Expansion Act of 1962. However, at this juncture, the U.S. Supreme Court’s support of IEEPA tariffs seems questionable and any disruption to them may initially result in more turmoil and less optimism than one might think.

Investment implications

Aside from these ongoing concerns, what do we now know (or do not know) about tariffs and their potential effect on the economy and financial markets that may be of help to investors as they navigate through this new global trade reality?

We’re starting to gather more clarity on aspects of the Trump administration’s plan the longer it plays out. For instance, it appears as if the percentage level of tariffs is being tiered to favour near-neighbours to the United States versus countries that are farther away. Moreover, for countries like Canada and Mexico, the effective tariff rate will be lower than the headline rate due to existing USMCA exemptions. More broadly, businesses will likely employ flexible approaches to managing their supply chains that enable them to do end-runs around the most onerous country tariff levels; indeed, there is already some early evidence that this may be occurring.

We also know that U.S. tariff revenues continue to rise into the hundreds of billions of dollars annualized, which has a host of economic and market implications that seem to favour U.S. Treasury bonds as much as any other asset class. This is not only because higher revenues could lead to lower deficits — all else being equal — but also stems from the general belief that tariffs will lead eventually to lower consumer spending and/or corporate profit margins and weaker economic growth.

Granted, how low and how weak likely depends on Trump not pushing the proverbial envelope on tariffs again, as I mentioned earlier. But if they stay close to as is, we believe the current supply chain dynamics are flexible enough to adapt, with consumers potentially absorbing two thirds of tariffs, and companies and suppliers splitting the rest, based on current estimates.

While that would obviously lead to higher goods inflation and some negative impact on economic growth and corporate margins, it’s our opinion that these conditions could be temporary, and we expect the economy and financial markets to be resilient enough to handle them.

David Stonehouse is Interim Chief Investment Officer and Head of North American and Specialty Investments at AGF Investments Inc.

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