Summary of the tariffs
The US has introduced a sweeping 10% blanket tariff on all imports, with additional “reciprocal” tariffs aimed at countries with large bilateral trade surpluses or perceived unfair practices.
For instance, China faces a cumulative 54% tariff, while the European Union is subject to a 20% tariff, and 46% on Vietnam. The UK will be subject to the blanket 10% tariff.
In terms of timings, the 10% tariff comes in on Monday, while the country-specific reciprocal tariffs come into force April 9, which implies there is some room for negotiation.
These new tariffs are in addition to existing 25% tariffs on automotive, steel, and aluminum imports. Canada and Mexico are exempt from new measures, as they are already subject to the 25% rate.
These changes push the US’s effective tariff rate to between 20–25%, well above expectations, and the highest since before World War I.
At the time of writing (Friday afternoon) China is the first country to react, having just announced retaliatory tariffs of 34% on all US goods from 10 April.
This article may contain technical information and this is not to be considered as financial advice.
How the tariffs were calculated
The methodology, disclosed by the US Trade Representative (USTR), uses the US trade deficit with each country as a proxy for unfair trade. The formula is (Trade Deficit / Total Imports) divided by 2.
The formula used to calculate the tariffs, released by the US trade representative, took the US’s trade deficit in goods with each country as a proxy for alleged unfair practices, then divided it by the amount of goods imported into the US from that country. The resulting tariff equals half the ratio between the two.
This method of calculating tariffs has drawn ire from economists for two reasons.
Firstly, the official formula published by the White House included two values which cancel each other out.
Soure: Office of the United States Trade Representative
Epsilon (ε): Defined as the elasticity of import demand with respect to import prices. In this case, it’s set at –4, meaning a 1% increase in prices reduces import demand by 4%.
Phi (φ): Represents the pass-through rate from tariffs to import prices, assumed to be 0.25. This implies that a 1% tariff leads to a 0.25% increase in import prices.
When multiplied together, ε × φ = –4 × 0.25 = –1.
This means that a tariff increase of X% leads to a 1:1 proportional reduction in imports, if the assumptions hold. Conveniently, the USTR uses this to argue that a tariff equal to the percentage size of a country’s trade surplus with the US would eliminate that surplus entirely.
While the USTR acknowledges that empirical studies don’t support these exact values, it goes on to adopt them anyway – arguably for the sake of arithmetic simplicity rather than economic accuracy.
Secondly, trade deficits often reflect structural economic factors – such as comparative advantage or consumption patterns – not manipulation or protectionism. For instance, bananas are imported not due to unfairness, but because they simply don’t grow in the US.
Countries with large export surpluses and minimal US imports, such as Vietnam (46%) and Cambodia (49%), were hit hardest. Conversely, the UK, which ran a goods trade surplus with the US last year, only faces the base 10% tariff.
The new tariff regime is therefore not “reciprocal” to anything, but instead is retaliatory in proportion to how big a surplus in goods trade a country happens to have with the US.
As Matt Levine and Joe Weisenthal of Bloomberg write:
“You could crudely characterize a portion of the trade between Vietnam and the US as (1) Vietnamese wages are lower than US wages, so Vietnamese people make sneakers and t-shirts that they sell to the US cheaply for dollars and (2) the US financial system is big, so Vietnamese people invest those dollars in US financial assets. We are good at making financial assets, they are good at making low-cost clothing, so we trade. To Trump this is necessarily unfair and we must stop it. My Bloomberg colleague Joe Weisenthal writes:
Now we’re slapping massive tariffs on them, but the question is … to what end? Do we think there are hundreds of thousands of people in the US eager to work in sneaker and t-shirt factories at the wages that sneaker and t-shirt factories pay? Are there people eager to work in sneaker factories even at ‘good’ wages? Do we think that the US has the level of robotic capability to replace these factories without having to hire a lot of workers? And if not, what is the administration trying to accomplish?”
Penguin tariffs
One of the more surreal stories to come out of the tariff announcement, was about a small group of islands called the Heard and Mcdonald Islands.
They’re an Australian territory, one of the most remote places on earth – it takes 2 weeks in a boat to get there from Australia – and they’re completely uninhabited. Nobody’s even visited them in the last 10 years, and it’s home only to penguins. Nonetheless, yesterday those penguins found themselves with a 10% tariff levied against everything they export to America.
This was made all the more puzzling given Trump’s justification for implementing tariffs was that “for years, hard-working American citizens were forced to sit on the sidelines as other nations got rich and powerful.”
I’m not sure how rich and powerful the penguins have become, but it’s hard to justify tariffs on the likes of Lesotho, Madagascar, and Botswana on the basis that those countries are getting rich and powerful.
Potential economic impact
The full extent of the impact of the tariffs is not yet clear, not least because the situation is still evolving.
What we do know so far is that these changes push the US’s effective tariff rate to between 20 and 25%, well above expectations, and the highest since before World War I.
Whether this leads to a recession depends on whether or how quickly the tariffs can be negotiated down, how long the tariffs stay in place, and whether retaliation follows. It’s clear from the market’s reaction to China retaliatory tariffs on Friday that any escalations in the trade war would be harmful for global economic growth, and would trigger severe selloffs. Central bank reactions will also be crucial, as they will likely have to deal with the toxic combination of surging inflation and diminished economic growth.
Initial estimates on the inflationary impact vary, but figures as high as 5% have been quoted. But second-order effects matter too. US retailers may use the narrative to raise prices even further – marking a return to the post-COVID ‘greedflation’ days. In which case, prices may rise even higher. However, any profit-led inflationary pressures may be counterbalanced by the economic slowdown these tariffs will likely bring.
US growth is likely to suffer in the immediate term, with analysts estimating US GDP contracting by around 1% over the year, and unemployment rising to 5.5% in 2026. (UBS?)
One unintended consequence of the tariff strategy is a rising anti-U.S. coalition, with countries like China, Japan, and South Korea coordinating responses, despite long histories of rivalry. Europe, too, is accelerating joint investment plans in defense and manufacturing as a counterweight.
Trump might just persuade the rest of the world to find new trading partners.
A question now is whether the hundreds of billions of dollars in additional tariff revenue that Trump predicted would be raised would be used to curb the deficit or injected into the economy in the form of tax cuts (both of which Trump pledged to do during his campaign).
A further question is how companies will respond. For global companies, this uncertainty makes US investment riskier. Why build local capacity if tariffs might be reversed – either under this administration as a result of negotiations, or under the next one?
How the market has reacted
Equities
Equity markets have fallen sharply in response to the tariffs.
On Thursday, the US market fell 4.2%, Emerging markets fell over 3%, the European market fell 2.8%, and the UK fell 1.5%.
Following China’s announcement of higher tariffs on US imports on Friday, the selloff deepened, with the US down another 3%, the UK down a further 3.8%, EM down another 4%, and Europe down over 4%.
Source: Bloomberg. US is the iShares Core S&P 500 UCITS ETF, UK is the iShares Core FTSE 100 UCITS ETF, Europe is the iShares MSCI Europe ex-UK UCITS ETF, Emerging Markets is the Vanguard FTSE Emerging Markets UCITS ETF. Past performance is not indicative of future results.
The biggest victims in the US are the companies which source a high percentage of their products from Asian countries hit with extremely high tariffs, sparking fears of rising production costs and weaker consumer demand in western markets. The Magnificent 7 companies are particularly affected given their reliance on Asian supply chains, as well as the likes of Nike, who make lots of their shoes in Vietnam. Similar issues affect large European companies, with shares in Adidas and Puma falling quickly, who both also rely on Vietnamese imports.
Bonds
Long-term and short-term bond yields fell, in the US, the UK, and more broadly, reflecting investors’ worries as they engage in a “flight to safety” by buying safer bonds.
The fall in yields also suggests that markets believe the potential inflationary effects of the tariffs (which place upward pressure on bond yields, as higher inflation means central banks would have to raise rates in response) are outweighed by the likelihood that central banks will have to speed up the pace of interest rate cuts to stimulate ailing global economies.
Currencies
The US dollar fell 1.7% against a basket of currencies after Trump’s announcement. This move was particularly interesting, as the US dollar is usually thought of as a safe haven asset which investors flock to in times of market turbulence, leading to a strengthening dollar. The fact that the dollar fell on the tariff news shows how fearful the market is for the state of the US economy (as it implies US rates are likely to have to come down more quickly than anticipated to stimulate growth).
Interest rates
On Wednesday, before the tariff announcement, traders were pricing in 3 rate cuts for the rest of the year in the US, and 2 in the UK.
At the time of writing (Friday afternoon) the number of likely cuts has increased dramatically, and now stands as somewhere between 4 and 5 for the US (a terminal rate of just over 3%, down from 4.5% today) and just over 3 for the UK (a terminal rate of just over 3.5%, down from 4.5% today).
Markets are clearly pricing in a severe reduction in global growth, necessitating swift cuts from central banks.
What investors can do
One silver lining (which one must squint hard to see) is that those who are looking to start using their fresh new-tax-year ISA allowance next week will be buying the markets at a discount. Global markets are now much cheaper than they were three months ago, and your cash will buy more ETF shares than it would’ve been able to at the start of the year.
Those investors who have a long time horizon will probably end up looking back on the selloff as a good time to buy – just like all the other market selloffs in history.
Nonetheless, such selloffs – especially ones as quick and severe as this – are scary. The uncertainty and fear which come with a downturn can make it difficult to see the long-term potential, even when history suggests recovery is the norm.
Market declines are normal
The global market’s drawdown this year, as measured by the MSCI All Countries World Index, is around -12%. This year’s pain has been particularly concentrated in the US, with European markets having held up well (until the last couple of days), which has helped shield global investors from the worst of the selloff.
History suggests it’s completely normal for markets to experience declines of this size. In fact, the average drawdown global investors can expect within a given year is 14%.
The chart below shows the average return over every calendar year since 1970 for the global stock market (blue bars), compared to the average market decline during that year (pink dots):
Source: Bloomberg. MSCI World Total Return in GBP. Past performance is not indicative of future results.
Despite the average intra-year drawdown (pink dots) being 14%, the average calendar year return (blue bars) is still a positive 12%. This means it’s normal for markets to have a 10-20% drawdown during the year, and still finish the year in firmly positive territory. Market drops aren’t the exception, they’re the norm – and they don’t mean the market won’t recover.
Based on this historical data, investors can expect roughly:
- A 10% drop every other year,
- A 20% drop in one in every five years, and
- A 30% drop every 10 years.
It’s very possible Trump’s tariffs cause the drawdown to extend further, and the pain to be felt for longer than some of the other corrections we’ve seen in the past. But one thing remains true for every single drawdown we’ve seen in the past, and that’s that the market has eventually recovered. Not only that, but every market drop, in hindsight, looks like a great buying opportunity.
Source: Bloomberg. MSCI World Total Return in GBP. Past performance is not indicative of future results.
It’s also worth bearing in mind that if equities weren’t so volatile, and weren’t prone to drops like this, then they wouldn’t generate the high long-term returns we’re all looking for. It’s because markets are risky that they generate high returns. Market drops are the price of admission for the stock market, and we can’t hope for high returns without them.
Diversification pays off
Market volatility can be unsettling, so it’s a great time to revisit your personal comfort with investment risks. If recent market swings have left you uneasy about your investments, it could be a good time to revisit your portfolio.
Your asset allocation – the mix between riskier stocks and safer bonds – should match your personal goals and risk tolerance. If you’re feeling uncomfortable with the current market dip, it may be a sign you’re holding too much risk in your portfolio.
A higher allocation to bonds may help you weather the storm against the inevitable larger future drawdowns, and further diversification within equities may be beneficial for investors who are heavily reliant on the US.
The charts below shows the drawdowns investors would’ve experienced firstly holding 100% global equities versus 60% global equities plus 40% bonds, and then for investors holding global equities versus just the US:
Source: Bloomberg. Global equities are MSCI World Total Return in GBP, bonds are FTSE Actuaries UK Conventional Gilts up to 5 Years Index. Past performance is not indicative of future results.
Source: Bloomberg. Global equities are MSCI World Total Return in GBP, USA is the S&P 500 index in GBP. Past performance is not indicative of future results.
The main takeaway is clear – diversification mitigates the pain felt by equity market losses. Investors can choose to diversify within their equity exposure by allocating to global stocks, and they can also diversify between asset classes, by adding/increasing exposure to bonds.
How much an investor decides to diversify is dependent on their own personal circumstances, but for those investors who are feeling uncomfortable with the losses they’ve been seeing in their portfolios, now might be a good time for them to reassess their risk tolerance and ensure their portfolio aligns with their comfort level and long-term goals.
While short-term volatility can be challenging, history suggests that staying the course has been a winning strategy for long-term investors.
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