Reciprocal tariffs, but not as we know them

“Liberation Day” has landed, and not with a whimper. In extraordinary scenes in the Rose Garden of the White House, President Trump held up a board outlining the level of tariffs the US will impose on countries around the world, and in most cases they were worse than worst-case expectations.

The calculation of these “reciprocal tariffs” was in the end very simple and based on trade balances, rather than existing tariff rates as had previously been pledged. Quite simply, the European Union had a goods trade surplus of $235.6bn with the US, and $605.8bn of goods exports to the US, therefore 235.6/605.8 = 39%. Divide this by two, for the discounted or “nice” rate, and you arrive (roughly) at the 20% tariff to be applied on the EU. Before this, a minimum 10% tariff was announced on all countries listed, though there were a few exemptions; Canada and Mexico were excluded, but are already subject to tariffs, while steel, aluminium and auto imports were already facing 25% tariffs. Other materials, such as critical minerals, gold, lumber, copper, semiconductors, and pharmaceuticals will be dealt with under separate sectoral trade investigators. Russia wasn’t mentioned, but according to the White House, trade with the country is already zero.

Taken as a whole, the tariffs were more severe than markets had anticipated, but it was Asian economies that were hardest hit with tariff rates ranging from 24%-49%. Tariffs on China were levelled at 34% (on top of the 20% announced earlier this year), Japan was hit with a 24% rate and Vietnam with 46%. The EU’s 20% tariff was broadly in line with expectations, while the UK escaped with the minimum 10% rate, though as mentioned above other tariffs have already been imposed (Reciprocal Tariff List). The 10% minimum tariff will be imposed from Saturday, while the larger tariffs will be imposed from April 9.  

In terms of market reaction, the moves have been large, but so far there doesn’t seem to be any sign of panic, and the prevailing consensus is that the tariffs can be negotiated lower. However, if retaliation comes first, market moves may become more pronounced. At time of writing, in Asian markets the Nikkei is down nearly 3% and the Hang Seng is down 1.6%, while in Europe the CAC 40 is down 2% and the Euro Stoxx 50 down 1.7%. In the US, S&P 500 futures are pointing to an open of around -3%.

In fixed income, government bonds have unsurprisingly rallied, but the negative growth fears are tempered by fears of higher inflation, which would limit monetary policy action from central banks. The tariffs, if not negotiated lower, are expected to cut US growth close to recessionary levels, while Core PCE inflation is expected to increase by 1-1.5% (from 2.8% currently), with unemployment expected to increase to over 4.5%. Currently, 10-year US Treasuries have tightened by around 10bp to 4.07%, while 10-year German Bunds are around 8bp tighter at 2.64%. In credit, the moves have also been fairly muted, with the Crossover index around 10bp wider than Wednesday’s close at 340bps, although that index was already pricing in some of the bad news having widened from 300bp a few weeks ago. Moves in European financials are also muted, with senior debt 4-10bp wider and AT1s between 25-65 cents lower in price terms. Unsurprisingly, price action is going to be concentrated on the sectors most impacted, and markets are moving on a case-by-case basis.

As the dust begins to settle, the reaction from the countries targeted will be very important. The EU has already promised countermeasures, though the president of the European Commission, Ursula Von der Leyen, has also said the EU would prefer to negotiate and avoid further confrontation. European growth is already low, and these tariffs will have further negative consequences, though EU consumers are in better fundamental shape than their US counterparts with an EU household savings rate at 15% compared to below 5% in the US. European banks also look in good shape, with exposure to the US consumer relatively low. The tariffs will have an inflationary impact on the Eurozone, though it is likely to be less severe than in the US, and traders have already boosted the likelihood of an April rate cut from the European Central Bank (ECB) to 90%.  

What the tariffs ultimately mean for global trade remains to be seen, but we would expect closer ties between all the countries impacted, though this will take time to build and the US will obviously remain vital to global trade. These tariffs could well help China to increase its trading ties, especially in Asia, which geopolitically might not be beneficial to the US long term. We doubt any immediate impact on monetary policy, but with the tariffs hitting quickly, the impact on inflation could also emerge in short order. The trading impact could also make GDP data very volatile as importers rush to stockpile before the tariffs come into force. For now, markets are relatively orderly and awaiting news from those countries impacted by the tariffs. The UK government is probably breathing a sign of relief, while the EU will know it could have been worse (at time of writing the FT has just reported the EU has given itself a four-week window to convince President Trump to drop his 20% tariffs on the bloc, with retaliation ruled out before late April).

It is highly likely that we have not seen the end of this tariff saga and stakes remain high. Rates, spreads, and equities seem to be pricing in a scenario where negotiations lead to lower tariffs than those announced on Wednesday. While this seems reasonable, we must acknowledge that the potential reward seems asymmetric. If negotiation does bring lower tariffs, then we might have a mild rally in spreads. If on the other hand, negotiations are unsuccessful then we would expect the downside to be larger. We are wary having much exposure to sectors directly affected and would prefer to focus credit exposures in the services sector over manufacturing, while maintaining a high average credit quality. We remain attentive to the sequence of how countries respond, and what kind of attitude the Trump administration shows towards negotiating a better outcome in the coming days and weeks. These will determine the chances of a more severe slowdown in the US and the global economy.