Tracking Trump’s tariffs

Markets had their first taste of Trump Tariffs 2.0 on Monday after levies on Mexican, Canadian and Chinese exports were announced over the weekend.

A 25% tariff on Mexican and Canadian goods, a lesser 10% tariff on Canadian energy and a 10% tariff on Chinese goods were due to take effect at midnight US time on February 4, with national security concerns relating to immigration and fentanyl smuggling cited as justification. The Trump administration also intimated that similar measures affecting the European Union would be coming shortly.

While all four said they would retaliate, investors had a swift reminder of the fluidity of the tariff policy with the announcement late on Monday that measures against Mexico and Canada would be delayed following phone calls between their leaders and President Trump. China, however, did impose retaliatory tariffs on certain US products overnight after a similar phone call failed to materialise.

Interestingly, even before the postponement of the tariffs on Mexico and Canada, the market reaction had been more muted than many would have expected, and the episode has left commentators wondering exactly what they’ve learned, particularly in relation to what it could mean for tariffs aimed at the EU.

25% enough to trouble growth outlook

So, what did we learn?

The most notable price action in rates was a rally in German, UK and Canadian government bonds. Longer dated US Treasuries (USTs) also rallied but gave back the gains before the market close in New York, with the UST curve having flattened significantly at one stage. We take this as a sign that the 25% number is big enough to cause growth concerns both for the US and the global economy, though less so for the former. The inflationary impact of tariffs would also have an impact, of course, though markets appeared more concerned with the potential growth impact yesterday. While this would also have implications for the Federal Reserve’s (Fed) outlook, in our opinion the risk of the Fed completely changing its stance on monetary policy seems low.

Risk assets were softer, but spreads did not suffer material widening. In Europe, CLOs were effectively unchanged while high yield spreads were around 10bp wider. US high yield reversed a milder 6bp move to finish the day unchanged. AT1 prices were down anywhere between 0.25 and 0.5 points, while investment grade corporate bond spreads were marginally wider. Given the rates rally, these price moves in credit were fairly small and there were no signs of panic with two-way flow throughout the trading session. Equities had a worse day than spreads, but even those moves look relatively contained all things considered.

Worst-case scenario off the table?

This relatively gentle reaction in risk assets would seem to indicate that markets anticipate that the worst-case scenario of these tariffs being in place in the long run is not the most likely one.

The assumption, which we agree with, is that some sort of middle ground might be found between these major trading partners which should limit the impact; the tariffs on Mexico and Canada being delayed for a month after both countries agreed to increase their military presence at the US border is proof of this. While 25% tariffs on North American Free Trade Agreement (NAFTA) partners were not the market’s base case when Trump returned to the White House, it is also true that should Mexico and Canada align with Trump’s requests then tariffs might be softened or not implemented at all. In that sense, it is sensible to think that despite short-term disruption, the longer-term effects might not be as catastrophic as feared for the global economy. The stakes are high, however, and the longer the uncertainty drags on the more severe the consequences will be.

Interestingly, the UK for now is benefitting from a slightly softer stance from Trump. This highlights that one of the motivations for these measures is to correct trade deficits, which the US does not currently have with the UK as opposed to Mexico, Canada, China and the EU.

Flexibility key in face of volatility

From a portfolio management point of view this current episode underlines the importance of remaining flexible and keeping a cool head in the face of volatility, as these chapters usually come with a lot of noise and headlines back and forth. While we remain attentive to the news flow, we do not think the current moves have opened up any opportunities to make material changes to our current asset allocation. In credit, we think portfolios with good average quality and no large exposures to sectors that would be in the eye of the storm in a worst-case scenario, and with duration and credit spread duration under control, have no reason to change course at this juncture.

In terms of longer-term consequences, it is way too early to assess how the balance of power will change as a result of President Trump’s administration. That said, we do think US exceptionalism and its enduring status as a safe haven and a recipient of foreign flows is partly derived from the predictability of policy. As of today, the market view of this certainly hasn’t changed, but there might be a point when investors begin to feel more uneasy. These characteristics are also inputs for rating agencies and carry some weight in the ongoing assessment of a country’s AAA rating. We doubt the rating agencies will react to Trump’s opening salvo, however if tariffs had stayed in place, GDP growth assumptions would also have changed, which could have prompted a review.