Tariffs: our latest analysis

Markets have been modestly encouraged by US President Donald Trump hinting at further tariff exemptions (this time for autos) and apparent progress in bilateral negotiations.

While our baseline assumption is for the US average tariff rate to eventually settle lower than its current 23%, there is likely to be substantial volatility along this path. And the US and global economy will slow in the meantime.

Meanwhile, Fed Governor Chris Waller struck a dovish tone yesterday, arguing that tariffs “would have only a temporary effect on inflation”.

This contrasts with other Fed policymakers, who have stressed the importance of keeping inflation expectations anchored.

Key Insight: Most Fed policymakers are probably a little more hawkish than Waller. But further easing is still likely. And if the economy does tip into recession, then the Fed would cut rates aggressively even if inflation expectations were elevated.

The Trump administration has issued a trade memorandum exempting a wide range of electronics from its reciprocal tariff list. This includes smartphones, computers, electronic circuits, TVs, as well as semiconductors and components for the manufacturing of semiconductors. 

These items account for around a quarter of US imports from China, and larger shares of imports from South-East Asian economies such as Taiwan, Malaysia, Thailand, and Vietnam.

The 125% reciprocal element of the China tariffs (but not the 20% ‘fentanyl’ tariff), and the 10% baseline tariffs on other economies, will not apply to these goods.

This is potentially a significant lowering in the weighted average US tariff rate on the rest of the world, reducing it from 28% as of Friday, to perhaps 22% now.

The big caveat, however, is that these products will be included in an expanded list of semiconductor sector-specific tariffs, likely to be announced this week. Prior sectoral tariffs have been at a 25% rate.

So, while the average US tariff on China will still fall because of all this, it will increase on many South-East Asian economies from the 10% baseline tariff.

Key Insight: That President Donald Trump has exempted some high-profile electronic items such as smartphones from reciprocal tariffs shows a degree of sensitivity to consumer pain and industry lobbying. However, coming sector-specific tariffs will undo a good amount of this exemption. 

US assets resumed their broad sell-off yesterday, with equities and the dollar falling and bond yields rising.

This combination of asset price moves is how emerging markets tend to perform in crises (or indeed the UK during Truss). It doesn’t resemble the usual price action of the provider of the global safe asset, where yields should fall amid flight to safety.

Strikingly, the move does not seem to reflect inflationary concerns as breakevens have fallen, nor (at least for now) a scramble for liquidity.

Instead, it’s about the US becoming a less attractive place to invest over the long run, given weaker potential growth, erratic policy decisions, and US reserve facilities potentially being threatened by aspects of the Miran plan.

There are no easy options for the Fed in this environment. Certainly, should treasury market functioning show signs of breaking down, then the Fed would intervene with liquidity.

But, despite the recession risks, significant monetary policy easing through rate cuts and asset purchases is riskier when consumer inflation expectations are increasing.

The Fed may have taken some comfort from CPI inflation coming in softer than expected in March. The headline rate fell by 0.1% month over month compared to expectations for a 0.1% increase, while core was up 0.1% compared to consensus of 0.3%.

This left the year-over-year rate at 2.4%, while the sequential rate of underlying inflation pressures was moderating. 

Inflation was partly dragged lower by steep falls in hotel prices and airfares, reflecting lower tourism into the US. Gasoline prices also fell, which will continue given the slide in oil.

It is interesting that the earlier set of Canada, Mexico, China, and sector-specific tariffs did not have a big impact on inflation in March.

But a large stagflationary shock is now about to hit.

Indeed, the administration announced yesterday that the tariffs on China add up to 145%, not the 125% previously mentioned by the president, as the fentanyl tariffs are stacked on top. With sector-specific tariffs this could stack even higher. China has just retaliated with a 125% tariff.

Vast differences between US tariffs on China and the rest of the world will incentivise Chinese exports to the US to be re-routed. Economies such as Vietnam, Taiwan or Mexico could experience big increases in their bilateral deficits with the US. This will complicate trade talks.

Meanwhile, the House approved the Senate budget blueprint. It enables $1.5 trillion (5% of GDP) in new tax cuts over 10 years, in addition to renewing the Tax Cuts and Jobs Act, offset by a pledged $1.5 trillion in spending cuts. For now, tariff revenue is excluded.

The focus will now turn to spending cuts, although these will be extremely difficult.

Key Insight: The US growth and inflation outlook has shifted considerably worse, even after the 90-day pause. The administration may hope that progress on tax cuts changes sentiment. However, the US is looking like an increasingly less attractive place to deploy capital over the long run.

US President Donald Trump announced a 90-day delay on US reciprocal tariffs above 10% for all economies other than China, which will see its tariff rate increase to 125%.
Risk assets surged on the news, with the S&P500 up around 9.5%, while front-end treasury yields rose sharply as the market priced less easing by the Fed.

The turbulence in bond markets yesterday was an important contributor to the decision, with the president saying “the bond market is very tricky”. This means bond market “vigilantes” may prove crucial in any future trade escalation as well.

Rapidly deteriorating consumer and business sentiment, pressure from donors, and the prospect of a big defeat at the midterms, also played a role.

The White House itself is presenting all this as part of Trump’s negotiating tactics, creating maximum leverage over other economies.

The end result of this might be 60% tariffs on China, a 10% global baseline tariff, a USMCA carve-out, and various 25% sector-specific tariffs (of which there are more to come, including on pharmaceuticals and copper).

However, we wouldn’t rule out tariffs moving higher on the way to this base case amid tit-for-tat retaliation.

A framework to think about this set-up, which is close to what Trump promised on the campaign trail, is that the baseline tariff is the revenue raiser, the China tariffs are part of long-term decoupling, and the sector tariffs on things like autos and metals are the industrial strategy component.

The US average tariff rate would still be materially higher than at the start of Trump’s second term.

So, this would represent a big stagflationary shock to the US economy, but with growth weakly positive rather than recessionary.

But recession is still a big risk (perhaps just below 50%). This extreme policymaking volatility is very damaging to consumer and business sentiment and investment decisions.

In an upside scenario, tariffs could fall back further, with the administration deeply chastened by markets. Economic decision makers could gain more clarity about the outlook, allowing them to adjust to the new trading environment.

In a downside, the 90-day delay could prove to be just that, with the reciprocal tariffs going back on. Indeed, if Trump finds that negotiations don’t go well, he could reimpose tariffs before then. There could also be further rounds of retaliation between the US and China, or with the likes of the EU and Canada.

Key Insight: Despite the elation in financial markets after the 90-day pause on reciprocal tariffs, the average US tariff rate on the rest of the world, and especially on China, has still increased enormously. This will impart a stagflationary shock to the US economy and weigh on growth elsewhere.

US yields have started to move sharply higher despite equity market weakness, and the curve has steepened significantly.

Falling equities and dollar, and rising yields, represent a pernicious combination. In any other country, this would be called a sovereign crisis.

This is particularly striking because the US treasury market is meant to be the risk-free asset that performs well when equity markets are falling.

Instead, bond yields appear to be rising for several reasons.

First, uncertainty around US policy means investors require higher term premia. Indeed, the move in nominal yields seems to be an increase in term premia rather than inflation compensation, with real yields moving up despite the weaker growth outlook.

Second, the US may be becoming a structurally less attractive place to invest over the long run, with tariffs reducing long-run potential growth, meaning portfolios will hold fewer US assets in the future.

Policy unpredictability and lower growth may also lead to greater concern about fiscal sustainability, with the US less able (and, if certain parts of the Miran plan are implemented, less willing) to service its debt.  

Third, because tariffs represent a stagflationary shock, they create a difficult trade-off for monetary policy. There is a risk that either the Fed doesn’t ease as aggressively as priced by markets, or that it allows an inflation overshoot as it focusses on growth.

Fourth, Asian investors in particular seem to be selling US assets. In extremis, this could evolve into the dumping of treasuries by China that has long been speculated about. However, such a move would cause the RMB to appreciate, which doesn’t seem to be the policymakers' preference for now.

Fifth, bond positions may be unwound to fund margin calls. The Aberdeen risk process has specified stress tests where a severe equity or bond shock is followed by position unwinding and liquidity drying up, ultimately leading to a full-scale breakdown in market functioning.

Key Insight: A collapse in bond market functioning would almost certainly require a policy response by the Fed. But any intervention could be like the Bank of England (BoE)’s move following the Liz Truss crisis of 2022, which stabilised market functioning without easing broader policy. It is possible that bond market weakness will prove more consequential in shifting the administration’s approach. So far, the pain tolerance for equity weakness has been high. But the equity market vigilantes were arguably easier to ignore when bond yields were falling. 


US “liberation day” tariffs, and further tit-for-tat retaliation with China, have gone live. The average US tariffs on Chinese goods is around 110%.

Tariffs could spiral higher still, with China promising to retaliate to US retaliation to Chinese retaliation.

This will almost certainly spur further policy easing by China – such as bond issuance brought forward and expanded – but it is unlikely to be enough to fully offset the shock.

Higher tariffs on other Asian economies reduce the ability to circumvent tariffs by re-routing goods via third economies, while the scale and breadth of tariffs across both EMs and DMs implies a broad-based global growth slowdown.

For now, we are penciling in another 1.25% hit to the level of Chinese GDP, which pushes down 2025 GDP growth to 4.2%.

Tomorrow’s CPI print will be important in judging underlying inflation going into the trade war, but the growth shock combined with the oil price fall will likely keep CPI inflation and the GDP deflator in negative territory.

The authorities continue to lean against FX depreciation pressure, with the latest reporting suggesting that state-owned banks have been asked to reduce their USD purchases. But, at the same time, the FX fix has been allowed to push higher, while the CNH/USD exchange rate briefly hit a record high of over 7.4 yesterday.

Key Insight: We continue to judge that the authorities will reassess the benefits of currency stability and condone a moderate depreciation in coming months, particularly if no off-ramp can be found to de-escalate.