Tariff Evolution: Speak Loudly but Carry a Small Stick

At the start of the year we identified tariff hikes proposed by the incoming Trump administration as a possible “chute” for the economy and markets in our Capital Markets Forecast (CMF) “Investing in a Chutes & Ladders Economy.” During the campaign, President Trump proposed massive, uniform tariffs across trading partners that would have taken overall effective rates to their highest levels since the 1930s. This, in our view, would have been deleterious to the economy. But as he is now reaching a full month in office, the President has evolved to a conspicuously different approach. He is going country-by-country, articulating a “reciprocal tariff” strategy to try and level the playing field, so to speak. If this approach holds it could lead to less tariff hikes than originally thought, effectively shortening the chute. We also argued in our forecast that using tariffs as leverage in negotiations could be a “ladder” for risk assets by opening up markets for U.S. firms. Odds have increased that we’ll land on a ladder, not a chute, although risks remain.

Speaking loudly

While running for office last year, then-candidate Trump famously said “tariff” is “the most beautiful word in the dictionary”, the “greatest thing ever invented.” He even referred to himself as the “Tariff Man.” President Trump has proposed a 60% increased tariff on all imports from China and a blanket 20% tariff on imports from all other countries. We estimated that would bring the effective tariff rate to 19% from its current 2.4%. For context, the series of tariffs implemented over the course of 2018 (on solar panels, washing machines, steel, aluminum, and on $250b of imports from China) raised the effective rate to 3% from about 1.5%.

Once in office, President Trump did not move forward with the blanket tariff approach, but did quickly announce on February 1 tariffs on imports from Canada (25%), Mexico (25%), and China (10%) to be brought into force on February 4. We estimate those would have brought the overall U.S. rate to 9.5% (before shifts in trading partners). While not as high as those floated during the campaign, they would also be jarring for the economy and markets, in our view.

Proposed tariffs would be a stark departure from recent decades

U.S. effective tariff rate and estimated impacts of proposed new tariffs (%)

^{Source: Yale Budget Lab, Wilmington Trust.}

^{Data as of December 31, 2024.}

Carrying a small stick (for now)

The tariffs on goods from China are in place but tariffs on the U.S.’s North American neighbors were delayed by a month as both countries agreed to shore up border protections, a key priority for President Trump. The takeaway here is by “speaking loudly” and using the tariffs as leverage, President Trump was able to make progress on some policy goals.

While progress on the goals enabled the delay, the White House may have also been keeping an eye on financial markets and been eager to hold off. The S&P 500 index, the main gauge of U.S. large-cap stocks, fell as much as 2% in the first hours of trading after the announcement, only to swiftly recover when the tariffs were delayed.

During that Monday morning selloff, investors were reacting to the sheer magnitude of trade with the three countries, including the integrated supply chains with Canada and Mexico that have developed over three decades under the North American Free Trade Agreement (NAFTA) and the updated U.S.-Mexico-Canada Agreement (USMCA), negotiated by President Trump during his first term. In 2024, the U.S. imported about $1.4 trillion from China, Mexico, and Canada combined, about 42% of all imports, and about five times more than the goods that experienced tariff hikes in 2018.

The auto industry is particularly vulnerable to tariffs, as supply chains are so interwoven that some components reportedly cross the U.S. border several times during production and would face the levy each time. Automakers and parts suppliers responded swiftly and loudly to the prospective tariffs, and there were reports that White House representatives told auto executives their products might be exempt provided they are in compliance with USMCA.

Exempting autos could be another example of President Trump’s tough negotiation tactics as he attempts to gain compliance with the trade agreement. But the reversal could also reflect his unwillingness to follow through. Tariffs are, of course, a tax, and the impacts will most likely be felt by the U.S. consumer, in our view. If the tariffs are fully implemented, we expect a 6% increase in the average price of a new vehicle. More reason for President Trump to seek a victory and not follow through.

Considering the interactions with Canada and Mexico alone, President Trump would appear to be using the heft of the U.S. economy as leverage for negotiations and not seeking to implement drastic tariffs. But that is far from the end of the story.

Tariffs on key trading partners are a risk to the economy

U.S. imports by product and country ($bn)

^{Source: U.S. Census Bureau, Wilmington Trust.}

^{Data as of December 31, 2024.}

So much speaking, so many sticks

President Trump continues to speak loudly, wielding the threat of additional tariffs on specific goods or industries even while those described above are in flux. On February 10, the White House announced increased tariffs on all aluminum and steel imports that will go into effect on March 4. On February 18, President Trump said he is considering tariffs on automobiles, semiconductors, and pharmaceutical products “in the neighborhood of 25%” and that they might increase over time. It is unclear whether this new mention of tariffs on autos would include those imported from Canada and Mexico.

In between those two announcements the President ordered federal agencies to study the implementation of “reciprocal tariffs,” which would go country by country and try to match each of them on tariff levels, perhaps for each good, to level the proverbial playing field. To complicate that approach further, the agencies have been instructed to include “non-tariff trade barriers” such as subsidies of local industries, technical barriers, value-added taxes, and any impediments for U.S. firms to access markets. The reports are due to be completed by April 1.

Core narrative

So what should we expect? With the flurry of tariff actions and announcements, it is impossible to say with any certainty how any of them will turn out. Given the balance of evidence, we see President Trump as using tariffs as leverage to achieve several policy goals. With Mexico, he has a clear intention to fulfill a campaign pledge to stem the flow of fentanyl and illegal immigration. For both Canada and Mexico, there is a strong desire to ensure the two are complying with the USMCA, negotiated during his first term. The other announced tariffs on specific goods along with the reciprocal approach with other countries are intended to level the playing field and provide a boost for domestic firms.

If all goes to plan, very few tariffs (sticks) will be needed, and we would not expect the “tariff chute” outlined in our 2025 CMF to drag significantly on the economy. Improved trade relationships and market access would be a boon to local industries, providing a ladder for equities, brightening the outlook for investors. But we remain cautious given the scale of uncertainty on this and other issues and maintain neutral weights to all asset classes in portfolios.

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