Tariffs - What does it all mean?

Given the recent announcement of 25% tariffs on Mexican and Canadian imports as well as additional 10% tariffs on Chinese imports, I thought I would provide you with a few thoughts as to their likely impacts. Of course, much uncertainty surrounding tariffs exists including duration, percentage, expansion to other countries and retaliation. All of which can alter the end impact. 

Economic Implications - Short-Term

In the near-term, the U.S. economy will likely be faced with slower economic growth as well as higher inflation. 

While a stronger U.S. dollar will mitigate some of the impacts, inflation will likely rise for three reasons: 1) the cost of importing goods will rise, 2) supply chain disruptions will likely occur as U.S. businesses have difficulty immediately sourcing American-based inputs to produce their own goods and 3) U.S. producers may see an opportunity to raise their own prices to take advantage of foreign competing goods having become more expensive. 

From an economic perspective, while potentially driving more demand to U.S. based businesses, it is unclear that domestic businesses will be able to handle increased demand without near-term disruption. Businesses will require additional workers in a tight labor market and may not have the manufacturing capacity which takes time to come on stream. Add to that the probable retaliatory actions by our foreign trading partners and it is likely that the immediate U.S.  economic impact is negative. 

Economic Implications - Longer-Term

Over the longer-term, U.S. economic growth may benefit despite price levels being higher than without tariffs.  

Assuming tariffs will remain permanently in-force, one potential benefit to the U.S. economy could be higher U.S. employment generated by greater US business growth as products formally produced overseas move onshore. Greater employment would perpetuate greater consumer spending and form a type of virtuous cycle. Still, one can not help but think that price levels in the United States will end up being higher in the long-term compared to a an environment without tariffs as U.S. businesses will likely be unable to produce certain goods as cost effectively as their global peers. 

Foreign Economic Implications

Given how trade makes up a larger percentage of the economies of Canada, Mexico and China, the impact of a tariff war on these countries should be more negative than for the United States.

Financial Market implications

My best guess is that financial markets will take a little time to digest the news and try to sort out all the implications. Since markets detest uncertainty, we may have a period where equity markets pull back. This will not last forever. As long as the U.S. economy does not head into recession (which we do not forecast), we do not expect anything greater than a typical correction. As such, for most portfolios, we are not expecting to make significant changes. At the point that markets have a better understanding of the implications, equity markets should stabilize and begin to advance once more.

As for the bond market, the path is a little more complicated to predict. While higher inflation raises the prospect of higher yields, lower economic growth has the opposite effect. As a result, after a likely knee-jerk reaction higher, it seems likely that bond yields will settle and then may edge lower.