The Trump Tariff Turnabout

Editors’ Note: MarketMinder Europe prefers no party nor any politician. We are politically agnostic and assess developments for their economic and market effects only.

Two weeks into US President Donald Trump’s second term, and the trade playbook already looks to us like a rerun of his first term: tariff threats, tariffs and … talks and deals.

Late last week, Trump announced he would follow through on campaign trail talk and issue an executive order on Saturday implementing blanket 25% tariffs on all Mexican and Canadian goods imports and an additional 10% tariff on Chinese goods.^[i] He followed through as promised, although the order cut tariff rates to 10% on Canadian energy products like oil or electricity.^[ii] The tariffs were slated to take effect midnight Eastern Standard Time on 5 February, and all three prepared retaliatory measures. A media firestorm ensued, to the extent Canadian sports fans booed the US national anthem during an ice hockey game on Sunday.^[iii]

Yet by Monday morning in America, there was a deal and delay with Mexico. A matching deal with Canada followed after market close.^[iv] The tariffs on China took effect, as did the tariffs China implemented in response, but they were smaller than many commentators we follow feared and both sides have talked of reaching a deal. Stocks fell modestly on the day but didn’t plunge. The US-orientated S&P 500 pared early declines to finish down just -0.8%.^[v] Canada’s S&P TSX 60 slipped just -1.2% in Canadian dollars.^[vi] Are markets right to take all this in stride? We think so.

In our view, taking any politician at their word—regardless of personality, policy or creed—is always perilous. But publicly, the Trump administration has portrayed these tariffs as foreign policy, not economic policy. He may occasionally mention trade deficits (the negative balance when imports exceed exports), but they aren’t the tariffs’ stated aim. It is to secure Canada, Mexico and China’s help with curbing the fentanyl trade and undocumented migration. To us, the tariffs seem like leverage, Trump’s way of bringing Mexican President Claudia Sheinbaum, (outgoing) Canadian Prime Minister Justin Trudeau and Chinese President Xi Jinping to the negotiating table. And whilst Canada and Mexico had retaliatory tariffs ready to go, these also appeared to be negotiating ploys. The world seems to be simply playing Trump’s game, in our view.

We think the deals with Mexico and Canada illustrate this. Sheinbaum didn’t win a delay by pledging to cap Mexican exports, reduce subsidies or raise labour costs. Rather, she pledged 10,000 Mexican National Guard Troops to border patrol and enforcement to tackle the drug trade.^[vii] And—getting far less discussion—Trump pledged to address the flow of high-calibre weapons from the US to Mexico.^[viii] Both can claim a win—Sheinbaum in her battle against the cartels, Trump in his efforts against trafficking. And both now have a month to hammer out the details and longer-term foreign policy agreements. Similarly, Trudeau won a 30-day delay after agreeing to deploy 10,000 troops to the northern border and work with the US to tackle fentanyl and organised crime.^[ix] In both cases, no one made economic concessions. Actually, much of what Sheinbaum and Trudeau agreed to was already existing policy.^[x] In our view, this makes the whole scenario look like political theatre.

China, too, seems eager to sit at the negotiating table. Unlike past tariffs, this levy ensnares small packages worth less than $800, putting two large Chinese e-commerce platforms (Temu and Shein) in its crosshairs.^[xi] China responded on Tuesday, announcing plans for a 15% tariff on coal and liquefied natural gas products and a 10% levy on crude oil, agricultural machinery and large-engine cars—all due to start 10 February. They also announced several American companies could face economic sanctions and launched an anti-trust investigation on a US firm that hasn’t done business in China for about a decade.^[xii] Whilst negotiations have reportedly paused, Chinese officials previously signalled their willingness to talk and indicated everything is on the table, including fentanyl, the ownership of social media platform TikTok and the reinstatement of China’s Phase One trade deal with the first Trump administration.^[xiii]

In our view, these events are worth bearing in mind as the conversation shifts to potential tariffs on EU goods, which Trump has hinted at lately.^[xiv] The UK may also skip the tariff tango entirely, as Trump talked down the prospect of tariffs and Prime Minister Keir Starmer has spoken of his government’s desire to work out a bilateral trade deal.^[xv]

But for argument’s sake, what if all these talks and deals fall through and tariffs take effect and stay in place? Focussing on those proposed in concrete terms already, many commentators we follow warn it will mean higher inflation (broadly rising prices across the economy) in the US and tougher times in Canada, Mexico and China. They claim markets haven’t adequately priced these risks and will have to adjust.

We think this is overstated. The first Trump administration’s tariffs on China, which the Biden administration preserved and added to, didn’t spike US inflation or even import costs. Whilst import prices did rise in 2018 and 2019, this was more about the global rise in oil prices.^[xvi] Consumer goods import prices barely budged, rising 0.4% in 2018 and falling -0.4% in 2019.^[xvii]

We see a few reasons for this. One, Chinese producers avoided tariffs by trans-shipping goods through Vietnam and other stopovers.^[xviii] Two, we saw numerous reports of businesses adapting, either adjusting supply chains or negotiating with suppliers to share the tariff load. Three, we saw anecdotes of businesses finding workarounds, like adjusting the design of shoes to avoid having to pay tariffs on certain kinds of rubber.

Even if import costs had risen, it wouldn’t be inherently inflationary. Tariffs apply only to wholesale costs at the border, which are far lower than retail prices. US goods imports are about 11% of gross domestic product (GDP, a government-produced measure of economic output).^[xix] Canada, Mexico and China combine for about 42.9% of total US imports.^[xx] It adds up to new taxes on a small piece of GDP, not nearly broad enough to affect prices of all goods and services, according to our research. Plus—most importantly, in our view—tariffs can’t affect inflation unless the money supply spikes alongside them. We think only that would enable businesses to pass on all added costs indiscriminately. Absent it, we find tariffs inspire substitution, which reduces demand and generally keeps prices in check. Today, US money supply is growing at a normal, pre-COVID pace.^[xxi]

We think the potential economic effect on America’s neighbours also seems overstated. Trade is important to Canada’s economy, but goods exports are 23.7% of its GDP.[xxii] The vast majority of this, 77.3% of total goods exports, does go to the US.^[xxiii] But again, this trade almost certainly isn’t going to vanish. We highly doubt the US would just stop buying Canadian oil, roughly a quarter of US imports from Canada, for example.^[xxiv] US refineries aren’t equipped to process the light sweet crude that bubbles from America’s shale oil wells—they need Western Canada’s heavy crude. Maybe Western Canada Select oil prices fall a bit to adjust to the tariff. Maybe US refiners just swallow the tax. Maybe a little of both. But pipelines between Canada and the US are highly, highly unlikely to run dry, in our view. And more broadly, we think the relationships between US and Canadian businesses are too strong not to find workarounds in other industries.

The same likely goes for Mexico—a beneficiary of the last round of Chinese tariffs, which prompted firms to “nearshore” production.^[xxv] And China, we have already seen that movie. The prior round of tariffs didn’t cause the long-feared Chinese economic hard landing to finally materialise. Trade re-routed. Life went on.

Lastly, our research strongly suggests surprises move markets most. Whether the masses think they are good or bad policy, Trump’s tariffs are in line with what he proposed on the campaign trail and after the election. So are the accompanying foreign policy aims. We think it is fair to say, markets have known about these for months. Investors have therefore, presumably, assessed the probabilities and made the corresponding trading decisions. Yes, one could probably argue tariffs’ history of being negotiating ploys is also priced in, but that is a US-centric view. We find investors outside America tend to be far less optimistic on the dealmaking front, and their scepticism counterbalances US optimism. In our view, global forces always hold sway.