The Trump administration has made good on the President’s campaign promises to wield the threat of tariffs on allies and adversaries alike as leverage to advance both economic and national security agendas. The administration has said it is prepared to levy hefty taxes on goods coming into the country from its largest and most crucial trading partners, including Mexico and Canada. The frequent developments surrounding the implementation of Trump’s trade policies have left markets oscillating with each headline.
What’s a tariff?
Simply put, a tariff is a tax on goods imported into the country. When U.S. retailers and manufacturers purchase goods from other countries, a duty (similar to a sales tax and paid to the federal government) is added to the cost of the goods before delivery. On the surface, the buyers pay the tax.
However, the tariff’s impact likely extends beyond the original buyer. To compensate for the additional cost of goods, the foreign seller may lower their prices, squeezing their own profit margins. As buyers shift toward other supply chains, the currency of the seller falls and thus lowers the effective price (and raises the cost of U.S. exports). Finally, the buyer often passes on the additional cost to the consumer to preserve their profit margins.
Trade hawks argue that tariffs make domestic producers more price competitive. Historically, however, domestic manufacturers have raised their prices in concert with the tariffs, reducing the relative benefit to consumers while increasing their own margins.
Are tariffs inflationary?
This is an area where economists disagree. While the expected outcome of an increase in tariffs is higher prices, destructive inflation is generally associated with a persistent increase in price levels rather than a one-time increase. We have a recent historical example from the first Trump administration. In January 2018, the U.S. imposed tariffs on residential washing machines. While the initial reaction was an increase in prices for the U.S. consumer, the long-term deflationary trend in place for household appliances quickly reverted. In our view, the Federal Reserve and most investors will likely overlook these one-time price adjustments.
However, if the initial tariffs are followed by further escalations, the cumulative impact of one-time price adjustments could become indistinguishable from true inflation, compelling the Fed to further slow its pace or even reverse course on interest rate policy.
How should investors be positioned?
Economic policy never happens in a vacuum. The administration has also promised lower corporate and individual tax rates and decreased regulations, which have the potential to offset some of the trade-related pressures. Given the uncertainty around the magnitude and duration of proposed tariffs, the ultimate impact on corporate profits and economic growth is difficult to assess. Investors with broad, globally diversified portfolios are likely to be positioned to capture returns from regions and sectors that are less sensitive to the effects of tariff policy.
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Sources: Consumer Price Index, Major Appliances, Bureau of Labor Statistics. The information provided is educational and general in nature and is not intended to be, nor should it be construed as, specific investment, tax, or legal advice. Individuals should seek advice from their wealth advisor or other advisors before undertaking actions in response to the matters discussed. No client or prospective should assume the above information serves as the receipt of, or substitute for, personalized individual advice. This reflects our opinions, may contain forward-looking statements, and presents information that may change. Nothing contained in this communication may be relied upon as a guarantee, promise, assurance, or representation as to the future. Past performance does not guarantee future results. Market conditions can vary widely over time, and certain market and economic events having a positive impact on performance may not repeat themselves. Investing involves risk, including, but not limited to, loss of principal. Opinions may change over time due to market conditions and other factors. This is prepared using third party sources considered to be reliable; however, accuracy or completeness cannot be guaranteed. The information provided will not be updated any time after the date of publication.
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