When the World Divides
What happened last week?
Trump announced reciprocal tariffs on Thursday but later added they would not start until April which relieved investors.
He has gravitated towards reciprocal tariffs to raise customs duties that could help finance tax cuts, promote domestic production, and provide negotiating leverage.
This week, 46 S&P 500 firms report their 4Q24 results bringing the total to 430. If the remaining firms report in-line results, S&P 500 4Q24 EPS will be up 12.7% y/y. Following the observance of President’s Day, the market focus will turn to housing and consumer sentiment data, as well as ongoing trade and geopolitical developments.
3 Things to Know
Tariffs Are Unlikely to Impact the U.S. Budget Deficit
The coming year may be one of difficult adjustment for those that are US trade-dependent.
Even so, it just may be that 10 years from now, one will look back at the peak in globalization and the political and economic divisions of the world that are coming into focus and see a quite different picture for global asset prices than today. As we noted, stay open minded and well diversified.
Tax Extensions Will Not Be Covered by Tariff Measures
To visualize the size of this, President Trump’s proposal for “reciprocal tariffs” — tariffs equal to those imposed by US trading partners — would raise U.S. tariff collections about US$93.5 billion in the year imposed (this doesn’t account for potential exemptions or changes in consumer behavior.
It also doesn’t account for the 25% tariffs on Mexico and Canada that have been postponed).
That increase is just around one-third of the amount of federal revenue that would be raised if US federal income taxes rise in line with current budget law in 2026 and would still leave a $1.7 trillion budget deficit.
In other words, even the massive tariff increases Trump has announced would have to be much larger to pay for extensions of US tax rates.
Consumers Are Likely to Bear the Brunt of Tit-for-Tat Tariffs
Tariffs will act as a form of Value Added Tax, a fiscal tightening that many believe the US sorely needs with a budget deficit at 6.3% of GDP.
Does it not strike anyone as ironic that Trump is the only Republican in decades who is proposing to raise taxes of any sort? Such revenue increases should be a positive influence on the US Treasury market, all else constant.
But what other messages do tariffs send to allied nations? What about threats to security alliances, trade agreements, and even borders?
If US federal workers can feel insecure, so too can foreign investors in US assets. Economists hate tariffs. Almost everyone else in affluent countries hasn’t thought that much about them in a long time.
But with the return of President Trump to the White House and the renewed battle over import duties, we must all think more about tariffs than anyone really wants to.
So, to answer who “pays” for US tariffs, it’s not as simple as who pays the actual duty. Rather, it’s “paid” for by consumers who have to shift their consumption patterns, exporters who cannot compete in international markets, and those who explicitly pay higher prices for the duty items.
Tariffs additionally add a layer of uncertainty about business conditions in a country which can impact decisions on where to do manufacturing for multinational firms, as stable and predictable legal and trade frameworks are crucial for confidence to deploy capital investment.
See our weekly CIO Strategy Bulletin for more details