The era of trade wars begins

Implications for businesses and markets

U.S. President Donald Trump has implemented 25% additional tariffs on all imports from Mexico and Canada and 10% additional tariffs on imports from China. Energy resources from Canada will see tariffs at the lower 10% rate. Mexico and Canada have already negotiated a temporary pause in implementation, and talks are continuing with China. Here are some implications of these actions for the United States:

Retaliatory measures: Mexico, Canada and China have all declared retaliatory measures, setting the stage for a rapidly escalating trade war.

Economic volatility: Despite services comprising over 80% of the American economy, these tariffs target manufactured goods, significantly impacting economic volatility.

Higher prices and lower margins: Nearly half of U.S. imports are inputs for U.S. companies, meaning these tariffs will unevenly affect businesses, forcing some to raise prices, accept reduced margins, or both. In the long run, it will affect supply chains.

Prolonged uncertainty: The long-term nature of these tariffs remains uncertain. They could be a negotiation tactic by President Trump or the onset of a protracted trade war, risking lower gross domestic product growth, higher U.S. inflation, a stronger dollar and higher U.S. interest rates. The uncertainty complicates capital investment decisions for companies.

Mixed impact on earnings: For companies experiencing reduced foreign competition and limited imported raw materials, tariffs may bolster earnings. However, companies that are dependent on newly tariffed imports or heavily dependent on imported raw materials will face significant margin pressure.

Markets and companies do not like uncertainty: While there have been several market-positive policy positions taken since inauguration, the uncertainty of tariff policy may offset those positives.

Commitment to increasing U.S. domestic production: President Trump’s decisive actions on Canada and Mexico, despite a new free-trade agreement with both countries during his first term, underscore the seriousness of his commitment to imposing 60% tariffs on Chinese imports and a 10%-20% universal tariff on all products imported into the United States. These tariffs aim to spur domestic production of goods in the United States.

The market to broaden: This situation reinforces our expectation that stock market performance will broaden and reach a wider array of companies. Small-cap companies not reliant on imports or exports may outperform large-cap stocks with international operations. This increases the urgency for artificial intelligence to demonstrate real-world productivity gains in the United States.

“This time is different”: Historical parallels to the Smoot-Hawley tariff legislation and the worsening of The Great Depression arise in most trade-war discussions. Unlike the 1930s, today’s attempt to maintain a stable money supply, low taxes, and reduced business regulations may mitigate negative tariff impacts.

Vigilance from the Federal Reserve (Fed): The Fed’s response to these tariffs is critical. We would expect the Fed to approach this issue aggressively and continue to rely on a data-driven approach.

Stephen Dover, CFA, is Franklin Templeton’s Chief Market Strategist and Head of the Franklin Templeton Investment Institute. Originally published on Stephen Dover's LinkedIn Newsletter. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.

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