Navigating Tariff Complexities

A second Executive Order also ends the de minimis exemption for China. This allowed China imports valued under $800 to avoid tariffs. Starting May 2, those goods will be tariffed at 30% of their value, or $25 per item, which increases to $50 per item starting June 1.

There are some key exceptions to the additional tariffs. The pre-existing tariff structure on Mexico and Canada will remain as is. This means that USMCA compliant goods will not be tariffed, which represents around half of imports from Mexico and Canada. That proportion is likely increasing as the countries now have strong incentive to ensure goods adhere to USMCA compliance. The additional tariffs will also not apply to the 25% tariff on steel, aluminum and autos tariffs. It will also exclude many key products including copper, pharmaceuticals, semiconductors, lumber articles, certain critical minerals, energy products and all products listed in Annex 2 of the Executive Order. The scale of imported products that are exempt from increased tariffs will be a key area of focus and research in the coming days. Unfortunately, Annex 3 which includes a more comprehensive list of sector has not been released yet but we should assume that products that are of critical importance to the US economy are likely to be exempt and therefore reduce the effective tariff rate.

Macro impacts

If upheld, these tariffs could push the U.S. weighted average tariff rate to around 25%, with product exemptions whittling the increase down toward 20%. That would put it at levels last seen around 100 years ago. It also represents a more aggressive approach than we believe consensus expected heading into the press conference.

We expect baseline tariff expectations will move higher, leading to downward revisions to consensus growth forecasts and upward adjustments to inflation projections. And given the unknowns that still remain, we also do not think uncertainty has been significantly reduced.

From a monetary policy perspective, the Federal Reserve’s challenge is to assess the relative impact from higher temporary inflation and the drag on economic growth. If growth fears were to intensify, the Federal Reserve would have ample room to cut interest rates and would prioritize its growth mandate over short-term inflation concerns.

Countries that are most negatively impacted by the hike in US tariffs are also likely to respond with additional fiscal measures. This would be in addition to the already announced boost in fiscal measures in Europe and Asia over the past two months.

Regarding the impact on equity markets, ongoing uncertainty around trade policy is expected to drive further earnings downgrades and exert pressure on valuation multiples. The upcoming earnings season will offer insights into corporate sentiment and specific strategies to mitigate the negative impact from higher import costs.

Net, we believe this increases the odds of our “Supply Restraint” risk scenario in which tariff policy weighs on growth and leads to temporary inflation. This could put downward pressure on equity earnings estimates, with the potential for multiple compression sooner. It also raises the odds of recession cuts from the Federal Reserve.

At the same time, these tariffs may represent the ceiling for tariff rates that could increase the odds of incrementally positive trade news. Information is still highly fluid and the coming days could reveal very important information regarding the outlook. The Investment Policy Committee meets on Wednesday, followed by the Tactical Asset Allocation team’s meeting on Tuesday.

Given the uncertainties, please do not hesitate to reach out with any questions or concerns. We are happy to assist in any way we can.

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.

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