The Trump administration recently announced additional tariffs of 10% on all imports from China which prompted China to impose retaliatory tariffs on some goods imported from the United States. Tariffs of 25% on imports from Mexico and Canada, announced at the same time as the China tariffs, were suspended for 30 days to allow for ongoing negotiations. The administration stated their intention for the tariffs was to pressure the countries into changes related to trade, border security and drug trafficking.
What are tariffs?
At their most basic level, tariffs are taxes on goods and services imported from other countries. Since tariffs increase the cost of foreign goods and services, they’re intended to make domestic products more attractive to consumers.
In addition to giving domestic companies an advantage over foreign producers, governments have used tariffs to penalize other countries and maintain national security.
Who pays for tariffs?
When companies import products or services into a country that imposes tariffs, the company pays the tariff directly to government tax authorities. While companies could choose to absorb this additional cost, historically companies have been more likely to pass on the cost of the tariff to their consumers in the form of higher prices for their goods and services.
What could be the impact of higher tariffs?
Global financial markets displayed considerable volatility in the immediate wake of the announcement. In addition to an increase in short-term market volatility, full implementation of the announced tariffs would also likely put pressure on the Federal Reserve to keep interest rates higher for longer, drive currency volatility in the affected countries and potentially squeeze earnings on companies in the impacted sectors.
Tariffs are inherently inflationary and, therefore, could contribute to upward inflation pressures over time. If fully implemented, the combined tariffs on imported goods from Mexico, Canada and China could increase domestic inflation by nearly 1% while reducing economic growth by a little over 1% in the first year (based on estimates from PIMCO). If only tariffs on China were fully implemented, the economic impact would likely be less pronounced, as the U.S. trades considerably more with Canada and Mexico than with China.
The total value of goods imported into the U.S. is about $3.3 trillion on an annual basis while the cumulative value of personal incomes among U.S. workers is about $25 trillion. Therefore, a 25% increase in tariffs on all imports would be roughly equivalent to a 3% tax increase on all income.
The full extent of the impacts is not yet known as countries may implement retaliatory tariffs (as is already the case with China), exemptions on certain goods (or goods under a certain dollar amount) may be implemented, and the reactions of financial markets and currencies will also play a part.
We’ve been here before…
Given all the unknowns, markets may be volatile in the short-term, but it’s important to remember that economic growth and corporate profits have historically been more important for long-term financial market performance than short-term shifts in government policy or geopolitical events. The following chart, from JP Morgan Private Bank, shows how geopolitical events rarely have a lasting impact long-term equity returns:
Historical data shows the typically fleeting impact of geopolitical events on equity returns
Average real S&P 500 return vs. average real S&P 500 return after geopolitical events
Sources: Robert Shiller, Haver Analytics. Data as of December 31, 2023. Note: Return refers to price return. Geopolitical events in the above chart refer to 36 events selected from 80 years of geopolitical events beginning with Germany’s invasion of France in 1940 and ending with the war in Ukraine in 2022. We measured the 3-month, 6-month and 12-month returns following these events.
Just as tariffs can be imposed quickly, they can also be reversed just as fast. We continue to encourage long-term investors to focus on fundamental drivers—valuations, earnings growth, and diversification—rather than reacting to short-term policy shifts.
The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding investments, sectors or markets in general. The above statistics and/or commentary have been obtained from sources we believe are reliable, but we cannot guarantee their accuracy or completeness. Past performance is no guarantee of future results. Specific securities discussed herein are illustrations and do not represent securities purchased, sold or recommended for client accounts. Such information does not constitute, and should not be construed as, a recommendation to buy or sell specific securities. This is not a complete analysis of every material fact regarding any company, industry, or economic condition. Due to shifting market conditions, all expressions of opinion are subject to change without notice.
The information contained in this document does not cover all tax strategies that may apply, is not a complete guide to tax planning, and does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Before implementing any ideas suggested here, consult with your tax advisor regarding your specific tax situation.
Talk to your financial advisor before acting on information in this document.