Weekly global economic update
What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
Tariffs and their impact on trade
- President Trump exempted computers and smart phones from the 125% tariff on Chinese imports, but only temporarily. This had a positive impact on equity prices. Many investors interpreted the move as suggesting flexibility. Still, administration officials said that these products will eventually face tariffs.
It appears that some industries will get exemptions while others will not. Moreover, the uncertainty created by exemptions may have a chilling effect on investment. As some businesses may believe that in this environment, the best strategy is a wait-and-see approach.
- Meanwhile, the Yale Budget Lab estimates that the current array of tariffs implies an effective average tariff rate for the US of 27%, the highest since 1903. The Yale Budget Lab also estimates that, if the tariffs cause imports from China to fall by more than two-third (which is probably a conservative estimate), it will yield an average tariff rate of 18.5%, still the highest since 1933. Also, given that imports of goods are 11% of US GDP, the existing tariffs are estimated to boost the overall price level by 2.9%. This is on top of whatever other inflation exists. The latest rate of consumer price inflation was 2.4%. Thus, the tariffs could temporarily boost inflation to over 5%. This also means a loss of purchasing power of US$4,900 per US household. This calculation is based on the estimated increase in the prices of goods purchased by consumers.
- China’s exports soared in March when the US tariff was only 20%. It is likely that exports were frontloaded in anticipation of higher tariffs. Exports, evaluated in US dollars, were up 12.5% from a year earlier. This included a 9.1% increase in exports to the United States, 11.6% for ASEAN nations, and 10.3% for the European Union (EU). Imports from the United States were down 9.5%. This likely means that Chinese manufacturers were already planning to cut back on production. As such, they reduced purchases of imported inputs from the United States. Overall Chinese imports were down 4.3% from a year earlier.
- In addition to having imposed a 125% tariff on all imports from the United States, the Chinese government is using other means to put pressure on the United States. This includes new restrictions on the exporting of seven rare earth minerals. Specifically, China now requires that companies acquire export licenses in order to sell these minerals outside of China. Moreover, China has leverage given that 61% of rare earth mining takes place in China and, more importantly, 91% of the refining of rare earths takes place in China. Plus, the United States relies on China for 70% of its consumption of rare earths. These minerals are critically important in the production of high technology and clean energy products. Although the United States and other countries have begun efforts to acquire rare earths in other locations, this will be a long-term process involving massive and time-consuming investments.
China also ordered Chinese airlines to halt deliveries of large jet airplanes made in the United States. In the first quarter of this year, US exporters delivered 18 aircrafts to China accounting for 14% of global deliveries. Thus, an inability to deliver planes to China could ultimately hurt the company, one of the largest US exporters. The Chinese airline industry is one of the key targets of US exporters given the expectation that their domestic airline market will grow rapidly in the next two decades.
- The US imposed a 25% tariff on imports of steel and aluminum, starting on March 12. In March, Japanese and Korean steel shipments to the United States were down sharply, with Japanese exports falling 16.6% from a year earlier and Korean exports falling 24% from a year earlier. It is reported that exports had previously benefitted from frontloading in anticipation of tariffs. Although the United States initially announced high reciprocal tariffs on both Japan and South Korea, these were postponed for 90 days while a baseline tariff of 10% was imposed on all imports from both countries. For now, the biggest US tariffs are on imports from China as well as imports of steel, aluminum, and automobiles.
- A delegation of Japanese government officials held talks with their US counterparts in Washington, the goal of which was to reach a trade agreement. To their surprise, President Trump participated in the talks. That was seen as a signal of the seriousness with which the United States takes these talks. Moreover, other countries are watching this closely. What happens with Japan will provide evidence as to what strategy might work or not work with the United States. However, it was reported that no progress was made and that the delegation returned home empty-handed. It was also reported that one of the issues raised by the United States was the cost incurred by the United States to station military facilities in Japan.
Disruption to global finance
Meanwhile, the rapid events in trade have been disruptive to global financial markets. Here is what you need to know about finance:
- Global equity prices fell recently after Fed Chair Powell gave a speech on April 16, with comments about the trade situation. Powell said that “the level of the tariff increases announced so far is significantly larger than anticipated. The same is likely to be true of the economic effects, which will include higher inflation and slower growth.” There was nothing new here, but markets reacted to the implications of Powell’s remarks.
In addition, Powell said that “tariffs are highly likely to generate at least a temporary rise in inflation. The inflationary effects could also be more persistent. Avoiding that outcome will depend on the size of the effects, on how long it takes for them to pass through fully to prices, and, ultimately, on keeping longer-term inflation expectations well anchored.”
Regarding the Fed’s dual mandate to minimize inflation and maximize employment, Powell stated that “we may find ourselves in the challenging scenario in which our dual-mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.” This left unanswered how the Fed will respond to tariffs. But it did offer something of a road map, highlighting how the Fed will choose what to do. Powell’s speech demonstrated that the tariff situation is now at the center of Fed deliberations.
Meanwhile, the European Central Bank (ECB) cut its benchmark interest rate by 25 basis points to 2.25%. The unanimous decision of the ECB’s policy committee put the rate at the lowest in more than two years. The ECB commented that “the disinflation process is well under way.” This implies that monetary easing is warranted. But there is more. The ECB alluded to potential economic troubles, saying “the adverse and volatile market response to the trade tensions is likely to have a tightening impact on financing conditions. These factors may further weigh on the economic outlook for the euro area.” This, too, implies a need for monetary easing.
- An index of the value of the US dollar against a basket of other currencies is now at the lowest level since March 2022. Plus, the Japanese yen hit the strongest level since September 2024. This rapid descent of the dollar was not expected, even when the US administration started to announce tariffs. Normally, an increase in tariffs leads to currency appreciation. That is because US tariffs reduce imports, thereby reducing demand for foreign currency, putting downward pressure on the value of foreign currencies (or upward pressure on the dollar). Indeed, the dollar did appreciate considerably early in the administration when tariff increases were expected.
Yet the factors that would normally cause dollar appreciation were more than offset by the possibility that tariffs could ignite a recession. Moreover, there is a growing sense that US policy is unpredictable and unrelated to a fundamental strategy. This uncertainty has undermined confidence, leading to an increased aversion on the part of global investors to holding US assets. That, in turn, contributed to the depreciation
One result has been a sharp increase in currency value volatility. That, in turn, has led to increased demand for currency hedging. In recent days, a measure of currency volatility has hit the highest level since the March 2023 collapse of a medium-sized bank in California. Global companies, exposed to currency risk, are increasingly purchasing hedging products meant to protect them from volatility. In addition, there has been a sizable increase in demand for futures contracts. Hedging has a cost, but evidently businesses are willing to pay the cost in exchange for predictability.
China’s economic growth accelerates
- At a time when the tariffs threaten to undermine China’s economy, it was reported that China’s economy performed better than expected in the first quarter. Real GDP was up 5.4% from a year earlier, the same as in the previous quarter, which was the best performance since the second quarter of 2023. In part, strong growth reflected the frontloading of exports in anticipation of tariffs. Thus, with tariffs now in place, it is likely that growth could decelerate going forward. However, in part, China’s strong growth was due to a strong rebound in retail sales, industrial production, and business investment.
The Chinese government reported that, in March, retail sales were up 5.9% from a year earlier, the best performance since December 2023. Most categories of spending experienced a rebound. Meanwhile, industrial production increased 7.7% in March versus a year earlier, the best performance since June 2021. There was strong growth for manufacturing, especially in computers, communication, and automobiles. Finally, fixed asset investment surged in the first three quarters of 2025, up 4.2% from a year earlier. While property investment continued to decline, non-property investment grew quite rapidly.
The favorable nature of this data might partly reflect the impact of recent policy adjustments meant to propel domestic demand at a time when the country faces severe obstacles to export growth.
Japanese inflation remains too high
- Rice is now a problem in Japan. After a long period in which the amount of land under cultivation for rice has fallen, and as demand for rice has risen especially due to increased inbound tourism, the price of rice has risen sharply, contributing to persistent inflation. In fact, it is reported that the price of rice was up 92.1% in March versus a year earlier. Given how much rice is consumed in Japan, this has led the share of household spending devoted to food to increase to 28.3%, the highest in 43 years. Part of the problem is that Japan is self-sufficient in rice. The tightness of the rice market could be eased if imports were permitted. However, Japan’s agricultural minister recently said that it is “not good for Japan’s food security to rely on overseas sources for staple foods.”
In any event, the rice situation has contributed to overall inflation. The government reports that, in March, consumer prices were up 3.6% from a year earlier. Although this was lower than in the previous two months, it was still historically high and at a level not seen since 2023. Moreover, when volatile food and energy prices are excluded, so-called core-core prices were up 2.9% in March from a year earlier, the highest in 12 months. Thus, inflationary pressure in Japan remains much higher than the 2% target of the Bank of Japan (BOJ).
For the BOJ, this is a period in which making policy is challenging. On the one hand, inflation is higher than desired, which suggests the need to tighten monetary policy further. On the other hand, the yen has been rising in response to the policies of the US government. A rising currency is disinflationary, thus alleviating the need to raise interest rates. Moreover, the burgeoning trade war with the United States threatens to undermine Japanese economic growth. If that happens, it will also ease pressure on inflation. Thus, from the perspective of the BOJ, it might make sense to wait and see what happens.
Tariff wars continue
- After President Trump temporarily postponed many of the tariffs announced recently, investors initially rejoiced. Yet with the US tariff on Chinese imports now 145%, and with many other tariffs still in place, the reality is that the average effective tariff rate for the United States is now likely higher than following the initial announcement of massive tariffs. Thus, the US tariff rate is the highest in more than a century and the increase in tariffs since the start of this year is the biggest ever.
Meanwhile, China’s tariff on US imports is now 125%. This means a nearly complete economic decoupling between the two countries. Large companies are uncertain what to do. It is likely that many small- to medium-sized businesses in the United States are in trouble due to the trade situation.
The trade war between the United States and China is now the focus of much attention. The tariffs are so high now that, if the tariffs don’t change, it will result in a substantial decoupling between the two countries. There has already been some decoupling in the last decade, but this will be decoupling on steroids. Yet will companies make significant investments to decouple their operations from China if there remains a threat of tariffs on alternative countries? It is not clear. Recall that the Biden Administration retained the tariffs on China imposed during the first Trump Administration. Biden added new restrictions on trade and cross-border investment but mainly related to technology and clean energy. However, Biden’s Treasury Secretary Janet Yellen said that “our two economies are deeply integrated, and a wholesale separation would be disastrous for both.”
Regarding US imports from China, China accounts for more than 60% of the imports of game consols, PC monitors, toys, mobile telephones, lithium-ion batteries, and personal computers. With the tariffs, the prices paid in the United States for these products are expected to rise substantially until alternative sourcing can be arranged.
Many smaller US companies design products that they pay contract manufacturers to assemble in China. For these companies, the tariffs will now be far more than the cost of imports. This creates cashflow problems for some. For others, there is the question of whether to proceed if prices must be raised accordingly. I saw one entrepreneur interviewed on television saying that she will attempt to divert shipments from China to other countries, hoping the goods can be sold elsewhere.
The imposition of massive tariffs follows statements by Chinese officials to the effect that they will not back down. On April 7, a Chinese official said that China will “resolutely take countermeasures to safeguard its own rights and interests. If the US insists on going its own way, China will fight to the end.” China likely believes it can withstand this assault, especially given that trade with the United States is not nearly as large a share of its economy as is the case for many other countries. Indeed, trade between the United States and China has been decreasing as a share of GDP ever since Trump’s first round of tariffs in 2018. China’s trade has shifted toward other emerging nations. Moreover, with many of those nations facing severe US tariffs, it is likely that China will seek to improve economic and political relations with those countries. Thus, even though there might be an economic cost to China from this trade war, there could be geopolitical gains in the long run.
Indeed, China appears to be taking advantage of this situation to boost its geopolitical standing, even though the tariffs will likely damage the Chinese economy. China’s government welcomed a visit from Spain’s prime minister today while China’s president is planning a visit to Vietnam, which previously was seen as a US ally in the effort to reduce the influence of China. In addition, he will visit other Southeast Asian countries in an effort to boost economic and political relations. Southeast Asian countries were hit by very high tariffs in the US initial announcement on April 2. Those tariffs have been postponed for 90 days. It is reported that China hopes to convince countries in the region that it is a credible and reliable partner.
Also, some countries have proposed zero for zero tariffs with the United States. This includes Vietnam and the European Union (EU). The United States turned down both offers. It says it wants other countries to not only reduce their tariffs, but to also purchase more goods from the United States. It has put particular emphasis on getting other countries to commit to purchases of liquid natural gas (LNG) from the United States. On the other hand, some leaders in the US administration continue to say that negotiations are not the goal. Rather, they say that the goal is permanent tariffs that will drive a return of manufacturing to the United States.
Regarding such negotiations, it is not clear what the United States seeks. Some countries such as Vietnam have suggested that they could eliminate tariffs on imports from the United States if the United States does likewise. However, the United States has imposed tariffs on other countries mainly based on the size of their trade surpluses with the United States. Tariff movements are not likely to have a significant impact on overall trade balances, but they might influence bilateral balances. Yet countries cannot promise to end a trade surplus.
It is useful to think about what a trade deficit entails. I personally have a trade deficit with my dentist. He sells root canals to me while he buys nothing in return. Yet this works because he is better at doing a root canal than if I tried to do it myself. Meanwhile, I have a trade surplus with Deloitte. I provide analyses for Deloitte while they pay me. I buy none of their services in return. I certainly don’t need an enterprise software implementation for my home.
These trade imbalances are not necessarily a problem. Rather, they are a reflection of comparative advantages. Likewise, the United States buys aluminum from countries that produce it cheaply and uses that aluminum to produce airplanes that are sold to other countries. The point is that trade imbalances are not necessarily a bad thing. Yet if the United States seeks to eliminate all bilateral imbalances, it will fail and will cause a substantial decline in efficiency and productivity in the process.
It is also important to note that a trade deficit is not a reflection of economic weakness. The US has been running trade deficits for decades. It has also been one of the strongest developed economies in the world, the envy of many. Some countries with trade surpluses, such as Germany and Japan, have been stagnating.
Finally, it is possible that the US trade deficit will decline substantially, but mainly due to a weakening of US demand or even a recession. Trade balances tend to be inversely correlated with economic conditions, with stronger growth leading to bigger trade deficits and vice versa. Thus, if the US economy goes into recession in the coming year, which is now seen by many as a strong possibility, the trade deficit will likely decline sharply. Yet that would hardly be a favorable outcome.
Once again, uncertainty is the prime issue that now faces many global companies. Plus, uncertainty is likely to stifle investment decisions, for at least 90 days if not longer. Given the uncertainty as to what happens next, the best strategy for many companies is probably to wait and see. That fact will likely have a negative impact on the US and global economy, with investment decisions being postponed. Companies will likely be worried that any major investment decision, based on a view as to where tariffs will be, could easily be made unprofitable by unexpected tariff decisions by the US administration.
In any event, the combination of uncertainty and historically high tariffs increases the likelihood of an economic slowdown or recession for the United States in the coming year.
Financial markets react
- Although equity prices have been very volatile (falling yesterday and rising today), they are of lesser importance than the prices of currencies and bonds. The volume of currency transactions and the size of the United States and global bond market dwarfs the equity market. The trade situation has raised questions with investors both about the future path of the US economy and the future status of US markets as a safe haven. Consequently, there has been a sizable decline in the value of the dollar and a sharp rise in US bond yields.
The yield on the US Treasury’s 10-year bond rose recently to 4.48%, the highest since mid-February, having been as low as 3.93% earlier this month. The value of the dollar has fallen, with the exchange rate hitting 1.13 euros per dollar late last week, the lowest value for the dollar since early 2022. Regarding the Japanese yen, there were 143.7 yen per dollar last week, the lowest value for the dollar since September 2024. And the Swiss franc appreciated against the US dollar to the highest level since 2011, rising 3% in one day.
These movements were likely a result of risk-averse investors flooding into perceived safe assets, which no longer means US dollars. The reasoning is likely that a withdrawal of the US from the global trading system makes US assets attractive and possibly less liquid. Plus, it likely means slower growth, higher inflation, and potentially less inbound investment. This also makes the United States less attractive. Finally, Switzerland and Japan, with low inflation and stable economic policies, now appear far more attractive.
The sharp rise in bond yields partly reflects concern about liquidity in the massive US bond market. If everyone wants to sell and no one wants to buy, then liquidity dries up. This can create a vicious cycle of worsening confidence, possibly leading to a seizing up of some parts of the financial markets. Thus, the president of the Federal Reserve Bank of Boston, Susan Collins, said that the Fed “would absolutely be prepared” to intervene to restore liquidity. She added, “We’re not seeing liquidity concerns overall.” However, she noted that the Fed “does have tools to address concerns about market functioning or liquidity should they arise.”
US consumer confidence drops precipitously
- The tariff war has taken a toll on US consumer confidence. The University of Michigan’s index of consumer confidence fell again in April, hitting the second lowest level since the index began in 1952. Confidence has fallen for four consecutive months and the index is now 30% below the level seen in December and 34.2% below a year earlier. The sub-index of consumer expectations is down 37.9% from a year earlier. However, the April data was obtained before last week’s announcement of a postponement of some of the tariffs.
Notably, consumers evidently expect that tariffs will drive higher inflation. The survey found that consumers expect inflation in the year ahead to be 6.7%, the highest expectation since 1981. Consumers also expect a sharp rise in unemployment. Although indices of consumer confidence are not always a good predictor of consumer behavior, sharp movements in the index could suggest a change in behavior.
US inflation continues to ease even as worries about tariffs emerge
- Although consumers evidently expect higher inflation due to tariffs, investor expectations of inflation have fallen, likely based on expectations of recession. Meanwhile, the US government reported that, in March, inflation was quite favorable. The consumer price index (CPI) was up 2.4% in March versus a year earlier, the lowest since September, which had been the lowest since February 2021. The CPI was down 0.1% from the previous month, the first month to month decline since 2020.
The weakening of inflation was due to a drop in energy prices. When volatile food and energy prices are excluded, core prices were up 2.8% in March versus a year earlier. This was the lowest annual rate of core inflation since March 2021. The weakening was due to a deceleration in the price of shelter (housing). Core prices were up 0.1% from the previous month.
Prices of durable goods were down 1% from a year earlier while prices of non-durables were up 0.5%. Most inflation continued to stem from services. Yet service inflation, at 3.7%, was the lowest since October 2021.
If it were not for the tariff situation, there would be reason to believe that inflation is largely defeated. This, in turn, would call for a further easing of monetary policy by the Federal Reserve. Yet the threat of tariffs suggests at least temporary inflation. Bond investors, however, expect that to be short-lived and that a potential recession will likely reduce inflation.
Week of April 07, 2025
Tariff announcement shakes the global economy
- After much anticipation, last Wednesday, US President Trump announced his tariff plan. In his speech, he said that the plan is to impose reciprocal tariffs on other countries. Yet the tariff rates will not be based simply on the tariffs that those countries impose on the United States. Rather, his administration said that the tariffs will reflect the impact not only of tariffs but also of currency manipulation and nontariff barriers. The latter include quantitative restrictions on imports, onerous regulations, and even high value-added taxes.
How did the US administration calculate the implicit tariff that other countries impose on the United States? The administration used a simple formula, which it revealed in a report. It divided the US trade deficit with a country by that country’s exports to the United States. For example, last year, the US trade deficit with the European Union was US$236 billion, while EU exports to the United States were US$605 billion. Dividing the deficit by the export numbers yields 39%. Likewise, the US trade deficit with Indonesia was US$18 billion, while Indonesian exports to the United States were US$28 billion. Dividing one by the other yields 64%—the same as the administration’s figure.
Trump said that he will impose a reciprocal tariff of only half the estimated implicit tariff charged by other countries. As such, he will impose a tariff of 20% on all imports from the European Union. In the case of Japan, the effective average tariff on imports from the United States is 1.9%, but the administration estimates that the true impact of nontariff barriers is equivalent to a tariff of 48%. As such, the administration is imposing a tariff of 24% on imports from Japan.
The numbers vary by country. The tariffs to be imposed will include 34% on all imports from China, 31% on Switzerland, 26% on India, 32% on Taiwan, 25% on South Korea, 36% on Thailand, 32% on Indonesia, 46% on Vietnam, and 49% on Cambodia. The tariff on imports from the United Kingdom, however, will be only 10%. Trump said that there will be a baseline tariff of 10% applied to all countries regardless of their trade policies.
Regarding Canada and Mexico, the reciprocal tariffs will not be applied—at least not yet. Rather, the existing 25% tariff minus exemptions for goods covered by the United States-Mexico-Canada trade agreement will remain in place. However, the administration said that, once the dispute over fentanyl is resolved, the United States will revert to reciprocal tariffs for Canada and Mexico. Also, the administration will implement the 25% tariff on imported automobiles that was previously announced.
The administration’s formula yields results that are not necessarily related to actual trade restrictions by other countries. For example, in the case of the European Union, the actual average tariff on imports from the United States is 2.7%. As for currency manipulation, it is difficult to make that case, given that the euro/dollar exchange rate is largely determined by market forces. Finally, there might be nontariff barriers, but it is unlikely that they are equivalent to a tariff of nearly 39%. Thus, the 20% tariff on imports from the European Union that was announced is surprisingly large and will leave the United States with a far more restrictive trade policy than the European Union.
Also, it is important to note that the tariffs announced will be added to existing tariffs. Thus, the 34% tariff on Chinese imports adds to the 20% already imposed. Thus, every item exported from China to the United States will face a minimum tariff of 54%. However, when that tariff is added to existing tariffs that were imposed in 2018, the Peterson Institute calculates that the average US tariff on Chinese imports will now be 74%—a massive number that is higher than the 60% President Trump had threatened during the election campaign.
Some countries were lucky, in that they will only face the baseline 10% tariff. Aside from the United Kingdom, these include Brazil, Chile, Australia, Turkey, and Colombia. On the other hand, some of the steepest tariffs were applied to some of the world’s poorest countries. These include tariffs on Bangladesh (37%), Pakistan (29%), Myanmar (40%), and Sri Lanka (44%). If these countries face obstacles to exporting to the United States, it is likely that their businesses and governments will focus instead on other export markets such as China and the European Union.
- Importantly, trade between countries involves not only physical goods, but also services. In fact, services trade is massive. It includes financial services, professional services (such as what we do), tourism and hospitality, transportation, and more. Although the United States runs a trade deficit in goods, it has a trade surplus in services. When trade balances in goods and services are combined, along with net payments and transfers, it amounts to the current account balance, which is the only balance that really matters. The current account plus the capital account is the balance of payments. In the case of the United States, it is usually close to zero. That is, capital flows pretty much offset current account flows. The balance of trade in goods has no real meaning, yet it is the focus of everything that is now happening.
Why is this important? The reason is that the formula that the US administration used to determine what tariff to charge other countries only included trade in goods. If it had included trade in services, the formula would have led to almost no tariff on the European Union. Tariff rates on other countries would have been significantly different as well. On the other hand, it is probably just as well that the United States did not impose tariffs on imported services. This would have severely disrupted our own business model at Deloitte and would have been even more disruptive to financial markets than what we are now seeing. Meanwhile, the European Union is considering restrictions on service trade with the United States as a way to retaliate against US tariffs on EU goods.
- Trump said that his tariff plan would generate significant revenue for the US government, would compel companies to invest more in production in the United States, would revitalize US manufacturing, and would generate wealth for the country. Critics might say that significant tariffs would boost consumer prices, thereby creating higher inflation and compelling the Federal Reserve to adjust monetary policy; increase production costs for US companies, thereby reducing their global competitiveness; undermine consumer purchasing power, thereby leading to slower spending growth; and damage relations with allied countries.
- There was a financial market meltdown during the two days that followed the announcement. By Friday, the price of Brent crude oil was down 6.4% from around 12% from two days earlier. The price of copper and other key metals as well as the price of European natural gas were down sharply.
In addition, after having dropped nearly 5% on Thursday, the S&P 500 index of US equities closed down 5.4% on Friday. This put equity values at the level last seen in August of last year. US equities were not alone. The rout continued around the world. Equities were down sharply in Western Europe, Japan, Canada, and many other places. It was a global decline in the prices of risky assets.
Bond yields fell as well. The yield on the US Treasury’s ten-year bond fell to 3.93% on Friday, before bouncing back to 4.0%, having been as high as 4.18% just two days earlier. The yield is now the lowest since early October. Yields in most other developed economies were down sharply as well. This reflected an expectation that central banks will be more aggressive in easing monetary policy in the coming year. That, in turn, reflected expectations of a substantial economic downturn. Indeed, futures markets’ implied probability that there will be two US interest rate cuts this year fell from 35% one month ago to just 4% now. Investors now see a 75% chance of four more Federal Reserve rate cuts this year. One might infer that investors are now expecting a recession soon. Also, the drop in US bond yields likely reflected a flight to safety on the part of global investors. US Treasury bonds are still seen as the world’s safest asset, especially at a time of uncertainty and risk.
Regarding the Fed, the chair of the Federal Reserve, Jerome Powell, gave a speech late last week in which he said, “It is now becoming clear that the tariff increases will be significantly larger than expected. The same is likely to be true of the economic effects, which will include higher inflation and slower growth.” He noted that uncertainty remains high, as we don’t yet know how long the tariffs will remain in place, and what degree of retaliation will take place by other countries. He said, “Inflation is going to be moving up and growth is going to be slowing, but to me, it is not clear at this time what the appropriate path for monetary policy will be.” He added that “while tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could be more persistent.” In other words, it remains unclear what the Fed will do.
Interestingly, the five-year break-even rate for US Treasury securities, which is a measure of bond investor expectations for average inflation over the next five years, fell by 10 basis points in the two days following the tariff announcement. Thus, despite the introduction of high tariffs, which are normally inflationary, investors evidently expect lower inflation to ultimately prevail, perhaps after a temporary hike in inflation, likely due to a sizable decline in demand.
- The tariffs that were introduced are without precedent in modern times. One might compare this to the Smoot-Hawley tariffs that were introduced at the start of the Great Depression and exacerbated it. Yet the new US tariffs represent a bigger increase in tariffs than the Depression-era boost in tariffs.
In fact, the Yale Budget Lab has estimated that the new tariffs, added to existing tariffs, will boost the effective average tariff rate of the United States to 22.5%, which is the highest level since 1909. In addition, they estimate that, if the tariffs are fully passed through to consumers, the average US household will see its purchasing power reduced by US$3,800.
- One reason that investor sentiment declined late last week is that China retaliated against US tariffs. The Chinese government announced that it will impose a 34% tariff on all imports from the United States. This is far more aggressive than anything China has done previously. In addition, China imposed new restrictions on exports of rare earth minerals and launched an investigation of a large US-based chemicals company. It is likely that China’s action is meant to set the stage for negotiations with the United States.
The 34% tariff launched by China is the same as the 34% tariff announced by the United States. Meanwhile, China imported US$143 billion in goods from the United States last year. The high tariffs will likely lead to a reduction in imports from the United States, with trade being diverted elsewhere.
The high US tariff on imports from China could lead China to attempt to boost exports to other countries, perhaps by lowering prices. This is a concern for the European Union. As such, it is reported that the European Commission is preparing to impose emergency tariffs on China, should there be a surge of imports from China.
In recent years, many global companies have shifted some processes from China to neighboring countries in Southeast Asia. This shift, often known as “China plus one,” was a reaction to US tariffs on China as well as fears of further worsening of US-China relations. It is a strategy undertaken by companies based in the United States, Japan, and Europe. Yet, now, this strategy is under question, given that the United States is imposing severe tariffs on several Southeast Asian nations, especially Vietnam. Indeed, Vietnam has been a major destination for producers of electronics, apparel, and other consumer products.
- In anticipation of tariffs, imports had surged in January. It is likely to be true of February and March as well. In January, imports of goods and services hit a record high of US$401.2 billion. This was up from US$364.6 billion in December and US$326.0 billion in January of last year. That is a 23% increase from a year earlier. Now that high tariffs are being introduced, it is likely that imports will recede in the months ahead. Meanwhile, exports remained steady in January. The increase in imports was entirely due to a surge in imports of goods. Service imports were steady. Also, it has been reported that consumer spending on cars surged recently in anticipation of tariffs.
- Finally, one question that arises is whether the US administration will keep these elevated tariffs in place for a prolonged period. In the past three months, the administration has backtracked on some tariff proposal and reversed course on others. Investors and business leaders have become wary of making investment decisions based on tariff expectations. It is likely that uncertainty has taken a toll on business investment and business confidence. Business leaders will want to know what the trading environment will look like, not only in the next several months, but in the next several years. Only with that knowledge can they make sensible long-term investment plans.
US tariffs on automotive imports and their potential impact
- In recent days and weeks, there have been conflicting announcements regarding US trade policy. Tariffs have been proposed but not implemented, announced and then postponed or reversed, generating a high degree of uncertainty about trade policy. In addition, there were reports that the President intends to relieve some countries of the new tariffs that are planned for April 2. “I’ll probably be more lenient than reciprocal,” he said, “because if I was reciprocal, that would be very tough for people.” All this suggested that the US administration might take a more measured approach to tariffs than previously expected. And then the President made an announcement that suggested otherwise.
President Trump recently announced that, starting on April 2, there will be a 25% tariff on all automobiles and some automotive parts not assembled in the United States. This would include automobiles imported from Canada and Mexico as well as those coming from Europe and Asia. He said, “This is the beginning of Liberation Day in America. If you build your car in the United States, there will be no tariff.” When asked if there is any chance these tariffs could be delayed or reversed, he said that “this is permanent.”
The US tariffs on automobiles are, according to the US administration, meant to revive car manufacturing in the United States. In his proclamation, the President said that the automotive industry “has been undermined by excessive imports threatening America’s domestic industrial base and supply chains.” Yet, following the announcement, shares of US and foreign automotive companies fell sharply. Plus, automotive executives warned of significant price increases and a likely decline in sales. There is also an expectation that supply chain disruption will lead to a temporary decline in production.
The tariffs will apply not only to cars but to major components such as transmissions, engines, and other large parts. There is talk of extending the tariffs to other smaller components as well. In addition, regarding the existing free-trade agreement with Canada and Mexico, known as the USMCA, the President said that “USMCA-compliant automobile parts will remain tariff-free until the Secretary of Commerce, in consultation with US Customs and Border Protection (CBP), establishes a process to apply tariffs to their non-US content.” In other words, the tariffs will not immediately apply to all automotive products imported from Mexico and Canada. Yet the statement implied that some tariffs may eventually be applied.
The reason that the automotive tariffs are so important and potentially so disruptive is that nearly half of all cars sold in the United States are imported. In addition, the domestic content of the cars assembled in the United States accounts for somewhere between 40% and 50% of the value. The remainder involves imported components. The introduction of such large tariffs is unprecedented in modern times and the potential impact could be huge. If it leads to a decline in automotive employment, that could cascade to many other industries that supply the automotive industry.
Automobiles are the second most traded product in the world. Moreover, the US accounts for 21% of all the imported vehicles. In 2023, the most recent year for which data is available, the United States imported US$208 billion and exported US$65.3 billion worth of cars. The United States was the biggest importer of cars, by far, and was the fourth largest exporter after Germany, Japan, and China. In 2023, trade in automobiles amounted to nearly one trillion dollars. Thus, a disruption of US automotive trade will have significant global repercussions. The immediate response to the announcement on tariffs was that share prices of automotive companies fell sharply.
Also, some analysts have noted that the 25% tariff will be added to other existing and potential tariffs such as the reciprocal tariffs the United States promises to introduce soon. As such, the tariff on some automobiles could be much more than 25%. For example, the administration has already introduced a 20% tariff on all imports from China. Adding the 25% tariff on cars will bring the total to 45%. Also, the United States already has a 25% tariff on imported SUVs (sport utility vans). The new tariff will bring the total to 50%.
One concern is that the United States is a major automotive exporter. Yet the cars that are exported have plenty of imported components. European automotive companies export as much as 60% of the cars they assemble in the United States, using plenty of imported components. If the tariff applies to those components, US automotive exports are expected to become less competitive in global markets. It is possible that European producers might then choose to shift assembly back to Europe.
The tariff announcement sent shockwaves around the world, with political and business leaders in Europe, Japan, Canada, and Mexico facing difficult choices. In Japan, Prime Minister Ishiba said that there needs to be an appropriate response and that “all options are on the table.” A senior official said that Japan hopes to negotiate exemptions. It has been suggested that Japan could offer to boost defense spending, including purchases of US-made weapons, in exchange for tariff forbearance. South Korea’s Hyundai announced a US$21 billion investment in the United States last week. The Korean government hopes that such action might help to obtain exemptions.
Europe likewise faces difficult choices. European Commission President Ursula von der Leyen sharply criticized the tariffs. Yet she also said that “the EU will continue to seek negotiated solutions, while safeguarding its economic interests.” Another senior EU official said, “We are going to back an industry that complies with the highest standards in terms of labor rights, in terms of environmental standards. And that is key for a well-functioning economy here in Europe and worldwide.” That suggests the possibility of financial support for companies that are disrupted.
In addition, French President Macron said that he hoped “to find an accord to dismantle the tariffs.” The question, then, is what can Macron and other European leaders offer to the United States that might compel it to back down? Perhaps more defense spending and purchases of US weapons. Germany, meanwhile, took a harder approach. The economics minister, Robert Habeck, said there must be a decisive response and that “it must be clear that we will not back down.” German automobile producers are highly dependent on the US market. Also, many of the cars they produce for the US market are assembled in Mexico. On the other hand, European high-end luxury producers such as Porsche and Jaguar can probably boost prices without necessarily hurting demand due to the lower price sensitivity of their customer base.
Regarding supply chains, if automotive companies perceive the tariffs to be permanent, they will likely consider significant changes in their operating models, including undertaking assembly in the United States even if it involves importing components. US auto makers import a sizable number of vehicles from Mexico, while European and Japanese car makers import some cars and assemble others in North America.
Interestingly, it is reported that, prior to the announcement of tariffs on imported automobiles, global automotive producers were rushing to ship cars and automotive components from Europe and Asia to the United States. The goal was to get the cars to the United States before new tariffs are implemented. Consequently, ships were being rushed to Europe and Asia to collect the cars. This has been going on since the new US administration took office. In February, for example, the volume of cars shipped from the European Union (EU) to the United States was up 22% from a year earlier. Shipments from Japan were up 14%.
It is likely that the impact of tariffs on automobiles won’t show up in the form of higher new car prices for about two months while dealers sell existing inventories. However, demand might surge in the interim, leading to a quick unwinding of inventories and a sooner increase in prices. When new car prices rise, it will likely lead to a surge in used car prices. Recall that this happened during the pandemic. At that time, the rise in used car prices made a disproportionate contribution to the overall rise in inflation. Also, if new car prices rise sharply, it will likely dampen demand for new cars, thereby boosting demand for used cars.
US proposes new fee on China-related ships
- The US administration is concerned that the United States is too dependent on Chinese shipping, with particular concern that the US military relies on foreign shipping to obtain supplies. The United States has 185 ocean-going commercial ships while China has 5,500 such ships. To revitalize the US shipping industry, the administration has proposed imposing a fee of up to US$1.5 million on any Chinese-built or Chinese-flagged vessel docking at US ports. The idea is to discourage use of Chinese ships and thereby undermine China’s dominance of the industry. It is also meant to encourage more shipbuilding in the United States.
However, there are several potential problems with the plan. First, many US-based shipping companies use ships made in China and, consequently, would be subject to the fee. In fact, China accounted for 50% of global shipbuilding in 2023. Thus, a large share of ships operated by US companies were built in China. It has been suggested that US shippers can offset the higher cost by shipping goods to ports in Canada and then transporting the goods by land to the United States. Of course, if tariffs are applied to Canadian imports, this wouldn’t be effective. If goods are diverted to Canada, it would hurt US port facilities.
US consumer spending slows
- The US government reported recently that, in February, real (inflation-adjusted) consumer spending grew slowly despite a strong rise in income. Households boosted their savings. Meanwhile, underlying inflation appeared to accelerate modestly in February. This data spooked already jittery investors who pushed equity prices down sharply. Moreover, bond yields fell while the value of the dollar dropped against the euro and the Japanese yen. The drop in bond yields, despite a signal of potentially accelerating inflation, likely reflected concern that the economy could be weakening, thereby ultimately leading to easing of monetary policy later this year. In any event, let’s look at the data.
In February, real disposable personal income (which is after inflation and taxes) was up 0.5% from the previous month, driven by strong growth of wage income as well as transfer payments from the government. At the same time, real consumer expenditures increased only 0.1% from the previous month. This resulted from an increase in the personal savings rate, which rose from 4.3% of disposable income in January to 4.6% in February. This was the second consecutive month in which the savings rate increased.
Meanwhile, the real increase in consumer spending, which followed a sharp decline in January, included a 1% increase in real spending on durable goods from the previous month, a 0.5% increase for non-durable goods, and a 0.1% real decline in spending on services. It was the first decline in real spending on services since January 2022.
The relatively strong growth in spending on durable goods might reflect frontloading of spending due to anticipation of tariffs. The decline in spending on services, however, could reflect anxiety about the state of the economy. This would be consistent with data from the recent survey of consumer confidence conducted by the University of Michigan. The confidence was down sharply in February. It also fell again in March, perhaps boding poorly for spending in March. Also, the survey found weakening confidence among most cohorts, including across both political parties. The survey authors said that anxiety about tariffs played a role.
Finally, the report on spending and income included data on the Federal Reserve’s preferred measure of inflation; the personal consumption expenditure deflator, or PCE-deflator. In February, this measure was up 2.5% from a year earlier, the same as in January. However, when volatile food and energy prices are excluded, core prices were up 2.8% in February versus a year earlier, up slightly from the 2.7% seen in January. Notably, the core PCE-deflator was up 0.4% from the previous month, the largest such monthly increase since January 2024. Thus, underlying inflation clearly accelerated in February. However, one month does not make a trend. Moreover, the direct impact of tariffs on prices will not likely be felt for several months.
