The Trump administration ratcheted up trade tensions on 1 February by announcing a tariff of 25% on all imports from Canada and Mexico (subsequently suspended for 30 days), and an additional 10% on all Chinese products. The ultimate impact on global growth and inflation remains uncertain at this point.
The consequences will depend on whether other countries become subject to US tariffs and any countermeasures they may take.
The latest tariffs are noteworthy because they signal that US President Donald Trump is again willing to apply tariffs to any country, including US allies, in pursuit of his objectives. If implemented as initially announced, the level of the tariffs on Canada, China and Mexico would be much higher than those levied in the Sino-US trade war between 2018-19 (see Exhibit 1).
While the recent measures do not target Europe, the region remains high on Trump’s agenda as he feels strongly about what he views as its unfair trade practices.
A trade war, with other countries taking retaliatory measures, raises the risk of stagflation. Such a development could put central banks in a tough spot by increasing the risks around their pursuit of lower policy rates.
China – A manageable shock
The 10% tariff rise on goods imported by the US from China is less than the level feared by some observers. Moreover, the direct impact is, in our view, a manageable shock for China. We estimate the tariff would shave about 0.3% from China’s GDP over the year (assuming the tariffs are maintained the entire time).
However, we believe there is still a significant risk of further increases due to the numerous ongoing US investigations into China’s trade practices. The broader impact of US tariffs on global growth, trade, business confidence, and asset prices could weigh on Chinese growth.
Countermeasures and currency depreciation
China can be expected to focus on damage control.
On 4 February, Beijing unveiled limited additional tariffs of 10-15% on US liquefied natural gas, coal, crude oil and farm equipment, which it said would take effect on 10 February. China will also impose tariffs on selected car imports from the US and additional export controls on rare metals.
Broader tit-for-tat retaliation by China is simply not possible because the US imports far more from China than vice versa.
Currency depreciation could be a short-term tool for Beijing to combat US tariffs. The market consensus is for the offshore renminbi to fall to 7.6 (from 7.3 currently) against the US dollar by year-end. However, if Beijing manages to boost growth through domestic spending, market sentiment could reverse, generating portfolio inflows and pushing the exchange rate back to below seven to the dollar.
Broad-based US tariffs raise the downside risk to China’s growth in 2025 and 2026. They increase the pressure on Beijing to roll out more stimulative polices to boost the domestic economy.
If Beijing’s planned increase in the fiscal deficit by 1.5%-2.0% of GDP is fully implemented in 2025, it could, in our view, easily offset the negative impact of tariffs on China’s economic growth.
In the medium term, China can be expected to focus on developing new markets for its exports and increasing outward investment to build offshore production.
This diversion of trade and investment could eventually boost growth in the Asia region and counter, to some extent, the forces behind deglobalisation.
Slower growth for Asian exporters
In the short term, however, higher US tariffs on goods from China and the rest of the world would likely hurt the growth outlook of Asia’s export-oriented economies.
The most vulnerable are small, open economies. During the 2018-19 US-China tariff war, Singapore and Hong Kong suffered the severest deterioration in economic growth among their peers (see Exhibit 2).
Dollar gains and Fed policy
Tariffs are likely to lead to a stronger US dollar as other countries devalue their currencies to limit the damage to their exports. All things equal, this could prompt the US Federal Reserve to cut interest rates by more.
However, ceteris paribus does not apply. The short-term rise in inflation as tariffs boost the cost of imports could prompt the Fed to delay any further interest rate cuts. Indeed, since the start of the year, markets have scaled back their expectations for US rate cuts. Some analysts think the Fed is now on hold and may even hike policy rates later in 2025.
Should the Fed decide to look through the initial inflationary shock of tariffs, and if inflation expectations remained anchored, the central bank could resume lowering policy rates in the event of an economic slowdown.
In this case, stocks and bonds would initially suffer a negative shock from tariffs, but then recover as the US rate-cutting cycle resumed. Only time will tell.
