The election of Donald Trump to his first term as president in 2016 ushered in a new era of US trade policy defined by the threat and imposition of tariffs, sanctions, and other measures to try and rebalance America’s trade deficits. The policies were also motivated by a view that tariffs would encourage production to move back to the US, reversing years of industrial decline, even if historically tariffs have not proven a successful tool to achieve these goals.
While the Biden administration that followed returned the US to a policy of multilateral engagement with allies, it also continued with President Trump’s assertive approach towards China. The Biden administration retained tariffs implemented in 2018/19, hiked tariffs on a range of Chinese semiconductors and electric vehicles in 2024, implemented export controls, and scrutinized both inbound and outbound investment flows. With the benefit of bipartisan congressional support, the Biden administration also deepened its national industrial policy goals over the past four years to safeguard and promote US manufacturing, technology, and security interests through a range of legislation including the Inflation Reduction Act and the CHIPS and Science Act.
A second Trump administration promises a return to a more assertive, transactional, and isolationist approach to US trade policy. In our view, this will likely lead to a further ratcheting up of pressure on China. It is also likely to target other countries running large bilateral trade deficits with the US, deemed to be engaging in unfair trade practices, or shown to be facilitating the transshipment of goods to avoid tariffs. The new administration is also likely to focus its attention on sectors and products that are of high economic or national security importance.
In Figure 1, we summarize our scenarios for the different potential tariff outcomes.
Figure 1: Tariff scenarios
Scenario | Scenario | Probability | Probability | Description | Description |
|---|---|---|---|---|---|
Scenario | Selective | Probability | 65% | Description | Universal tariffs face challenges with Congressional / legal approvals, which pushes the administration in the direction of bilateral and selective tariffs. The effective tariff rate on all Chinese goods to be tripled in stages to around 30% by end-2026 (from c.10% currently). Bilateral tariffs imposed on major imports from other countries in categories where US substitute goods are readily available, for example EU autos. Retaliatory tariffs by trading partners. |
Scenario | Universal | Probability | 25% | Description | The US imposes large, universal tariffs on imports from multiple countries, provoking retaliation from trading partners. The effective tariff rate on all Chinese goods to be hiked to 60% by end-2026 (from c.10% currently). Tariffs (10-20%) on all goods from multiple other countries. Announced Q1 2025, implemented mid-2025. Retaliatory tariffs by trading partners. |
Scenario | Deal | Probability | 10% | Description | The US reaches a new trade ‘deal’ with China and Europe, facilitating improved geopolitical relations. This new deal could involve modest tariffs on some products but will more than likely involve agreements on purchase quotas to reduce the US trade deficit. Enforcement will be stricter than under the initial agreement, with enhanced oversight and Rules of Origin requirements. |
1. Blanket universal tariffs (25% probability)
President Trump has proposed aggressive tariffs that would apply to all goods entering the US. On the campaign trail, he frequently spoke of 60% tariffs on Chinese goods and 10-20% tariffs on the rest of the world. The US Constitution gives Congress control over trade policy, but, in practice, it has deferred to the executive branch since the Smoot-Hawley tariffs in 1930. Media reports indicate the administration may seek congressional approval to impose universal tariffs, both to obtain the legal backing and to generate revenue as an offset to the cost of other campaign promises.
One important advantage of having Congress impose the tariffs is the potential to recognize the generated revenue as an offset to pay for tax cut extensions under a process known as “reconciliation.” Under normal budget rules, 60 votes are required to overcome a filibuster in the Senate. With only 52 or 53 seats, Republicans would be unable to pass a budget without the support of a handful of Democrats. Under reconciliation, fiscal policy changes can pass the Senate with a simple majority of 50 votes (plus Vice President-elect JD Vance’s tie-breaking vote).
Republicans plan to use reconciliation in 2025 to pass a fiscal package that would include a full extension of the 2017 Tax Cuts and Jobs Act. The cost of extending the personal income tax cuts alone is estimated to result in USD 4-5 trillion of lost federal revenue over 10 years, a figure which doesn’t include other tax cuts and spending increases that Republicans hope to implement. With the budget deficit and government debt already at very high levels, we believe it will be politically difficult to increase the deficit much further. Therefore, the ability to recognize the tariff revenue under reconciliation would provide some critical maneuvering room.
In our view, President Trump would prefer to go the congressional route to achieve universal tariffs, although he has not yet publicly endorsed the idea. However, we believe that Congress will be unwilling to go along with it. Republicans hold a narrow majority in both the House and the Senate, so a few dissenting votes would be sufficient to block legislation, assuming there is no offsetting support from Democrats. Moreover, John Thune (R-SD), the newly elected majority leader of the Senate, has raised concerns over the inflationary consequences of universal tariffs.
If Congress is unwilling to impose universal tariffs, the Trump administration can try to implement them using executive authority. However, there is no precedent for this, and it remains to be seen whether such a move would hold up against legal challenges. President Trump might also face political blowback over such a move, especially if widespread retaliation by US trading partners results in an escalating trade war.
2. Selective tariffs (65% probability)
If universal tariffs are blocked by the courts and are not included as part of a reconciliation package, the President will likely have to rely on selective tariffs. We believe this is the most likely scenario. These would be tariffs on a range of goods or sectors from a country or region based on those powers afforded to the executive branch under Section 301 of the Trade Act of 1974 or Section 232 of the Trade Expansion Act of 1962. In our view, the use of selective tariffs is the most likely outcome.
A key focus will be trans-Pacific US-China trade. We expect the administration would likely seek to revisit the 2020 Phase 1 trade deal with China and would also threaten sharply higher tariffs. Across the Atlantic, officials would likely target the EU over its application of digital services taxes and seek to impose tariffs on imported cars. South of the border, the US could investigate Mexico over the transshipment of Chinese goods and the export of connected EVs that contain Chinese technology. Sanctions and other enforcement actions from the Commerce and Treasury Departments are likely to be used more often in the second Trump administration to promote progress on geopolitical and national security interests, as well as promote more balanced trade.
In a selective tariff world, three factors could soften the blow to economic activity on trade-dependent Asia during Trump 2.0. First, China has the scope and has signaled a willingness to use fiscal and monetary policy to dampen the impact of any escalation of trade tensions with the US. Second, intra-regional trade has deepened alongside China-led trade agreements and US import diversification. Third, US market share of trade with Asia ex-China has risen, with scope to climb further.
3. A brokered deal to avoid tariffs (10% probability)
Lastly, there remains the possibility, albeit slim in our view, that the arrival of the new president encourages trading partners to negotiate, avoiding tariffs altogether.
The growth and inflationary impact of tariffs has become a central theme for investors since election of President Trump and the Republican sweep of Congress. How tariffs impact both the US and global economies, especially inflation, will depend on how aggressively they are implemented (duration and magnitude) and the degree of retaliation.
The impact of selective tariffs on US inflation and a targeted country’s economic activity depend on whether trade is rerouted to avoid the tariff and the degree to which the US cracks down on countries that serve as way stations for avoiding tariffs. While bilateral trade between the US and partner countries may decline because of the tariffs, actual rebalancing of international trade or reshoring of economic activity back to the US would likely be negligible.
Universal tariffs, meanwhile, would likely be of greater harm to the US economy and create a short-term burst of inflation as importers pass along increased import costs to consumers. They could, however, lead to more significant onshoring of production. For the rest of the world, we expect US tariffs would harm economic activity as demand falls and could also prove deflationary as surpluses emerge in traded goods. The outlook for US inflation is clouded by the uncertain impact of tariffs on the final price of goods that consumers ultimately face.
On the one hand, (and contrary to misstatements in the press), a 20% tariff does not equate to a 20% increase in the final price of a product. A hypothetical imported pair of jeans that used to retail for USD 100 before a tariff is unlikely to cost USD 120 after a 20% tariff is imposed. Instead, we would estimate that a 20% tariff on a finished consumer good would translate to an average price increase of 8%, perhaps somewhat more.
Here’s why. Recall that tariffs are applied at the dockside, not to the subsequent supply chain, which includes a wide range of warehouse, wholesale, retail, advertising, transport and other costs that factor into the final price (see Figure 2). Econometric models that calculate the inflation impact will therefore assume a pass-through of just 40% of the tariff.
Figure 2: Hypothetical value-added costs in the supply chain
But equally, the final price could rise more than straightforward econometric models assume if tariffs open the door to expanded corporate margins and profit-led inflation. A 10-20% tariff applied to imported goods can create a powerful narrative to persuade customers to accept a higher price, and the potential for profit-led inflation would appear greater now than in 2018 (a year when margins were squeezed) because tariffs are more widespread and visible, and because US companies may believe that they have more pricing power now than in 2018.
Normally we think that the Fed would see tariffs as a one-time price increase like any other sales tax and would ‘look through it’ as it decides the appropriate policy rate. However, profit-led inflation would be more likely to trigger a reaction from the Fed in the form of tighter monetary policy.
An appreciation of the US dollar on either tighter expected Fed policy or safe-haven demand for US assets may not help to restrain inflation. In theory, a stronger US dollar shifts the cost of the tariff to foreign consumers (who must pay more for US imports), while offsetting the tariff for US consumers (who pay less in dollar terms for their imports, potentially offsetting the tariff). This is particularly the case with a universal tariff, where all imports are subject to the tax.
But while the 2018 tariffs were met with a depreciation of the Chinese yuan (RMB) against the US dollar (USD), this seems to have had little to no effect on import prices into the US. The US price of imports from China fell modestly, by 1.4% in 2019 (after the RMB weakened), but this was in line with the long-term trend in import prices for goods from China. China sells products like consumer electronics that tend to fall in price over time.
In short, the change in the dollar’s value seems not to have affected the price of exports sold in the US. This also fits well with the fact that China (like nearly all exporters to the US) prices and invoices in USD. So, for at least the duration of the contract, a currency move should have no impact on the level of the import price to which the tariff is applied.
What the RMB depreciation did allow for was an increase in profit margins on exports to the US, which offset the negative volume effect coming from the tariff (there were of course negative margin effects on China’s firms that depend on imports). The negative volume effect also took some time to kick in. US purchasers of imported goods (not necessarily retail consumers) had to pay the higher price of the tariff.
Overall, we would expect universal tariffs to have a noticeable, but somewhat fleeting effect, on consumer price inflation. In a September 2024 report on the economic and investment implications of higher tariffs, we estimated that a sustained 10% universal tariff applied across the board to US imports would raise overall price levels in the US economy by 1.3% for a year. The direct effect is a one-time price level change. (US goods imports represent 12.7% of GDP; a 10% rise in the price of these imports would therefore correspond to a 1.27% price rise.) If there is a profit-led price increase on top of the tariff increase, then the rise in inflation will be greater. Even if profit-led inflation is confined to finished consumer goods only, we could see a US universal tariff of 10% raise the price levels by 1.7%.
In Figure 3, we forecast the cumulative impact to GDP over three years relative to a baseline for a selection of regions and countries. We assume the following:
Under selective tariffs, we apply a 15% tariff to specific sensitive imports, which would allow some trade to reroute and thereby avoid tariffs. For China, we assume the effective tariff rate on all Chinese goods triples in stages to around 30% by end-2026 (from roughly 10% currently).- Under universal tariffs, we assume the US imposes a targeted 60% tariff on all imports from China and a 10% tariff on the rest of the world. Rerouting of trade to avoid tariffs is not a practical option.
Figure 3: Cumulative impact to GDP over three years in two tariff scenarios
Region | Region | Selective | Selective | Universal | Universal |
|---|---|---|---|---|---|
Region | US | Selective | -0.3% to -0.5% | Universal | -1.0% to -1.5% |
Region | China | Selective | -0.7% to -1.0% | Universal | -2.0% to -3.0% |
Region | APAC (ex Japan) | Selective | -0.8% to -1.6% | Universal | -1.2% to -1.8% |
Region | Japan | Selective | -0.4% to -0.6% | Universal | -0.7% to -1.2% |
Region | Euro area | Selective | -0.2% to -0.5% | Universal | -0.5% to -1.0% |
Three key observations stand out:
- A universal tariff will be more serious than a selective tariff because it cannot legally be circumvented.
- The economic impact to exporters should be measured by trade in value added, not absolute export volumes.
- Estimates depend on perceptions of how permanent the trade taxes would be, retaliation, policy response, etc. The process is somewhat reminiscent of trying to forecast the economics of the pandemic lockdowns in terms of complexity and multiple outcomes.
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