Reciprocal

The last time I heard the word “reciprocal” this much was when I was teaching my daughter basic math. That didn’t go so well, and this may not either for a great many countries.

The US has one of the lowest tariff regimes in its history.

After WWII, as consumption rose, production of goods was gradually moved overseas to decrease costs, and with that came lowering barriers to trade. It was in the country’s best interests to lower tariffs so that demand could be met, and prices could be lowered.

If we look at how tariffs work, this is quite clear.

“What happens when America puts a tariff on clothing, such as the $2 tariff shown in [the] Figure? There are three effects: (1) The domestic producers, operating under a price umbrella provided by the tariff, can expand production; (2) consumers are faced with higher prices and therefore reduce their consumption; and (3) the government gains tariff revenue. Tariffs create economic inefficiencies. When tariffs are imposed, the economic loss to consumers exceeds the revenue gained by the government plus the extra profits earned by producers.” - Economics (19th ed); Paul A. Samuelson; William D. Nordhaus

[Yes, I opened my econ textbook!]

What’s Happening with Tariffs?

President Trump directed his staff to create a “Fair and Reciprocal Plan” for trade, designed to align US tariffs, taxes, and non-tariff barriers—such as regulatory requirements, subsidies, and exchange rate policies—with those of other countries. This policy follows the reinstatement of 25% steel and aluminum tariffs, which took effect this week.

We’ve also now heard that tariffs may be imposed on autos, a category previously speculated to be exempt.

Why Are the Tariffs Being Imposed?

Trump argues that many countries impose higher tariffs on US products than the US imposes on their imports. The goal of reciprocal tariffs is to level the playing field by ensuring that US tariffs on imports match those imposed by other nations. The situation is actually quite lopsided as we can see in the chart below.

The other related reason is to manage the trade deficit that the US has with various countries. The US has the largest trade deficit with China, i.e., the US imports more from China than it exports to China. So if we look at particular country-related tariffs, there are quite a few nations that may be on the tariff increase target list.

And of course, the important reason we discussed earlier - to raise revenues for the government.

What if VATs are levied? - there is no indication yet that this will happen

The administration also seeks to address non-tariff barriers that disadvantage American exports. While these non-tariff barriers could be challenging to quantify, they could result in higher levels of tariffs overall.

Trump has criticized value-added taxes (VATs) in other countries, which he sees as giving foreign firms an unfair advantage. VAT is a tax that is imposed on the value that is added at each stage of production and distribution.

Goldman Sachs estimates it could raise the average effect tariff rate by another 10%, significantly impacting trade with high-VAT regions like the EU. This approach would likely face strong opposition and could trigger trade disputes.

Legislative Procedures for Implementing Tariffs

Trump could rely on several legal frameworks to impose reciprocal tariffs:

• International Emergency Economic Powers Act (IEEPA): Used previously to impose tariffs on China, this act grants the president broad authority to restrict trade. The use of the IEEPA to impose tariffs is a novel application that could be challenged in court. Congress can terminate a national emergency through a joint resolution, but this requires passage in both the House and Senate, and the President can veto it.
• Section 338 of the Tariff Act of 1930: Allows the president to impose tariffs of up to 50% on products from countries that discriminate against US exports. Since this law is already in place, no new approval is needed, but Congress could pass legislation to override or limit its use. This law has been dormant for decades and is rarely mentioned in modern trade policy, making its potential use controversial.
• Reciprocal Trade Act: A legislative proposal that supports tariff equalization, though it has yet to be fully enacted and will need full congressional approval before it can be used.

Unlike previous trade measures, these laws do not require extensive investigations, meaning the administration could impose tariffs relatively quickly. However, broader product-specific tariff adjustments could take longer to implement because they would need approvals from Congress.

Who Are the Winners and Losers?

The impact of reciprocal tariffs will vary by country and industry:

• Potential Winners:
• Potential Losers:

The Bottom Line Impact

Markets didn’t react much to the tariff news because they were skeptical of whether these tariffs would actually be implemented. However, when we look at how much other countries charge the US, it tips the scale in Trump’s favor to bump up US tariffs. There is also the issue of raising government revenues.

This also adds a layer of protectionism for US industries. Onshoring / re-shoring will be a major theme, and will likely lead to more job creation in the US, which is a good thing.

Nevertheless, if there is escalation and trade wars, the problem is the impact it has on regular people. People end up paying a higher price for goods, whether it is in the US, or in other countries.

Closing Thoughts - Higher Neutral

Fed Chair Powell has alluded to a meaningfully higher longer-term Fed Funds Rate. This suggests fewer rate cuts than expected and a longer Fed pause if inflation stays sticky or trends higher.

The Fed’s rate decisions may not directly impact the US Treasury Yields at the longer end, but we’re inclined to believe that a higher neutral rate will be the result of economic forces that will lead to higher long-term UST yields.

I think we’re going to see tariffs levied, whether there are escalations or not. It’s not just a bargaining chip. The biggest reason is that it’s part of the initiative that will allow for tax cuts to be extended and for further cuts to be implemented.

While DOGE seems promising, and many have high hopes for them, it’s doubtful that they will be able to sufficient cost reductions for the tax cuts, and reduction in the budget deficit. Tariffs, therefore, remain the important factor in this equation.

Have a safe trading week out there!