US threatens Mexico with tariffs

The dispute between the US and its major trading partners is widening.

President Trump has announced his intention to impose tariffs on all imports from Mexico from 10 June. The tariffs would start at 5% and rise by 5% each month up to 25% "until the illegal immigration problem is remedied".

At this point it is uncertain whether the full scale of tariffs will be implemented. Businesses are unlikely to be in favor, and a decision to impose tariffs which ignored NAFTA and WTO rules would also likely be challenged. President Trump has cited the International Emergency Economic Powers Act (IEEPA) as the authority for his proposed tariffs. This has previously been used to impose sanctions or freeze assets, but never to implement tariffs. But while there might be a legal challenge, the Congressional Research Service has concluded that tariffs are probably allowed under the statute.

So Congress is the most likely check on the president's authority, but has never attempted to terminate a national emergency invoking IEEPA. The question is whether there is political will to challenge the president, which would require a concerted bipartisan effort. There is broad bipartisan support for the Trump administration's overarching goal of "fair trade," but support is a bit thinner when it comes to tactics, in particular for the imposition of tariffs. The target could also matter. US voters and politicians would be more likely to support action against China, viewed as a geopolitical and economic rival, than against Mexico.

If the tariffs were implemented, we see the following effects:

The impact on US GDP could be significant.

• The US imported USD 352bn in goods from Mexico in 2018, more than the USD 250bn of imports from China currently subject to tariffs. We already estimate that if the US followed through on its threat to levy a 25% tariff on all Chinese imports (USD 550bn) in a prolonged trade dispute, this could reduce US GDP growth by 1 percentage point. A 25% tariff on Mexican goods as well would risk the US falling into recession.

Supply chains could be severely disrupted.

• Two-thirds of US–Mexican trade is intra-company (compared with 40% for global trade). Those supply chains would be at risk. If investment is canceled and employment reduced, then the risk of a recession increases significantly. The imposition of US tariffs in 2018 led to business uncertainty and delayed investment decisions. This contributed to a slowdown in global manufacturing, particularly in Germany, in the first quarter of this year.

Tariffs would be difficult for consumers to avoid.

• Mexico has been taking market share from China by selling products from the September 2018 US tariff list. It has taken share in a meaningful way in a number of areas including cameras, recording equipment, modems and computer components. US consumers will therefore find it harder to avoid import taxes if tariffs are imposed on both countries. For example, Mexico accounts for 35% of US imports of TVs. Tech hardware companies with exposure to computers, servers and TVs would therefore be most affected.

The auto sector would be hit particularly hard.

• Autos and auto parts are the largest category of US imports from Mexico (USD 93bn in 2018). The impact would also be felt outside the US. For example, all major European car manufacturers and suppliers are active in Mexico. If 25% tariffs were implemented, we estimate that European auto industry earnings per share could be reduced by a mid-single digit percentage, even without taking into account the potential for tariffs on direct European imports.

We would expect the Mexican peso to depreciate further.

• In the event of the full scale of tariffs being implemented we would expect USDMXN to trade at 21.5 (vs. 20.0 in the event this proves to be just a threat).

Bottom line

This latest potential widening of the scope of tariffs illustrates the current fragility of US trade relations, and the importance of holding a diversified portfolio, both across geographic regions and sectors, to mitigate idiosyncratic risks. Against this backdrop, we have reduced risk in our tactical asset allocation over the past month, and also recommend countercyclical positions to help protect portfolios from downside risks.

Please visit ubs.com/cio-disclaimer #shareUBS