To what extent does Trump's tariff policy operate?

President Trump’s tariffs on Canada, Mexico, and China will impact over 40% of US imports and hence are many multiples of the size we saw when he hiked tariffs during his first term in office. Those tariffs, which started in 2018, also lifted the dollar initially but then it fell away, with Trump’s whole 4-years in office seeing a near-10% fall in the US dollar index (on the DXY measure).

Many analysts doubt that it is going to be much different this time. For while we have been forecasting significant US dollar strength in the early months of Trump’s second term, with euro/US dollar falling to 0.95, for instance, we have felt that this strength will unwind over time, and we still think that’s the case. The theoretical argument for the dollar to rise on tariffs is based on the fact that the US’s trade deficit is a function of the country’s excess savings relative to investment. This is a truism borne of the national income identity. This deficiency means that the US has to draw in savings from overseas.

In order to do this, foreign countries in aggregate have to export more to the US than they import to generate the ‘excess’ US dollars to invest in the US. If tariffs do not shift this savings/investment imbalance in the US the trade deficit cannot improve through tariffs, meaning that the US dollar needs to rise to weaken trade and so counterbalance any trade improvement that occurs because of tariffs.

In fact, what has happened in the US since Trump was first president is that this net dissaving in the US has increased, much of it due to the wider budget deficit. This means a bigger trade and current account deficit despite the imposition of tariffs. But if tariffs did not work before they look even more impotent this time around because the focus is much more on Mexico and Canada than China, or at least so far.

Given that firms in all three countries habitually export and re-export goods across the border through the production process, the tariffs will harm US industry a good deal more than the Chinese tariffs from Trump’s first term. If we take autos, for instance, there is effectively no US auto industry; instead, there is a North American auto industry that now risks being shaken up dramatically.

So, while we don’t doubt that the initial reaction to today’s tariffs will be a stronger US dollar, the idea of long-lasting greenback strength on such a self-defeating policy seems odd. That’s how things turned out when Trump imposed tariffs in 2018; the dollar rallied but could not maintain the strength. With this in mind, we are both comfortable with our call that euro/dollar could fall as low as 0.95 in the next few months, but equally content with our one-year view of 1.10 for the euro.

The Standard Bank has long assumed that Trump would a) win the election and b) impose tariffs on specific countries and specific industries. But where we have been far more cautious is in relation to the idea of a blanket worldwide tariff, of the 10%-20% level talked about by Trump before the election. It still believes that this is unlikely even though Trump has come out with all guns blazing so far.

One clue to such an outcome came from Trump over the weekend when he suggested that the UK might avoid tariffs. That might not happen, of course, but the Standard Bank thinks his comments speak to the idea that he will use tariffs as a tool to air grudges against those that have acted “unfairly” towards the US; not as a weapon to punish all countries. This could clearly mean that certain currencies perform better than others, even if all initially fall against the US dollar. Sterling, for instance, should continue its recent recovery against the euro.

For in spite of the pound’s recent fall, the Standard Bank has stuck with its long-term view for euro/sterling to fall towards 0.80. It also picks out the yen and Swiss franc, in part because they might escape US tariffs and in part because their ‘safe asset’ status could hold them in good stead if US tariff announcements keep coming and the dollar continues to rise. Perhaps the most interesting currency will be the renminbi given that the central bank will presumably work hard to limit any depreciation. But its efforts will bear limited fruit with 8.0 for US dollar/renminbi expected before the year is out.