The week ahead: Trump playing Green Light, Red Light with tariffs

In less than two weeks Trump has imposed enormous trade tariffs on friend and foe alike. Then paused most of those tariffs for 90 days, while at the same time imposing a tariff of 145% on imports from China. Then exempted electronics (the majority of which are imported from China) and then caveated those exemptions by promising a new tariff on electronics in some form at some point in the future.

If you’re struggling to keep up, I don’t blame you. This reminds me of a logic puzzle with a series of double negatives designed to confuse. This haphazard way of making trade policy has two big consequences.

One is that it has created perverse incentives that actually disincentivise manufacturing in the US. For example, the tariff on importing a Chinese battery is 145%. To import the same battery as part of a laptop made in China is 20%. But to import the same laptop assembled in Vietnam? The tariff is now 0%.

The second consequence, and more important for the global economy, is the huge increase in uncertainty generated by the constantly changing tariff policy. If you have watched the hit Netflix drama ‘Squid Games’, then you will remember the Green Light, Red Light game where contestants move forward when the light is green and stop when it is red. But if contestants are caught moving when the light is red, then they lose their life.

While the punishment for a CEO caught moving while the tariff light is on red won’t be as final as in the fictional show, it could be extremely expensive. The logical move, therefore, is to press pause on any major investment decisions until the landscape looks clearer.

The UK experienced a similar investment paralysis after Brexit, which the Bank of England (BoE) estimates dragged investment down by around 11% between 2016 and 2019.

The impact on consumers will be similar. Households will choose to save money now in case inflation and unemployment rates start to rise.

To continue the Squid Game analogy, the games in the show got progressively more deadly. The next game the US administration plays may end up being even more harmful for US consumers. The biggest impact will be felt in the US where businesses and consumers will have to deal directly with trade chaos and rising inflation. A recession in the US now looks more likely than not.

UK impact of US tariffs

But the UK will still be impacted. For a start, the original 10% universal tariff and 25% on vehicles that applied to the UK are still in play, which will still knock around 0.2ppts off GDP.

UK business and consumer confidence will also take a hit. There is a bitter irony in that UK consumers looked like they were just starting to spend some of those punchy increases in real incomes over the last year. (Consumer-facing services grew by an impressive 0.7% in February alone.)

But the uncertainty and nature of the shocks means we expect consumers to cut back on discretionary spending and on those big-ticket items, preferring to keep saving for a rainy day. That drag on consumption will feed through into lower growth.

The other consequence of the huge increase in uncertainty is that financial conditions have tightened considerably in the last two weeks.

What does that mean? The collapse in equity prices, the huge increase in volatility and the sharp widening in credit spreads all make it much more difficult for consumers to spend – if you have checked your ISA or pensions recently, then you might not be feeling so flush – and businesses to borrow.

If businesses aren’t borrowing, then they probably aren’t investing and the increase in volatility further feeds into the uncertainty we were talking about above.

We will soon be relaunching The RSM UK Financial Conditions Index, which will allow you to see at a glance whether conditions in financial markets are helping or hindering the economy, so watch this space.

The big danger here is that financial markets are starting to lose confidence in the US institutions that have made the US the world’s most successful economy and the dollar the world’s reserve currency. This was unthinkable even a few months ago.

Admittedly, we are still a way off a Liz Truss-style moment. The US still retains its exorbitant privilege. However, recent moves in the price of US government debt and the dollar are concerning. A Liz Truss-style market moment in the US would have far reaching and extremely painful global consequences.

The cost of shock absorbing

Coming back to the UK, the weaker growth outlook does give the BoE scope to cut interest rates at a faster pace to help offset some of the blow. However, inflation is still going to rise to about 3.5% later in the summer, which will prevent the Monetary Policy Committee (MPC) from taking decisive action to support growth.

Ultimately, the successive shocks to sentiment, confidence and financial markets mean that despite a strong start to the year, we expect growth to materially slow. We don’t currently think it will be enough to push the UK into a recession.

However, given we only expected growth of about 1% this year, the chances of a recession have materially risen – especially if the constant uncertainty feeds into more turmoil in financial markets.