Tariff Wars II: the sequel impacting trade and industry sectors in credit

Tariffs have been synonymous with President Trump’s approach since his first term, marking a significant aspect of his policy toolkit. In 2018, he implemented various tariffs, primarily focusing on China and Mexico, but the European Union was also affected. These measures targeted specific imports, including steel and aluminium on a global scale, as well as specific products from the EU, such as aircraft, wine, cheese and olives.

However, this sequel is unfolding differently, especially regarding actions taken against Canada. The prospect of tariffs could act as a catalyst for negotiations on topics distinct from goods targets, which is ultimately the administration’s goal. We expect this could extend to other countries or regions, including Colombia, Panama, Greenland, as well as Mexico and Canada. Trump has already threatened, but not enforced, tariffs on goods coming from the EU, and he could turn his attention other countries within the Asia-Pacific region to highlight or address perceived trade imbalances. The President has, so far, been moot on the prospects of UK tariffs.

Evaluating the likelihood of tariffs becoming permanent versus adopting various other measures presents a significant challenge. The Trump administration employs a unique strategy in negotiations through tariffs, making it crucial to grasp the actual objectives of the President and his team.

The sector implications

Autos

The automotive sector is directly impacted, particularly the US big three Original Equipment Manufacturers (OEMs), General Motors, Ford and Stellantis, as they operate production facilities in Mexico and Canada to supply the US. Component suppliers are also caught in the crosshairs as they have factories shipping components across border or components are used in vehicles that are then shipped to the US.

One initial consideration is whether this situation represents an ‘opening gambit’ from Trump, aimed at negotiation. Notably, it was announced on the morning of 3^rd February that the imposition of tariffs on Mexican goods would be postponed for a month, alongside news that the Mexican president agreed to deploy 10,000 National Guard troops to the US-Mexico border. Another question is whether auto manufacturers will attempt to pass the burden of tariffs onto consumers, potentially impacting demand, or choose to absorb part of the cost, affecting their profit margins.

We believe that OEMs will probably, at least in the short term, take on the additional costs, leading to reduced margins before they adjust pricing strategies for both their customers and suppliers. Moving manufacturing back to the US is not a swift process, especially given the difficulty in sourcing appropriately skilled workers. Although there is spare capacity in several US-based factories, those that produce higher-margin trucks and SUVs (Sport Utility Vehicles) are operating at near full capacity, complicating any plans to relocate production. Repurposing existing facilities for new production lines would also necessitate a significant investment.

For European OEMs, it is mainly the German premium car manufacturers that would be impacted, as shown in Figure 1. However, the effect on companies like BMW and Mercedes might be mitigated by their significant manufacturing presence in the US, which aligns with their strategy of producing locally for the domestic market. The situation for Volkswagen (VW) is somewhat more complicated due to its large manufacturing facility in Mexico where it manufactures VW branded vehicles, although the US represents a relatively small market for the VW brands.  Its subsidiaries Porsche and Audi both import from Europe to the US and so would be affected.  Should tariffs extend to the UK, the greatest impact would likely be felt by Jaguar Land Rover and Aston Martin, given the US is a key market for each. Given these brands’ premium or luxury pricing, they should have more flexibility to offset tariffs with price increases, helped by the  depreciation of sterling against the US dollar.

Regardless of currency fluctuations, the larger OEMs could still struggle to pass the full extent of these costs onto pressured consumers. Vehicle price inflation in the US has significantly exceeded the general Consumer Price Index (CPI), with prices on average nearly 30%¹ higher compared to pre-pandemic levels. The estimated effect of tariffs is projected to exceed US$3,000 per vehicle on average, which would result in an approximate 7% increase in pricing.² With most new vehicles bought with finance, affordability has been further impacted by interest rates.

Tech

Turning to the technology sector, software is likely to be minimally affected by tariffs due to its non-reliance on physical asset production and the geographical distribution of its workforce. On the other hand, hardware, which is often manufactured abroad, relies on components such as semiconductor chips and wafers. These are predominantly produced in the Asia-Pacific region, excluding China (for example, in Thailand and Malaysia), before being shipped to Mexico for assembly, taking advantage of lower labour costs. The impact of the recently announced tariffs would therefore be most pronounced in the assembly phase. Large end-market manufacturers like Dell and HP would likely feel the effects more acutely than their suppliers.

Energy and commodities

The Trump administration likely factored in the effects of tariffs on energy and commodities for the US economy, as evidenced by the reduction of energy resources tariffs to 10% versus the 25% applied more broadly on Canada. The situation with steel is key as imports from Canada and Mexico (mainly Canada) make up about 35% of the total (Figure 2), yet 90% of US steel exports are destined for these two countries³, presenting a different perspective on the trade imbalance. The critical issue moving forward is how potential retaliatory tariffs might affect the flow of this commodity. Tariffs on aluminium could pose a greater challenge to the US economy, given the country’s status as a significant net importer of aluminium.

Navigating uncertainty

In conclusion, “Tariff Wars II” marks a complex chapter in global trade dynamics, with far-reaching impact across various sectors. The Trump administration’s strategy continues to unfold in unexpected ways. The responses from affected countries and industries, as well as the potential for retaliatory measures, will play a critical role in shaping trade and global growth dynamics.

For markets, it is evident that pricing dislocations present both relative value opportunities and risks, especially for companies unable to adapt to this challenging landscape. It is crucial for investors to engage in strategies that actively address these challenges, with a dynamic approach to allocate across regions and sectors. For example, automotive companies represent a material proportion of both investment grade and high yield indices. We have maintained a defensive stance towards the sector, recognising not only the rising threat of global trade wars, but also the subdued outlook for production volumes this year and the challenges arising from the uneven roll-out and adoption of electric vehicles around the world.

We believe that a robust credit research process to select issuers who are well-placed to overcome these challenges is key to effectively steer through these uncertain waters. Currently, our emphasis is on actively investing in companies that boast strong balance sheets, solid liquidity, and operations characterised by consistent cash flow stability and/or the potential for growth.

IMPORTANT INFORMATION

Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

High-yield or “junk” bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings.

Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.