What Are the Economic and Investment Implications of Higher Tariffs?

The potential reintroduction and increase of tariffs in the United States, particularly with the upcoming 2024 presidential election, could have significant effects on the economy and investment landscape.

During the Trump administration, tariffs—taxes on imported goods—played a central role in trade policy. As the U.S. considers reinstating higher tariffs, analysts at UBS assess the economic and investment ramifications of such actions.

Tariffs impose a tax on imported goods, which directly raises their prices within the domestic market. UBS points out that the inflationary impact of tariffs is clear and notable. For instance, a 10% universal tariff on imports could raise overall price levels in the U.S. economy by approximately 1.3%. This increase is not merely a one-off event; there is also a risk of “profit-led inflation,” where companies might elevate prices beyond the tariff’s immediate effect, taking advantage of consumer expectations for higher prices.

Higher tariffs are generally anticipated to slow economic growth. Analysts suggest that tariffs can decrease domestic consumption by raising the cost of goods, particularly affecting lower-income households. Additionally, tariffs raise production costs for domestic firms relying on imported components, diminishing their competitiveness compared to foreign producers. This could result in reduced economic activity and potentially lower employment rates.

In scenarios where either selective or universal tariffs are enacted, UBS predicts a negative cumulative impact on GDP over a three-year period. For example, under a universal tariff scenario, U.S. GDP could decline by 1.0% to 1.5%. The broader the application of tariffs, the more severe the economic consequences, as the disruption of supply chains becomes more pronounced and costs are felt across the entire economy.

Another economic consequence of higher tariffs is the likelihood of retaliatory actions from trading partners. Such tit-for-tat responses could further depress global trade, slow economic growth, and raise costs for consumers and businesses alike. Retaliatory tariffs by other countries may target politically sensitive industries, amplifying the negative effects on the U.S. economy.

UBS analysts anticipate that higher tariffs, particularly if universally applied, would exert downward pressure on U.S. equities. The introduction of a 10% universal tariff, along with corresponding retaliatory measures, could result in about a 10% decline in U.S. equity markets. Sectors likely to be impacted include retailers, automotive manufacturers, technology hardware, semiconductors, and various industrial parts. Conversely, domestic sectors less exposed to imports, such as U.S.-based steel producers, might experience reduced foreign competition.

Overall market sentiment is likely to remain negative, especially if tariffs lead to broader economic downturns and increased uncertainty regarding policy direction. In response to the economic challenges posed by higher tariffs, UBS expects the Federal Reserve to adopt a more cautious stance, potentially lowering interest rates to mitigate recession risks. While tariffs may initially inflate prices, the expected negative effect on economic growth is forecasted to lead to decreased long-term interest rates, as the Fed prioritizes economic stability over short-term inflation concerns.

Under a universal tariff scenario, UBS predicts that yields could fall to around 2.5% to 3%, as investors seek the relative safety of government bonds in times of economic uncertainty.

In the short term, the reaction in currency markets could see an appreciation of the U.S. dollar, driven by a flight to safety and the adverse effects on major trading partners’ economies. However, UBS analysts warn that this strength could be fleeting. As the U.S. trade deficit widens because of reduced exports and increased import costs, the dollar may face downward pressure over the longer term.