Markets are normally influenced by a wealth of factors. The weekly statistics from the EIA on US oil inventories are one of them. The late report showed a surprise build in crude oil stocks, which, in hindsight was not really unexpected. Imports grew by 1 mbpd, chiefly from Canada, as the anxiety level on import duties remained elevated throughout the week. This jump led to an increase in commercial inventories, even though gasoline stockpiles declined, and distillate inventories remained broadly unchanged.

And then there is geopolitics. It includes escalation in the Israel-Palestine conflict as the Jewish state expands its operation in Gaza. This, coupled with warnings from France that military intervention in Iran is inevitable unless a nuclear deal is reached quickly, usually sends oil prices considerably higher.  So do mutual Russian and Ukrainian accusations of breaching the terms of the latest ceasefire and allegedly attacking each other’s energy infrastructures and the suspension of a mooring at the Black Sea port of Novorossiysk.

These are, however, not normal times. The US President unquestionably captured, amongst other things, the attention of financial investors, who cancelled lunch and dinner meetings yesterday and ignored the aforementioned developments as they eagerly awaited the evening announcement on US tariffs. Well, a live reality show does not get more real and consequential than this. A baseline tariff of 10% has been applied to imports from all countries and reciprocal tariffs anywhere between 10% and 50% on the 60 ‘worst offenders’. It is based on the combined tariff and non-tariff barriers on US exports and half of that level is imposed on the 60 countries. Oil imports have been spared. Countermeasures are imminent and judging by the initial market reaction, recession and stagflation have become terrifying possibilities. No doubt further details/exemptions/reversals will emerge in the coming days. Below the background of the trade fallout is outlined.

Deliberation Day

A new chapter was opened yesterday in the thick book of trade wars as the US announced its reciprocal tariffs against its trading partners. In the run-up to the introduction of the latest trade measures stock markets tumbled and gold rallied hard. It suggested that the net effect, as far as the market assessed it, is inauspicious for risk assets and the mitigating move would act as a brake on economic growth. We use the phrase ‘mitigating’ because the logic behind reciprocal tariffs is to level an uneven playing field, the US Administration argues, and erect the exact same tariff (and non-tariff) barriers for exporters as US companies face abroad.

Import tariffs are designed to protect domestic manufacturers from cheap foreign goods and products. Similar measures from trade partners hurt American exporters. The logic behind reciprocal tariffs is solid. In the words of the US President, ‘If they charge us, we charge them. If they're at 25, we're at 25. If they're at 10, we're at 10’. And looking at the core numbers, the US has more to gain than to lose by the matching measures. The world’s biggest economy charges a comparatively lower average external tariff on imports than its trading rivals. According to the World Trade Organization (WTO), which the US is a reluctant member of but has recently paused financial contribution to, the average import tariff the US imposes is 3.5% (which has just gone up to 22%, Fitch calculates). This paled in significance with 5% from the EU, 7.5% from China, 11% from Brazil, and 17% from India.
It, nonetheless, can be argued that the latest US trade initiative is unfair because it goes against the fundamental WTO rule, the principle of the most-favoured-nation. It states that countries cannot discriminate between their trading partners. Different rates can be applied to different products but if one grants a special custom duty for one product, the same tariff must be applied to all other countries. A country cannot impose a 15% tariff on steel imports from, say, Canada but only 5% from Russia. This is the point where the picture gets blurred and gruelling to assess.

Tariffing other nations in order to protect the domestic economy or be competitive in the export market is a complex and bureaucratic exercise. Simply matching or using average external tariffs of trading partners breaches WTO rules, which state that the same tariff must be imposed on any given good, regardless of the country of origin. On the other hand, implementing excise duties on every single product from every single country (there are more than 160 members of the WTO), is an impossible undertaking. It would also entail the US actually lowering tariffs on some goods, chiefly agricultural products.

It is against this background that the way forward must be evaluated, and the potential effect estimated or quantified, if possible. As outlined above, the tariffs can be introduced on a country-by-country or a product-by-product basis. The centre-right policy institute, the American Action Forum, sees a third way, the creation of a three-tiered tariff system which would place countries in separate groups based on their tariff levels and other trade barriers. Whilst easier to manage it would probably lead to a greater backlash from within each group against countries that have more protectionist policies.

The potential cost of reciprocal tariffs moves on a large scale. The American Action Forum projects a net tax liability of $26.3 billion if the Administration moves rates higher or lower to align with trade partners. In the more plausible case of only increasing tariffs in the name of levelling the playing field the total tax liability would be $34.5 billion. When non-tariff barriers are accounted for, the most significant of which is VAT charged by most nations but not by the US, the cost to consumers and companies would balloon to $214.4 billion. Yesterday’s shock announcement implies that the latter served as the basis for the calculation. As tariffs are ultimately paid for by domestic consumers and businesses, their cost will inevitably increase impeding the rise in economic wealth. The only positive outcome would come from trading partners lowering trade barriers thus incentivizing imports by US manufacturers and producers.

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