Adjusting to US tariff shock

According to our Chief Economist, Ray Farris, US President Donald Trump’s announcements of new tariffs today have raised the US effective tariff rate from 2.2% at the end of 2024 to close to 20% in less than four months. If items currently under Section 232 investigation end up incurring tariffs, which seems likely, the US effective tariff rate is likely to rise to 25% - 27%, above those that followed the Smoot-Hawley tariff in 1930 act that exacerbated the Great Depression.

Auto tariffs take effect on April 5 while the new reciprocal tariffs hit on April 9. Copper, lumber products, semiconductors, pharmaceuticals, and some other products are currently excluded from the reciprocal tariffs but are at risk of future tariffs due to ongoing Section 232 investigation.

We are not optimistic that many countries will reach agreements with the US before the April 9 deadline, and we expect the EU, Canada, and China to announce retaliatory measures.

Markets have reacted negatively to the tariff announcements with S&P 500 futures down over 2.8%, Nasdaq 100 futures off 3.3%, the US 10-year Treasury yield down almost 8bps to 4.06%, and markets pricing 83bps of Fed cuts by year end.¹

We judge these tariffs, if sustained, as likely to push US GDP growth down from 2.5% to about 0.6% - 0.8% this year. Tariffs are a tax on consumption and investment that history shows also generate broader welfare losses due to shifts in resources to lower productivity uses.

Remember also that the tariffs come on top of other fiscal tightening measures of about 0.1% - 0.2% of GDP and rapid curtailment of immigration that is likely to cost US GDP 0.3% - 0.5%. Additionally, US exports are likely to weaken in response to likely retaliatory measures from US trading partners, particularly China, the EU, and Canada.

We assess the risk that these shocks culminate into a larger than estimated hit to the economy that turns into a recession as at least as high as the jump in market pricing of recession risk to just under 50%. US recessions are notoriously difficult to predict, but we think the risk of one in the next 12 months is now close to 60%.

Fig 1: Polymarket US recession risk price, %

Source: Bloomberg

Within Asia, Trump’s tariff shock is likely to weigh on growth in Vietnam, Korea, Japan, and China most, roughly in that order. Effective tariff rates on these countries have increased to 47%, 16%, 20%, and 48% respectively since the start of the year. However, these tariff rate increases need to be scaled by the countries’ exports to the US as a share of their GDP (see Fig 2 below).

Fig 2: Tariff table

Sectors subject to potential/likely tariffs; Semiconductors, Pharmaceuticals, Critical Materials, Copper, Lumber Source: The White House, Goldman Sachs Global Research, Nomura Global Economics. April 2025.

China and India are at risk of seeing their tariff rates rise to 79% and 51% respectively if the US’ 25% tariff on imports from countries that import oil from Venezuela is layered on top of the tariffs announced today.

More generally, all Asian economies are likely to face significant downward pressure on growth this year for three key reasons:

Fig 3: Exports to the US as a % of GDP, 2024

Source: LSEG Datastream. April 2025.

Against this background, it will be crucial to focus on economies where policy can work to offset these negative shocks. We think China and India stand out:

China: China's government has already announced fiscal stimulus worth about 2% of GDP for this year. That is insufficient to offset the tariff shock Trump announced yesterday, but China’s government has also suggested that it has measures in reserve it can use to support growth. We think it will adopt a “whatever it takes” approach this year to try to keep growth above 4.5%. This implies a very heavy focus on domestic consumption and investment spending.

India: The collapse in inflation to 3.6% year-on-year in February vs. the Reserve Bank of India’s ceiling of 6% gives it large room to cut its policy rate from the current 6.25% and ease restrictions on household credit growth. Additionally, India’s government has signaled a willingness to cut its tariff regime aggressively to do a deal with the US. Importantly, Indian exports to the US are small at 2.2% of GDP.

Returning to the risk of US recession and potential Fed rate cuts, we reiterate several points from our recent CIO Weekly updates:

Finally, if Treasury yields continue to fall, they could work to offset some of the negative effect of tariffs by pulling down mortgage rates and stimulating housing. We think the 30- year fixed rate needs to drop to close to 6% for this effect to be large. We also see a risk that if Trump imposes tariffs on lumber products and other building materials, the resulting increase in home building costs could offset much of the benefit of falling mortgage rates on affordability.

Investment Implications for Asia

According to Arthur Chai, Portfolio Manager, Asia Growth Equities team, the tariffs announced were worse than expected and, in some cases, larger than the worst-case scenarios assessed by investors in the preceding weeks.

On the flip side, there were modest positive outcomes for certain product categories, notably semiconductors and pharmaceuticals, which will be positive for certain large sectors of the Asian equity market, namely Taiwan and Korea semiconductor manufacturers, and Indian pharmaceutical manufacturers. The exclusion of semiconductors was unexpected, given previous US tariff threats to boost US domestic manufacturing. If semiconductors in finished products from Asia are also excluded, it reduces the value added by Asian tech hardware production and modestly lowers the blended tariffs on tech exports to the US. The reason for this exemption remains unclear.

On the whole, there are expectations the impact of tariffs will decrease as countries negotiate bilateral trade agreements with the US for tariff modifications in exchange for trade and economic concessions. That said, Christina Woon, Head of Asia Equity Income, adds that many Asian companies are more insulated from tariffs due to their domestic focus. A relatively higher proportion of Asian companies have net cash balance sheets. The higher free cash flow yield within Asia relative to rest of the world suggests there is a buffer from a yield perspective in a declining earnings environment. Additionally, the push for better shareholder returns is leading to rising dividend payouts, meaning tariff pressures may not linearly translate into pressure on dividends.

Meanwhile, Michael Sun, Client Portfolio Manager of Quantitative Strategies team, observes that as tariff policy uncertainties have increased market volatility, a significant rotation has taken place: at a market level from Developed to Emerging, at a sector level from cyclical to defensive, and at a style level from high risk to low risk and from growth to value. As such, diversification across regions, sectors, and investment styles is crucial to mitigate risks and seize opportunities in this dynamic market environment.