The Tariff Announcement That Shocked Financial Markets

Over the weekend, President Trump announced that he was following through with his plan for aggressive tariffs. Imports from Canada and Mexico will now be hit with a 25% tariff, while China will get a 10% tariff. Although aggressive action was promised during the campaign, the news still rattled global financial markets, sending futures tumbling and the dollar spiking. Then, on Monday, Mexican President Claudia Sheinbaum announced that after a discussion with Trump, the tariffs aimed at her country would be delayed by a month. Meanwhile, more talks with Canada and China are expected. So what exactly are the economics of such tariffs? Are they inflationary? Who pays for them? And what are the implications of these ongoing threats? On this episode, we speak with Paul Donovan, chief economist at UBS Global Wealth Management, who answers all of our questions on the still developing news and how things might play out. Read More: How Trump’s Tariffs Aim a Wrecking Ball at the Economy of the Americas Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:00Speaker 00

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• 0:45Joe Weisenthal?

  Hello, Odd Lots listeners. This is Joe Weisenthal. You are listening to an emergency episode of the podcast. It was recorded at 10am Monday morning, February 3rd. The reason I am telling you this is because markets and news are moving very fast. And so by the time you listen to this, parts of it may already be out of date. But the context for the discussion was over the weekend, Trump announcing 25% tariffs against Canada and Mexico, 10% tariffs on oil, another 10% tariffs on China. Since we recorded this, about a minute after we got out of the studio, Mexican President

• 1:26Joe Weisenthal?

  Claudia Scheinbaum announcing that the tariffs had been delayed on Mexico for a month. We're still waiting to hear if something similar happens in Canada. Other than that, take a listen.

• 1:56Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 2:01Joe Weisenthal?

  And I'm Jill Weisenthal.

• 2:02Tracy Alloway?

  Joe, how many of these emergency episodes do you think we're going to need to do over the next four years?

• 2:08Joe Weisenthal?

  Oh, my God. You know, well, anyway, I don't know, but this is two weeks in a row. A week ago, you know, we had to rustle up a deep-seak expert last Monday, this time a trade expert.

• 2:19Tracy Alloway?

  That's right. I feel like we might as well just preemptively convert the show into a daily because I feel like there's going to be a lot of news flow. But anyway, as you mentioned, over the weekend, President Trump basically confirmed that the US would be imposing 25% tariffs on imports from Canada and Mexico, which are, of course, you know, massive US trading partners. He's also implementing a 10% tariff on China. All of this is being done via the International Emergency Economic Powers Act, and the tariffs are supposed to become effective as of Tuesday, February 4. And of course, you know, a lot of stuff can change. The news cycle is very compressed at the moment, it feels like, and we're recording

• 3:04Tracy Alloway?

  this Monday morning. So we'll see what happens overnight by the time this episode comes out. But in the meantime, there are a lot of questions. And who better to ask than Paul Donovan? He is, of course, chief economist over at UBS Global Wealth Management, someone we've had on the show quite a lot, and someone who's been following the ins and outs of the tariffs, including some of the technicalities of how they actually work, where I think there is quite a bit of confusion. So Paul, thank you so much for coming on Odd Lots at short notice, too.

• 3:35Speaker 04

  No, thank you for having me on.

• 3:37Tracy Alloway?

  Why don't we just start with, I guess, there's a question that a lot of people have been asking. There's a lot of confusion, as I mentioned, about who exactly is paying these tariffs and when. And the Trump administration initially seemed to suggest that foreign countries were going to pay and that they were going to set up this external revenue service to collect the income. Now, though, there seems to be a lot more talk about Americans having to accept short-term pain for a longer-term gain. A 25% tariff on Mexican or Canadian goods, where is that money actually collected? And who is paying for it?

• 4:14Speaker 04

  So the US consumer is paying, there is no question about this. We have over 4,000 years of economic history on tariffs. There are literally clay tablets from ancient Mesopotamia detailing this. Consumers pay tariffs, end of discussion. The point at which the tariff is collected, though, is very important. The point of entry, when the goods arrive physically in the United States, that's when the tariff is paid. And that's why a 25% tariff does not fully equate into a 25% consumer price increase. 25% tariff would mean about a 10% consumer price increase.

• 4:52Joe Weisenthal?

  Explain that further.

• 4:55Speaker 04

  So essentially, if you think about it, the goods arrive in the United States. Your television has arrived from China in the port of Los Angeles. That's the point at which you have to pay the tariffs. So you pay it on the value of the television at the point of Los Angeles. But after that point, the consumers still got to pay for transporting that television around the country, for the advertising, for the wholesale, for the retail costs. Retailers take a quarter of your money to cover their costs and profit margins. So of course, all of those costs add up to about 60% of the consumer price. The import price, on average, is about 40%.

• 5:30Tracy Alloway?

  Okay, so maybe prices on maple syrup or avocados or whatever don't automatically translate to a 25% price increase because of the dynamics that you just laid out. But I guess the other question that's floating around in terms of the impact on the broader economy is, are these types of tariffs, you know, net inflationary or net deflationary? Because on the face of it, it seems like prices will go up. That would add to inflation. But there's this sort of contextual impact as well, where you could see, you know, maybe there are fewer jobs and slower economic growth as the US economy has to adjust to a new trade dynamic. And maybe that exerts downward pressure on prices.

• 6:15Tracy Alloway?

  Net-net, do you see this as inflationary or deflationary?

• 6:20Speaker 04

  So in the short term, by which I mean the next year, this is going to add to inflation in the United States because it's a sales tax, it's like a VAT tax increase or a consumer tax increase. And if you look at Japan when it's raised consumer taxes or the UK when it's raised value-added tax, you see inflation coming through in the first instance. And this is just the same. It's a sales tax under a pseudonym. So you will see inflation in the first instance. But then you're right, the question is, do we then see jobs being lost? Particularly because these taxes are a lot more focused on complicated supply chains than was the case back in 2018. That may be a lot more disruptive to the economy

• 7:02Speaker 04

  and potentially could create unemployment or just fear of unemployment, which would lower demand. And that would then be a disinflation force, but not now. A disinflation force in the future accompanied by significantly lower growth.

• 7:17Joe Weisenthal?

  One of the arguments made by advocates of tariffs from time to time is that the US is still by far and away the biggest consumer market in the world. And it's a sort of a privilege to be able to sell to us. So if you want to sell to us and there's the tariff, just eat the cost yourself, lower your prices by 10% or 25% or whatever, so that you could still sell into the US market competitively. Does that logic fly?

• 7:43Speaker 04

  Not really. For one thing, the debatable point as to whether the US is the largest consumer market in the world, Europe is the largest middle-income consumer market in the world. So it's not all about the United States. The other thing, of course, is that the US is generally a relatively competitive market. So in other words, it's not that consumers are making supernormal, I beg your pardon, producers are making supernormal profits when they're selling into the United States and we're just chipping away at those. No, exporters to the United States are very efficient, they're operating on thin margins, they don't have the room to do this. And if you look back at what happened in 2018... There was no change in import prices trends pre tariff.

• 8:26Speaker 04

  So import prices are the price before the tariff is applied. There was no change in those trends when tariffs were applied, you know, because the exporters to the United States just basically don't have the room to cut the margin.

• 8:38Tracy Alloway?

  Hmm. The other thing that you sometimes hear is that, okay, maybe this means prices go up for American consumers, but some of that price increase could, in theory, be offset by a stronger dollar. And we have seen the dollar, you know, rallying in recent weeks. And I have a twofold question on this. So one, you know, how valid is that particular argument, the dollar offset idea? But then, secondly, why is it that the dollar actually goes up when the US announces additional trade measures? I don't, I've kind of taken that for granted, and I've never stopped to actually think about why that's happening.

• 9:14Speaker 04

  Well, let's start with the second part first. So essentially, I think what is happening is traders are assuming that because the tariffs will raise consumer prices over a period of time, not all at once, that will then lead to a more cautious approach on the part of the Federal Reserve with regards to policy interest rates. If interest rates don't go down so much, or indeed start to go up, that tends to be supportive for the dollar at a time when other countries are still on an easing trajectory. So it's an interest rate differential expectation, generally speaking. Does a stronger dollar help offset the tariffs? I mean, to a very minor extent, a stronger dollar will tend to lower commodity prices that are globally denominating dollars.

• 9:59Speaker 04

  But the issue here is that 95% of US imports are priced in US dollar terms. And so what that means is that if the dollar is strengthening, there's no automatic response in terms of the price of those things, because the contract specifies you owe us $100 for this product. Doesn't matter what the exchange rate is, that's what the US has dictated. And again, when we look at what happens historically, you know, for example, China's 2018 devaluation of the renminbi against the dollar, that didn't change the trend in prices to the United States because effectively the exporters to the United States were just

• 10:43Speaker 04

  grateful to get a little bit more profit margin coming out of that process and the dollar didn't really have a big effect in terms of offset.

• 11:05Speaker 00

  What's next for virtual assets? I'm Jacob Rees, host of Economy Scale, a series exploring growth in key global sectors. And in this episode, we're diving into the digital forces shaping finance. Sean McHugh from Dubai-based Virtual Assets Regulatory Authority has this to say.

• 11:21Speaker 05

  We're seeing a lot of institutional players come in, digital asset dedicated hedge funds, high frequency traders and that sort of thing, and folks who service institutional clients.

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  As more capital enters the market, adaptive regulation is likely to become increasingly key. Reece Marika Ripple says.

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  A lot of regulators globally would like to keep the industry at arm's length. That's the opposite here. I think also what you'll find is that regulation and frameworks can come out, but some of them are maybe a slight iteration on some 80-year-old policy and not actually in line with what the technology can do and offer. And again, that's very different in Dubai.

• 11:57Speaker 00

  Listen to the full episode wherever you get your podcasts. This series is brought to you by Bloomberg Media Studios and the Dubai Department of Economy and Tourism.

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• 13:30Joe Weisenthal?

  As of right now, by the way, it's now 10:12 a.m. on Monday, the 3rd. Markets falling a little bit more. Nasdaq down 2.3%, S and P 500 down 1.78%. You know, this is not a gigantic sell-off by any stretch. On the other hand, it's significant, so it does seem to be a surprise. One of the things you heard, people love to say it, oh, don't take Trump literally, take him seriously. But as far as I'm concerned, it's not clear that anyone is taking him literally or seriously when it came to tariff. People are just sort of, I don't think they really think about it at all. Well, you know, when you talk to clients, when they ask you questions, how much surprise is there? How much, how different is this versus, say, what, basically what people were expecting?

• 14:16Speaker 04

  I think it very much depends on who you ask. I think that quite a lot of clients in Asia had been expecting quite an aggressive tariff response because, of course, they bore the brunt of the tariffs in Trump's first term. Whereas I don't think that that has been such an expectation in North America, and Europe is a bit mixed on this particular point overall. I think as well, I mean, the president prides themselves on their unpredictable management style, which, you know, makes my job as somebody who has to predict for a living a lot more difficult. But it also, of course, means that if we look at what happened with Colombia, where Trump retreated, you know, within hours from threats of tariff, you know, Colombia didn't

• 15:00Speaker 04

  really do anything, can, no, all of a sudden, we're backtracking because we can't have the price of coffee going up. That sort of thing, I think, means that there is still this lingering hope that there will be some sort of Colombia-style reversal coming out of the administration on the tariffs. We've not seen it yet, and the clock's ticking, but I think there's that sort of background belief still in the minds of many investors.

• 15:25Tracy Alloway?

  This is actually the other thing I wanted to ask you, which is, we have seen Trump historically use the threat of tariffs as a negotiating tool, right? So hopefully, he gets at least some of what he wants before the tariffs actually have to come into effect. But I feel like the more he does this, the less impact or the less bang for his buck he's going to be able to get, because at some point, people are going to start calling his bluff. I guess, I guess all of this is a way of asking, like, how many times can he do this with the same impact?

• 16:01Speaker 04

  Well, it's, it's more than just sort of, you know, crying wolf all the time, which is part of what we're seeing. There are actually some quite serious long-term implications from this, because, of course, you know, Trump, in their first term, renegotiated NAFTA, and, you know, within days of taking office in their second term, has torn up NAFTA. So if you do a trade deal with the US in a year's time, how much confidence have you got that trade deal is still going to be operable in two years' time or three years' time? And so that's going to make doing deals actually more difficult over the longer term. So I think that's a, a particular challenge that we are facing here. I would also say, though, that the rhetoric from the Trump administration...

• 16:46Speaker 04

  Does seem to have shifted. And I think that President Trump believes that tariffs are a good thing, all in capital letters, and not just a bargaining tool. That they think that tariffs can be useful for revenue raising, which I personally would disagree with. But it doesn't matter what I think. That's what the president seems to believe. So I think there has been a break from the very clear bargaining tool position of the first term, that there is sort of a larger role for tariffs in Trump's mind in the second term.

• 17:19Joe Weisenthal?

  I just have one last question. Explain to us, you said it earlier on, the disruptive potential of tariffing intermediate goods. One of the things we know, for example, about the auto industry, whether we're talking about the Canadian border or the Mexican border, or maybe both. You see parts and you see components crisscross the border several times along the way. Talk to us about like how this potential intersects.

• 17:44Speaker 04

  I think one of the problems that we have is a number of people, including, I would suggest, some people in the administration, are sort of stuck in the early 1970s in an imperial model of trade. You import raw materials. Everything is manufactured at home. You export the finished product. And that's sort of the state of play when Nixon did universal tariffs back in 1971. But that's not how the world works now. A majority of global trade is a company shuffling goods between its subsidiaries. So a majority of global trade takes place inside companies as part of complicated supply chains within a firm. So when you start to impose these tariffs, if you've got an auto part in the United States, in a car made in the United States,

• 18:28Speaker 04

  crossing the border with Mexico 12, 14 times. If every single time it comes back into the United States, you're slapping a 25% tax on it, that very, very quickly becomes an uneconomic proposition. And that's the real risk. So that's where the disruption comes through. Supply chains are a lot more complicated than they were 50 years ago. This ain't 1971 anymore.

• 18:49Tracy Alloway?

  We sort of touched on this earlier, but I think it's an important point to hammer home and is the proximate source of the market's confusion at the moment. And also, we would be remiss if we didn't ask Paul to do his impression of a central banker. But How do you expect central bankers to react to all of this? Because as we spoke about earlier, on the one hand, you would expect this to be inflationary in the short term. So maybe they might raise rates to try to offset some of that. But at the same time, you would expect this to slow GDP in one way or another. Eventually, central banks like being ahead of the curve, or at least they say they do,

• 19:30Tracy Alloway?

  would they perhaps try to lower rates in order to offset that contraction? Which way are they going to go here?

• 19:36Speaker 04

  So like most questions in economics, the answer is it depends. So if we just get first round effects, if all you see is the tax being paid by US consumers pushing up prices, central banks should ignore that. Central banks should not respond to a one-off tax increase, which is a one-off price increase because there's nothing they can do about it. However, if we see second round effects, and this is where it starts to get very problematic. If we see, for example, retailers expanding profit margins again, another profit-led inflation episode, if we see US companies saying, well, our competitors' goods are now being taxed, so why don't we raise our own prices?

• 20:19Speaker 04

  As happened with the washing machine tariff, where you slap a tax on imported washing machines and domestic manufacturers raise their prices because they can, because there's less competition. That the central bank needs to respond to. That then becomes a problem. And then there's sort of associated second round effects. Do you see wage pressures coming through in certain sectors? I think that's unlikely, but if you do, the Fed would have to respond. If you see, for example, higher auto prices, that could lead to higher second-hand auto prices, which would lead to higher insurance costs for auto. And that sort of chain effect is something the Fed needs to start paying attention to. So the direct effect of the tariff, I think the central bank should ignore. And indeed, the Fed could conceivably continue to cut rates.

• 21:04Speaker 04

  But if you see those second round effects coming through, that is a five-alarm-bell warning. That's where the Federal Reserve or any other central bank needs to start paying attention.

• 21:15Tracy Alloway?

  All right. Paul Donovan from UBS Wealth Management, thank you so much for coming on Odd Lots for what is probably going to be the first of many impromptu episodes, I imagine. Thank you, Paul.

• 21:26Speaker 04

  Thank you.

• 21:40Tracy Alloway?

  Joe, I'm really glad we could do that at short notice.

• 21:43Joe Weisenthal?

  Yeah.

• 21:43Tracy Alloway?

  It answered a lot of questions for me and also kind of contextualized a lot of the big questions. I will just say, on that second order effect point that Paul made

• 21:52Joe Weisenthal?

  Yes.

• 21:52Tracy Alloway?

  at the very end, I already, I'm looking at my inbox right now at a note from Bank of America saying they expect US car insurance rates to go up as a result of the tariffs.

• 22:04Joe Weisenthal?

  Oh, man.

• 22:04Tracy Alloway?

  So, you know, sort of already in motion.

• 22:07Joe Weisenthal?

  The two big things for me are, A, the sort of real risk of the second order effects, all these other things that could happen, the more persistent. And then this idea, I like what he called, you know, the imperial model of trade, where, one, the old style, you're importing raw goods, you build it all here, you export it, you capture that value add, versus these really complex supply chains where something goes across the border multiple times. And then, to your point, to your question, I thought this was key, like, even if these get reversed really quickly, the idea of like, well, what does that mean for the prospect of any sustained sort of free trade block or free trade zone that it's also rip up a ball, I think is really key.

• 22:47Tracy Alloway?

  Yep. Lots of questions. Time to start brushing up on our tariff and trade history. So, shall we leave it there?

• 22:55Joe Weisenthal?

  Let's leave it there.

• 22:55Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 23:01Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at theStalwart. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashal Bennett at Dashbot, Kail Brooks at Kail Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots, where we have transcripts of blog and a newsletter, and you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 23:22Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we do these emergency episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. If you're a subscriber, You'll also get access to our daily Odd Lots newsletter. Joe and I are going to have some thoughts on the tariffs in there as well. Thanks for listening.

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