How Trump’s Tariff Fight Could Backfire on US Stock and Bond Investors
U.S. trade policy has been on a wild roller-coaster ride, and no one knows when it will end. The latest is President Trump’s declaration of 25% tariffs on aluminum and steel imports. Separately, Trump has promised to impose reciprocal tariffs on trading partners later this week.
The first tariff salvo came in January after Colombian President Gustavo Petro revoked landing rights to a U.S. military flight carrying deportees. Trump announced he was levying 25% tariffs against imports from Colombia. This would have devastated the Colombian economy. Petro soon caved, and Trump took tariffs off the table (for now).
More recently, Trump announced 25% tariffs on Mexico and Canada, and 10% additional tariffs on China, for, he said, allowing the flow of illegal drugs and immigrants into the United States. Mexican President Claudia Sheinbaum caved first, agreeing to send 10,000 troops to the U.S.-Mexico border to cut off drug shipments in exchange for a one-month reprieve on the tariffs. Canadian Prime Minister Justin Trudeau got his reprieve a few hours later, also in exchange for strengthening the U.S.-Canada border.
China is still in play, with Trump noting that the 10% hike on imports from China was just “an opening salvo.” But even if these tariffs, too, are paused, the events of the past few weeks have reinforced already sky-high uncertainties about prospects for future U.S. trade policy. In fact, the only certainty is that the next four years of trade policy will be arbitrary, capricious and unpredictable. This uncertainty could do even more damage to the U.S. economy than the direct effects of the tariffs themselves.
Before businesses invest their time, effort, and money in new projects, they need to know what costs they will face, what prices they can charge, how much revenue they will make, and what profits they will earn. An unforeseen hike in tariffs scrambles the equation. It can boost costs and disrupt production for companies that rely on imported inputs. It can close off foreign markets to U.S. exporters as America’s trading partners retaliate with tariffs of their own.
And if the overall level of tariffs rises sufficiently, the cost of borrowing will rise as the U.S. Federal Reserve tightens monetary policy to head off rising inflation. In response to such uncertainty, many companies will hold off on investment decisions until they achieve greater clarity.
This gloomy scenario is not a mere theoretical possibility. During Trump’s first administration, his salvos of tariffs against China, Canada, the EU and others led to an unprecedented rise in uncertainty about future trade policy. Researchers at the Federal Reserve quantified this uncertainty based on the number of news articles mentioning the risks of protectionist policies. They defined an index of trade policy uncertainty, or TPU, as equal to 100 when 1% of all news articles reference tariff threats.
Ultimately this research found that after bouncing below 50 for the previous three decades, the TPU soared to over 250 in late 2018 and again in mid-2019. Despite the fact that the average level of U.S. tariffs rose only marginally, the confusion about future trade policy weighed heavily on the economy: the growth of real investment was halved by early 2019, while industrial production stalled entirely.
This was not a coincidence. Numerous contemporary observers identified worries about tariffs as a key factor undermining growth, and both tariff uncertainty and the resultant softening of the global economy helped trigger a sharp decline in the stock market in 2018. The Fed study also identified a significant connection between previous rises in trade policy uncertainty and declines in economic activity; it concluded that the rise in uncertainty observed in 2018 and 2019 could indeed lead to a material contraction in economic growth.
Uncertainty about future trade policy largely receded after 2019 and remained relatively low during most of the Biden administration — even as most of Trump’s tariff hikes were retained. However, uncertainty crept back up as the presidential election campaign progressed, and by the end of 2024 it surpassed peak levels of Trump’s first administration. We await more recent data, but it is fair to say that after the events of the past few weeks, speculation about Trump’s trade policy is now at a fever pitch.
The only way to restore stability and predictability to the tariff regime would be to wrest unilateral control of trade policy out of Trump’s hands. But prospects for this are dim. The U.S. Constitution gives Congress to power to set tariffs, but this authority was long ago ceded to the president, and the political will to take it back is sorely lacking.
By the same token, the courts are unlikely to stall or reverse Trump’s tariff hikes in response to lawsuits by U.S. companies, industry groups, or foreign organizations. The most likely curb on Trump’s tariff proclivities would be a sustained fall in stock prices, which Trump views as a central metric of his performance. But hoping for a stock-market bust as a way to restore rationality to trade policy is a sorry hope indeed.
Steven B. Kamin is a senior fellow at the American Enterprise Institute. He is a former director of the Federal Reserve Board’s international finance division.