Stocks and bond yields fell and the Mexican peso depreciated after US President Donald Trump announced his intention to impose tariffs on all US imports from Mexico from 10 June. The tariffs would start at 5% and increase by 5% each month up to 25% "until the Illegal Immigration problem is remedied." The Euro Stoxx 50 index fell 1% in morning trade on Friday, US 10-year Treasury yields dropped a further 5bps to 2.17% and the Mexican peso fell by more than 2% against the US dollar.
If the tariffs were implemented we see the following impacts:
* The negative effect on US GDP could be significant. The US imported USD 352bn in goods from Mexico in 2018, more than from China. We already estimate that if the US carried through on its threat to levy a 25% tariff on all Chinese imports in a prolonged trade dispute, this could reduce US GDP growth by one percentage point. A 25% tariff on Mexican goods as well would risk the US falling into recession.
* Supply chains could be severely disrupted. Two-thirds of US–Mexican trade is intra-company (compared with 40% for global trade), and those supply chains would be at risk. If investment is canceled and employment reduced, then the risk of a recession increases significantly. The imposition of US tariffs in 2018 already led to business uncertainty and delayed investment decisions that contributed to a slowdown in global manufacturing (particularly in Germany) in the first quarter of this year.
* Tariffs would be difficult for consumers to avoid. Mexico had been taking market share from China by selling products from the September 2018 US tariff list. It has taken Chinese share of the US market in a meaningful way in a number of areas including cameras, recording equipment, modems and computer components. If Mexican goods are taxed, US consumers will find it harder to avoid the China trade taxes. For example, Mexico accounts for 44% of US imports of air conditioning units and 35% of TVs. From a company perspective, tech hardware companies with exposure to computers, servers and TVs would be most affected.
* The auto sector would be hit particularly hard. Autos and auto parts are the largest category of US imports from Mexico (USD 93bn in 2018). About 35% of the value of US autos exports is composed of imports. The impact would also be felt outside the US. For example, all the major European car manufacturers and suppliers are active in Mexico. If 25% tariffs were implemented, we estimate that European auto industry earnings per share could be reduced by a mid-single digit percentage, even without taking into account the potential for tariffs on direct European imports.
* We would expect the Mexican peso to depreciate further. In the event of the full scale of tariffs being implemented we would expect USDMXN to trade at 21.5 (, vs 20.0 in the event this proves to be just a threat)At this point, we think it looks unlikely that the full scale of tariffs will be implemented. Senior members of Congress have already expressed their concerns about the proposal, and Republican party donors would also likely not be in favor. A decision to impose tariffs which ignored NAFTA and WTO rules would be also likely challenged in court.
Nonetheless, this latest potential widening of the scope of tariffs illustrates the current fragility of US trade relations, and the importance of holding a diversified portfolio, both across geographic regions and sectors to mitigate idiosyncratic risks. Against a backdrop of ongoing – and potentially broadening – trade disputes, we have reduced risk in our tactical asset allocation over the past month, and also recommend countercyclical positions to help protect portfolios from downside risks.