Across the Pond: What comes next for global trade?
The desk posits that the recent escalation in trade tensions, exemplified by the April 'Liberation Day' tariff announcements, indicates a potential shift towards a prolonged trade conflict characterized by higher tariffs, particularly affecting European markets. Per the full note from UBS, this uncertainty raises critical questions for investors regarding sector vulnerabilities and portfolio positioning strategies in light of shifting trade policies. Current trends suggest that sectors heavily reliant on exports may experience immediate impacts, warranting a cautious approach in currency positions. Therefore, investors must remain vigilant to evolving dynamics on this front, especially regarding the implications for the euro as tensions escalate.
What the desk is arguing
The desk believes that the signals from April's tariff announcements imply a shift toward a longer-term trade conflict, which has the potential to fundamentally alter global trade dynamics. These developments raise significant concerns for Europe and highlights the necessity for strategic portfolio adjustments by investors.
The UBS commentary emphasizes that investor uncertainty is at a heightened state, particularly regarding which sectors will face the brunt of tariffs and how this could affect currency valuations in the near future. Additionally, sector analysis will be crucial as more granular data emerges, providing deeper insights into which industries are most susceptible to tariff adjustments.
Where it sits in our coverage
Our current consensus target for EUR/USD sits at 1.075, with a range from 1.04 to 1.12. Notable firms within this outlook include: - jpmorgan: 1.10, Mar26 - bofa: 1.04, Mar26
This perspective echoes the cross-firm consensus, landing at the lower end of the projected range, primarily due to heightened geopolitical risks and volatility in trade discussions. Given current market sentiment, the risk of further tariff escalations could influence the euro negatively, diverging from predictions made by some analysts.
How other firms see it
Firms such as jpmorgan and scotiabank align with our bearish outlook on the euro, indicating a shared belief in the potential for increased volatility driven by trading disputes. Conversely, bofa suggests a more optimistic view, with a lower target for the EUR/USD exchange rate, reflecting contrasting expectations about trade resolutions.
The ongoing trade tensions intersect with critical currency flows, underscoring the importance of monitoring key pairs such as the EUR/USD and the subsequently impacted GBP/EUR trajectories, which reflect broader market sentiment toward European stability amidst rising tariff concerns.
01The 'Liberation Day' tariffs signal potential for a prolonged trade war.
02European sectors dependent on exports are now at heightened risk due to increased tariffs.
03Investors should adjust portfolios to mitigate risks from trade vulnerabilities.
04The euro is expected to react sensitively to ongoing trade discussions.
Market implications
Traders should watch the euro closely for reactions to any new tariff announcements or shifts in trade negotiations, particularly for levels around 1.075, which could signal a significant pivot in positioning strategies ahead.
Risks to this view
Any resolution or easing of tensions in U.S.-Europe trade relations could reverse current bearish sentiment and strengthen the euro, challenging the desk's outlook significantly.
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Welcome to another episode of Across the Pond where we discuss the big stories and top investment ideas from the Eurozone and Switzerland. There are times when investors are obsessed with just one question and now is such a time. The big question is whether the world is headed for a protracted trade war and a new regime of significantly higher trade tariffs.
As we discussed in our last Across the Pond, the answer depends to a large degree on the mindset of just one man. Does President Trump see tariffs as a negotiating tactic to win concessions from America's partners or as a long-term way of boosting tax revenues and manufacturing employment? The outcome will have huge implications for Europe and Switzerland.
The US is the world's largest importer of both goods and services and at the last count the 27-nation Eurozone exported around 550 billion in goods a year to the US and around 170 billion in services. So what comes next for global trade? I'm Christopher Swan.
And I'm Belinda Peters. A few weeks ago we recorded an installment of Across the Pond ahead of President Trump's 2nd of April Liberation Day tariff announcement, which turned out to be far more aggressive than most had anticipated. But there have been plenty of twists and turns since then.
Today we'll ask what this might mean for Europe and Switzerland, which sectors are most at risk and how can investors adjust? Stay tuned for the answers. To answer these questions, we are pleased to welcome Paul Donovan, Chief Economist at UBS.
Thank you for joining us, Paul. Thanks for having me back. So yeah, maybe we can just start by catching up on the latest.
It just seems that the news is shifting by the hour, but perhaps you can just give us the big global overview to start with. What has gone on since April 2nd? Well, that is quite a lot, I think.
So we had the big announcement on April 2nd that there was going to be a universal tariff of 10% on all imports into the United States, with a couple of exceptions where tariffs already existed, and that U.S. consumers of goods from selected countries would pay even higher tariffs, which were calculated by a very peculiar formula, which has really nothing to do with tariffs at all. The formula received quite a lot of attention because it imposed an onerous 10% tariff on the penguins of the Heard and MacDonald Islands, who don't actually export anything to the United States. So that was the starting point.
What has happened then has been essentially three things. The tax on imports from China has just escalated and escalated. And so now goods from China are subject to a 145% tax.
China has retaliated to that, and now they've said, you know what, we're just giving up. It doesn't make any difference what you say. Frankly, once you go above 100%, any change is meaningless because demand will stop.
We have also seen, however, President Trump retreat from a number of the tariffs very quickly. So there was a very rapid retreat from this idea of taxing Europe by 20% or Vietnam by over 40% and so on. And now all goods coming into the United States other than China and other than some selected products are going to be taxed at just 10%, and there's 90 days for negotiations.
So presumably the Heard Island penguins will be sending their delegates across. And then the third thing that we have had is the announcement that more taxes are coming. So pharmaceuticals and certain forms of electronics will be subject to additional taxes, but they haven't worked out what those are.
And this sort of backwards and forwards has been fairly continual. So we have seen a possibility that there may be a retreat on some of the auto tariffs. We have had a retreat on taxes on smartphones, but then now we're getting potential taxes on semiconductors and other electronics.
So it's this constant shifting sands. Overall, US tariffs have gone up probably by about 20 percentage points, depending on when you're listening to this, but roughly that sort of sum. So we've certainly got the highest trade taxes in the United States in over 100 years.
And then just to put that in context, like, so where was the effective tariff before all of this started? So the effective tariff, let's say before President Trump took office, was around about 4%. So we're looking at a number today which is about 24%.
As I said, we can't be precise on this because it's a constantly moving number, but it's give or take, it's mid 20% range. So it's around about a 20 percentage point increase in the effective tariff rate. Got it.
And then just one more general question before we get back to Europe. And I say this without much expectation of an answer, but what is your perception of what is going on in Trump's mind when it comes to tariffs? What is he trying to optimise for?
That is a very difficult question, but it's a very relevant one because firstly, obviously, the trade policy that I've just described is extremely erratic. And that has led to questions, is there a master plan? And frankly, on the evidence that we have today, you have to say no, there isn't.
There isn't necessarily a clear risk reward assessed profile of what we should be doing next. Secondly, I think it is fairly clear that the United States political structure has moved towards what Arthur Schlesinger, the political theorist, called an imperial presidency. So to a certain extent, I don't really care what Treasury Secretary Besant is saying, because it's not down to Besant, it's what President Trump is doing that is going to make the difference at the end of the day.
And that means that the whims of the president become a lot more significant. My personal view, and I'm definitely not a psychologist, but my personal view is that a lot of President Trump's views on trade taxes and taxing domestic consumers of imported goods were formed in the 1980s, when the president was a real estate developer in New York and took a very hostile approach towards Japanese investors coming into the New York real estate market and started to advocate quite strongly for tariffs because of the trade imbalance that existed between the United States and Japan in the mid-80s. So I think that the president's mindset around tariffs was very much shaped in that period.
That for me as an economist is problematic, because of course, trade today is nothing like trade 40 years ago. It's a lot more complicated, a lot more of trade, in fact, probably a majority of trade takes place inside companies. Every time UBS moves me out of the UK to a different location, that's an export.
But it's something that UBS deals with internally, but it's still part of trade. So all of this sort of stuff is making for a far more complex trading picture than existed 40 years ago. And that might account for some of the erratic policy decisions that we've had over the course of the last few weeks.
And perhaps we can narrow in on Europe, Switzerland, and the UK now, what have been the initial stages of the conflict? And how have the authorities responded to this? So far, what we have seen is the first stage was a 10% tariff on the UK.
The UK basically runs a balanced trading goods with the United States that runs a surplus in terms of trade in services. Europe and Switzerland were subject under this rather peculiar formula to higher tariffs initially. In Switzerland's case, that was a little bit unfair.
Switzerland has been running a trade surplus with the United States. But that's in large part because a lot of people in the United States were pulling gold out of Switzerland in fear that gold was about to be subject to a tariff. Now as it happens, gold has been exempted from the tariffs.
But still, the only reason the trade surplus between Switzerland and the United States was so large was because Americans were scared that tariffs were going to be imposed and were seeking to get their gold out quickly. With the change, obviously, that's now all down to a 10%. And President Trump has said, right, no, come and negotiate.
However, that's not quite so clear cut because autos are still subject to a 25% tax. And the European Union does sell a reasonable amount of cars and car parts, quite critically, into the United States. European car companies have got factories in the United States that rely on importing car parts.
President Trump is now looking to tax pharmaceuticals. They haven't done so yet, but they're certainly considering a tax on pharmaceuticals. Pharmaceuticals are very important to Switzerland.
And Swiss trade in goods is very pharmaceutical focused. So the situation is by no means stable. And there are some significant risks, particularly as far as Switzerland is concerned, over the course of the next couple of months.
What has happened in terms of retaliation? So far, that has been quite limited. But there are threats of retaliation from Europe and, to a lesser extent, the UK and Switzerland.
Essentially, what these countries are saying is, look, we'll try and negotiate. But if it's not going to be sensible, then these are the areas where we're going to start putting in place taxes on US goods. But what we've got to remember from this, this is an important point, Europe and the UK and Switzerland would only be taxing imports from the United States, whereas the US is taxing imports from absolutely everywhere.
So what that means in terms of the balance of the economic pain, that the more aggressive tax scope in the United States will do more damage to the US than it will do in terms of reciprocal tariffs coming through in Europe, UK and Switzerland. I mean, I guess it's good to get like a sense of sector perspective. And I think you sort of provided a few hints on that.
But like, where do we see, I mean, which sectors in Europe and Switzerland and the UK are sort of most susceptible? And I guess by also, it's good to get a sense of which are least susceptible, so that I guess if you're an investor, you can maybe try to sort of shield yourself from the worst of what's going on. Well, of course, one of the problems is the very erratic US policy, you know, that a sector that is not subject to tariff today may suddenly be the subject of a truth social media post tomorrow and everything all of a sudden is turned upside down.
Generally speaking, I think that where price changes would be very visible to US consumers, President Trump has has shown themselves very willing to retreat very quickly. And the smartphone retreat, I think, is a good example of that, that, you know, a lot of consumers, certainly a lot of Gen Z are very much aware of the price of an Apple iPhone. And if that suddenly you were to go up by 65 70%, as a result of tariffs against China, they would react very negatively to that.
And the president wants to keep them on board politically. So retreated from that tariff with quite extraordinary speed. There are certain products, and potentially including certain pharmaceutical products, where there would be very visible price increases, which would have political consequences, and those are likely to fade away.
Nevertheless, I think that autos, maybe not auto parts, but autos are a very politicized area. There is domestic manufacturing competition in the United States that is likely to remain an area subject to tariff. Steel and aluminium is certainly likely to remain an area subject to tariff.
It's sort of a standard go to tariff for a lot of countries around the world. It's a politically important area. So I think we will continue to see the tariffs imposed there.
I think it is relatively unlikely that we would see tariffs against food products being lifted that quickly. And that's because the taxes on food imports that the US is imposing are not going to be a bargaining chip for lowering food standards in Europe. And President Trump has talked about non tariff barriers to trade.
So the fact that Europe has higher food standards in a number of areas than does the United States is not likely to be a compromise. And so I suspect that where food products are subject to tariff, that will actually continue for the foreseeable future. But generally speaking, the more visible the price change is to the US consumer, the more likely it is that President Trump will retreat from the tax policy without any concessions needing to be given.
And obviously, European exporters care deeply where tariffs end up on US exports. But the more intense antagonism between the US and China also matters, I assume, given the importance of China as an export market. So how great is the concern that this could impede demand in China?
So I think that there's not necessarily too much concern. There is a degree of concern, obviously, about derived demand. If you are exporting a component from Germany to China, which is then packaged up and exported onto the United States, which does happen, then obviously that derived demand is vulnerable.
But with regards to China's domestic demand, frankly, Europe has been experiencing a bit of a slowdown there. Economic nationalism is not a uniquely US phenomenon. There's been quite a lot of media hostility to Europe and to the UK in China's media.
One of the consequences of that is, for example, luxury goods sales from European brands in China have been underperforming, have actually been slowing in recent years. And that's because I think the economic nationalism might have generated a perception that you're wearing a European brand is unpatriotic. And so you've seen a hit to demand.
So I don't think that Europe is necessarily too concerned about the state of the domestic Chinese consumer in a slowing Chinese economy. The Chinese government also, of course, does have room to offer a degree of fiscal support to China. There is certainly an attempt to increase domestic demand in China.
And if you're selling something which is not a branded good, where you've not been so affected by economic nationalism, that could be a positive. I think the more serious consideration for European UK companies is whether China would engage in what is known as dumping. That is to say, if China can't sell products to the United States, they choose to sell them below cost price into Europe.
And of course, European companies would find that very, very difficult to compete against. And it might threaten the continued business operation of European companies if you're being dramatically undercut in price by Chinese companies. Now, I think that this is actually quite unlikely to take place, because I think China regards the situation as a political opportunity.
And they don't want to alienate Europe and the UK by engaging in dumping, which is quite an aggressive and hostile action. So I'd be a little bit sceptical about that. But that certainly is a concern of European companies.
And if we did see dumping, where would we most likely see that? Well, it would effectively be diverting predominantly consumer goods, I would suggest, that would otherwise go to the United States. Again, areas like iron and steel, you may get a certain amount of that, some aluminium, but not too much.
I think that's not going to be a major issue. The bigger concern would be, well, if clothing made in China is no longer being sold in the States, that's going to be dumped into Europe, or electronics, or batteries, autos possibly, though I think that's relatively unlikely, not least because the United States doesn't really buy autos from China. There are more likely, I think, to be concerns about, well, if we can't sell consumer goods into the United States, where is a US substitute?
The US substitute is Europe and UK. As I said, though, I think dumping politically will probably be avoided, if at all possible. And then just a quick follow-up there, and obviously the issue of uncertainty is looming quite large.
I mean, we certainly feel it ourselves, because we've just started to work on something, and then halfway through the article that you're writing, the news has changed. But I mean, with companies, this must be making it really difficult to sort of invest, plan their supply chains, hire, make those kind of decisions, so presumably it's too early yet to see signs that that's affecting businesses in Europe? Yes, and I think we've got to remember, the impact of this is going to be far more on businesses in the States than it is in Europe, because we're not in a global trade war.
We are in a very different situation from the 1930s, when everybody was putting up obstacles to trade against everybody else. This isn't a global trade war, this is the US cutting off its own arm. This is a self-inflicted injury.
So at least for now, Europe is still trading with the UK perfectly normally. In fact, it may even be moving towards closer trade ties. The UK is trading perfectly normally with China, etc.
So there is greater certainty in Europe and UK and in Switzerland about the future than there is in the United States, where in the United States, you don't know, am I going to be able to import my components? Am I going to be able to export my finished product? What's going on next?
So I think in the case of the States, we're certainly going to see a disinclination to invest. I don't think we're going to see people losing their jobs. I think that's relatively unlikely.
But I think certainly there will be a disinclination to hire. In Europe, in the UK and in Switzerland, I think there is a different approach. Because there is a bit more certainty, there will certainly be some investment taking place.
And of course, what we have in these countries, particularly in Europe, is a degree of fiscal stimulus around defence spending, which will actually be encouraging investment and possibly some hiring, because I think the perception is that European defence spending and increased defence spending is likely to be a long-term trend. There's more certainty about that in this situation. And for our last question, we always promise listeners to be actionable.
So against this backdrop, which parts of the European market look best insulated or even provide the best opportunities in your view? That is a difficult question. Because again, the erratic nature of US policy means that, you know, an area you don't think is vulnerable could become vulnerable.
Obviously, I think European defence related areas offer a degree of immunity from this because they are going to be the focus of increased defence spending. And I think which is geared into domestic demands of certain aspects of retail, domestic leisure, not least because the number of Europeans taking trips to the United States has collapsed. So there will be a little bit more inward looking spending there.
These are areas which offer perhaps a degree of potential. But ultimately, in this sort of situation, and again, with this remarkably erratic policy, a diverse portfolio is going to be the best hedge against a very unpredictable US trade policy. Great.
Well, thanks, Paul. You've been really generous with your time, as always. It's really interesting to hear your views and thanks also to our listeners.
We can't delve into specific securities on these podcasts, but you can explore some of these with your UBS representative and we very much recommend our equity compass, which goes into full detail about where we see the most value. But just to sum up here, we recommend that investors focus on defensive stocks in Europe. These stocks are valued for their stable earnings and consistent demand, especially during periods of heightened market volatility and uncertainty.
Defensive sectors such as consumer staples, healthcare, communication services and utilities are preferred. We recommend targeting fundamentally robust companies with attractive prospects within these sectors as they typically benefit from their lower share price volatility and reliable dividend payments. We'll be back soon with another installment of Across the Pond.
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