Asset Management: Monthly Macro Insights - February 2025

A trade conflict with the US’s closest economic partners might begin soon, and all indications are that these actions are a start to a widening trade war. The complete ramifications are unknown, yet the cost of uncertainty could be large and increases the risk of stagflation.

Higher inflation, lower growth?

US President Donald Trump announced his intention to impose heavy tariffs on goods imported from Mexico, Canada and China and, as a result/subsequently, all three nations announced their intention to retaliate. Model estimates suggest that the size of a sustained 25 per cent tariff hike is large enough to throw the Mexican and Canadian economies into recession. Yet, although smaller, the impact on the US economy is most likely not trivial.

For now, the global manufacturing PMI improved somewhat in early 2025 to the neutral 50-threshold, as sentiment was in part supported by businesses’ desire to build inventories before the possible installation of higher trade barriers. Yet, confidence will be a key determinant of global macroeconomic outcomes over the coming year, and the manufacturing PMI might get hit significantly after the latest threats from the new US administration.

An uncertain new source of revenue

Investors have been of the view that the most aggressive threats from Trump’s election campaign were just tools to extract deals from trading partners. Yet, most Trump administration officials genuinely think that tariffs could become a new source of revenue, reducing the reliance on income taxes in a context of fragile fiscal outlook.

The irony is that while the tariffs could indeed generate extra federal tax revenue, the increase might be much more muted than hoped, precisely because the tax base, namely imports, will decrease due to the trade war. In fact, with lower exports and imports, the trade deficit might end up not improving much, if at all.

Unintended longer term consequences

Given the relative strength of the US and weakness of many other countries – both cyclically and structurally – the weaponisation of trade promises some gains for the US in the short-term. However, Trump is giving strong incentive for countries to reduce their economic and financial dependence on the US and accelerate the fragmentation of an international economic order that has historically served America well. In the end, this could well undermine its economy, its power and its national security.