Early Impacts of the Trade War

This week continues the temporary ceasefire in the trade war, with many tariffs on a 90-day delay. But market volatility is likely to return as we get an early read on theoretical updates from global economic forecasting organizations and real-world impacts of the trade war from global corporations' earnings reports and guidance.

Last week, the head of the International Monetary Fund (IMF) gave a warning that the global economy will slow due to the U.S.-led trade war but noted that a global recession is not in the forecast. The IMF is scheduled to release new forecasts in its World Economic Outlook on Tuesday, April 22, when we will get the details on the impact to each country. Their forecasts are likely to include a downgrade for global growth with North American economies expected to take the biggest hits.

The IMF's last semi-annual analysis report, published in October of last year, analyzed the potential impact of U.S. tariffs, which were then assumed to be across the board 10% tariffs, tariffs and retaliation by all countries at a rate of 10%, which resulted in only a small -0.1% impact on global growth with the biggest drag (-0.4%) felt in the United States. The much higher tariffs both implemented and proposed in 2025 will likely worsen the magnitude of the economic impacts coming out of last fall's analysis.

The original IMF forecast was similar to a report from the Organization for Economic Cooperation and Development (OECD), another international institution focused on facilitating economic growth and stability, published just last month. With total exports to the U.S. from all other countries only accounting for 5% of non-U.S. gross domestic product (GDP), the OECD estimates that a 10% tariff on all U.S. imports and exports would reduce U.S. GDP by seven times more than in China, three times more than in the eurozone, with a bigger impact on U.S. inflation than elsewhere, as you can see illustrated in the chart below. This analysis was further supported by the World Trade Organization report published last week that foresees a stall in global merchandise trade this year (-0.2%) driven by a large drop in North American exports of -12%.

The worsening U.S. outlook compared to major trading partners may have helped prompt the 90-day delay in some tariffs announced on April 9th and could urge the Trump administration to cut bi-lateral deals in the interim time. The administration expressed positive sentiments about its tariff talks last week with the United Kingdom, Japan, and European Union.

The theoretical forecasts may be directionally correct, but it's important to take all these seemingly precise estimates of the impact of tariffs with skepticism, in part because we don't know how successfully the tariffs will be avoided in the real world. The incentives to avoid tariffs are very high with China tariffs over 100% but only 10% or less on neighboring countries where Chinese businesses have subsidiaries.

One way to avoid tariffs is by transshipping from China to an intermediary country such as Vietnam, Cambodia and Thailand and then on to the U.S., thus paying a much lower tariff rate—something the data indicates China has been doing increasingly since tariffs on Chinese produced goods were levied in 2017, during President Donald Trump's first term. In fact, the data shows the rise in the U.S. imports from those three countries since before the 2018-19 tariffs were implemented is the same amount China's exports to those three countries has increased. And it's a lot—about $15 billion per month over the past year. Adding that to the $45 billion in direct monthly exports from China to the U.S. each month suggests 25% of China's exports are being transshipped through these countries to avoid tariffs. That percentage is likely to increase unless the tariff rates change.

Another way to avoid tariffs is to under-invoice the value of Chinese goods. The under-invoicing began with the first rounds of Trump tariffs on China in 2018-19, which were maintained and widened under Biden. Since then, the value of imports claimed in the U.S. has gone from being higher than what was claimed to be exported from China. The blue line in the chart below shows the over-invoicing to get money out of China prior to the 2018-19 tariffs shifting to being more than $100 billion below on under-invoicing in the U.S. presumably to avoid tariffs. In percentage terms, this means that currently 20% of the value of China's exports to the U.S. are not being accounted for in the U.S. imports data.

Taking both these actions together, it may be that nearly 50% of China's exports to the U.S. are already avoiding the full tariffs. Chinese exporters and US importers are facing big and increasing incentives to do so. Risks to growth, inflation and profit margins from the high China tariffs may be somewhat mitigated by the avenues of avoidance.

So, let's set these projections aside for the moment and look at the real-world implications of the tariffs so far. The trade war may be in a temporary ceasefire, but earnings reports are shedding light on the effects of the initial salvos of Trump's trade war are having on business activities. Firms in industries including construction, apparel, and luxury goods did disclose some inventory increases were made (confirmed on earnings calls by shipping companies CSX and JB Hunt) in anticipation of increased costs but were careful to not rule out the possibility of price increases or applying tariff surcharges later in the year. While many companies are taking a wait-and-see approach to the impact, last week's comments from business leaders included:

- Discount retailer Five Below asked vendors to cancel shipments of products waiting in China before they set off for the United States.

- Luxury product maker LVMH said tariff talks weighed on demand, noting soft U.S. sales.

- United Airlines offered guidance to analysts that included two scenarios driven by "light" and "heavy" tariffs.

- Also, an inventory write-down showed the impact of non-tariff restrictions on Nvidia's chip exports to China.

While earnings are at risk and there are typically no absolute winners in a trade war, we continue to favor international diversification with an emphasis on Europe. European stocks have recovered all of their April 2 "Liberation Day" losses, as you can see in the chart below. Not so for U.S.'s S&P 500. This isn't simply because of the poor performance of the U.S.'s Magnificent Seven since the equal-weighted indexes show a similar gap. This illustrates it isn't just a handful of mega cap stocks that account for the difference in performance, the average stock in Europe has been outperforming the average U.S. stock.

Michelle Gibley, CFA^®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.