What to know about tariffs

The US has imposed tariffs on imports from China and may yet also do so on imports from Mexico and Canada. The tariffs are intended to pressure those countries to change their policies on trade as well as on border security and drug trafficking. The prospect of tariffs have prompted Canada and Mexico to address border security concerns, leading to a 30-day reprieve from any new tariffs. Meanwhile, China has responded by placing tariffs of its own on some imports from the US.

It’s still unclear how long the tariffs might remain in place, whether some imports might be exempt, and whether changing currency exchange rates might lessen the impact on the prices of US imported goods.

Given these unknowns, there may be some potential for short-term stock market volatility. However, it is important to remember that US economic growth and corporate profits have historically been far more important for financial market performance than have short-term shifts in government policy.

Institutional Portfolio Manager Naveen Malwal says that maintaining a diversified portfolio with broad exposure to global stocks and bonds across many regions and industries remains the best approach to confronting market volatility, regardless of what might be causing short-term market moves.

What are tariffs?

Tariffs are taxes on goods and services imported from other countries.

Throughout history, governments have taxed goods and services imported from other countries. They’ve used these taxes—called tariffs—for a variety of purposes, including protecting their domestic producers, penalizing other counties for actions they disapprove of, and maintaining national security.

After the end of World War II, many of the world’s major economies signed an agreement called the General Agreement on Tariffs and Trade (GATT) that reduced tariffs in favor of policies that encouraged increased trade in goods and services between countries.

In the past decade, though, governments around the world have reconsidered the impacts of what is known as free trade and have adopted policies intended to benefit domestic industries by raising the cost of competing imported products. According to the International Monetary Fund, the number of new tariffs imposed by countries worldwide rose from a historic low of 239 in 2012 to 2,845 in 2023.

How do tariffs work?

Tariffs that are intended to give domestic industries and companies an advantage in the marketplace do so by increasing the prices of goods and services made by foreign competitors, which may help make domestic products more attractive to consumers.

Another type of tariff is known as a countervailing or anti-dumping tariff. Rather than seeking to give domestic producers a competitive advantage, these tariffs are intended to increase global trade by enabling one country to respond to what it views as unfair trade practices by another country. For example, an anti-dumping tariff may be used if a government believes that a foreign trading partner is unfairly exporting subsidized low-priced goods to try to drive the importing country’s producers out of business. The object of this kind of tariff is to raise the artificially low price of the foreign products and create fair competition between foreign and domestic companies.

Does the US use tariffs?

The US government has a long history of using protective tariffs to benefit US industries. As early as 1789, a tariff on foreign sugar was imposed and tariffs on many other foreign products followed. In 2018, the US placed tariffs on $360 billion worth of imports from China in response to that country’s policies, which included pressuring US companies to give up their rights to their own intellectual property as a condition of doing business in China. Those tariffs are mostly still in place and this year, additional tariffs were applied to another $18 billion worth of Chinese products, including steel and aluminum, semiconductors, and electric vehicles. In some cases, the latest round of tariffs has raised the tax rate on Chinese imports to as high as 100%.

Who pays for tariffs?

Tariffs are paid directly to government tax authorities by companies when they export products or services into countries whose laws impose tariffs on those products. The amount that the importer pays is typically passed along to consumers of the products or services in the form of higher selling prices.

Advantages of tariffs

Proponents of tariffs say they protect existing companies and the people and communities that rely on them for jobs and income. For example, since 1964, the US has charged a 25% tariff on imported light trucks. The tariff was originally intended to penalize European governments that the US administration claimed were allowing European chicken producers to dump their products into the US market at artificially low prices. Since then, the so-called chicken tax has helped US truck manufacturers to continue to dominate the US pickup truck market, even as they’ve watched their share of the US car market (which is not protected by tariffs) shrink from 90% to 40% over the same period.

Tariffs may also help what Alexander Hamilton called infant industries to grow until they are able to compete with foreign rivals. This approach is evident in recent tariffs intended to encourage the production of medical supplies and semiconductors in the US, rather than continuing to rely on foreign sources for what are viewed as essential products.

Disadvantages of tariffs

Critics say tariffs do more harm than good by increasing the prices that consumers pay. However, the US tariffs of the past decade have not been accompanied by a sustained rise in inflation. When the US imposed its initial round of tariffs on China in January 2018, the US Consumer Price Index (CPI) stood at 2.1%. By mid-year, inflation had ticked up to 2.9% before dropping back to 1.9% in December for an annualized rate of 2.4%. Over the following year as trade tensions between China and the US continued, inflation in the US never exceeded 2.5% until the impact of COVID-related policies began appearing in 2021.

Despite the possibility of more tariffs, Fidelity’s Asset Allocation Research Team expects inflation to follow a “flattish trend” over the next year. However, they also say that returning to the stable, low inflation of the past 20 years will be “challenging.”

Tariffs are also often accused of harming the workers who might expect to benefit from them. In this view, because tariffs raise the prices of imported goods, domestic producers can also raise the prices they charge for raw materials. That raises costs for producers of finished goods who may be forced to lay off workers in order to remain profitable.

In addition, some believe that tariffs can slow economic growth. The Tax Foundation, which is generally skeptical of tariffs, says that the tariffs imposed by the US since 2018 are likely to reduce gross domestic product (GDP) by 0.2% and that proposed new tariffs could mean an additional 0.8% reduction in GDP.

What might new tariffs mean for markets?

Director of Quantitative Market Strategy Denise Chisholm looks to history to anticipate what might happen in the future. She notes that when the US first began imposing tariffs on imports from China, “They were not really inflationary. However, the S&P 500 did experience a 15% peak-to-trough contraction in 2018. But at that time, unlike now, the Fed was also raising interest rates, real rates were much higher, and maybe most importantly, valuation spreads were low. Today, though, valuation spreads are wide, which says to me that the market is uncertain and that the higher the uncertainty, the more likely the equity market is to climb the wall of worry.”

Of course, there will always be uncertainty for investors. That makes it important to take a long-term view of an investor's investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation. Ideally, an investor's investment mix is one that offers the potential to meet thier goals while also letting them rest easy at night, regardless of uncertainty about political events.

Investors should think about defining their goals and time frame, take stock of their tolerance for risk, and choose a diversified mix of stocks, bonds, and short-term investments that they consider appropriate for their investing goals.