With the prospect of new tariffs – taxes on imported goods – being rolled out by the US and its trading partners, Vanguard’s senior international economist Kevin Khang discusses the potential implications for financial markets and what it all means for long-term investors.

What can we learn from past tariff experiences?

When dealing with an elevated level of uncertainty, history can provide valuable insights. By understanding what has happened in the past, we can better imagine what might happen this time around. For tariffs, there are two examples from history which are helpful:

• 2018-2019 US tariff increases: Initial proposals in late 2017 and early 2018 were broad in scope and aimed at many trading partners. Over the next year and a half, we witnessed many changes as the policy took shape. Ultimately, those tariffs targeted primarily steel and aluminum, which was a more measured outcome than initial proposals suggested.

• 1930 Smoot-Hawley Tariff Act: This legislation raised the effective tariffs on goods imported into the US to about 20%, leading to swift retaliation from many trading partners and likely worsening the Great Depression that was already underway. While the Act was eventually repealed in 1934, it highlights how a severely adverse economic outcome can result from unsuccessful trade negotiations.

As we enter what could be a new wave of US tariff negotiations, these past experiences can provide helpful context and perspective.

How are markets reacting to the prospect of new tariffs?

Until late on 31 January, markets didn’t seem to think there would be an immediate implementation of 25% tariffs on imports into the US from Canada and Mexico. But on 3 February, as the prospect of tariffs loomed, swings in prices suggested that markets were beginning to anticipate the possibility.

The value of the US dollar increased rapidly against the Canadian dollar and Mexican peso. Tariffs are expected to push up US inflation (the rate at which prices for goods and services rise over time). This could keep interest rates higher for longer which would, in turn, support the US dollar. 

US shares experienced losses, led by US automobile manufacturers and homebuilders – industries that would be most directly impacted by the proposed tariffs on Canada and Mexico. As further negotiations and timelines were announced, we saw these movements largely reversed.

How might global trading change? 

Over the long term, global trading may evolve, creating both disruptions and opportunities. 

For instance, supply chains have already evolved since the 2018-2019 tariffs, with China now accounting for much less of the market share for US imports than before 2018. These changes, though disruptive, can offer opportunities for new businesses positioned to take advantage of them.

What should investors keep in mind?

With tariffs likely to continue generating headlines for some time, there are two important points  for investors to keep in mind:

1. There may be increased market turbulence: Tariff negotiations are ongoing with multiple nations, which is leading to uncertainty and may result in sharper fluctuations in share prices in the weeks and months ahead. To help navigate choppy markets, we believe it’s important to tune out the noise, keep perspective and remain focused on your long-term goals.

2. Staying diversified is key: Investing in the right mix of shares and bonds¹ for you, and spreading your investments across different industries and regions of the world, can protect your portfolio from market downturns. By holding a broad spread of investments across different industries and regions, you can benefit from investments that may perform well when others are falling.

¹ Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term.

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