What are the economic and investment implications of higher rates by Investing.com

Investing.com — The possible reintroduction and increase of tariffs in the United States, especially as the 2024 presidential election approaches, could have major effects on the economy and investments.

Tariffs, which are taxes on imported goods, have been a key part of trade policy during the Trump administration.

As the US considers a return to higher tariffs, analysts at UBS look at the potential economic and investment impacts of such actions.

Tariffs act as a tax on imported goods, directly raising the prices of those goods in the domestic market.

According to UBS, the inflationary impact of tariffs is simple but significant. “Thus, a universal 10% tariff on US imports should increase the overall price level in the US economy by 1.3%,” the analysts said.

This increase is not just a one-time thing; there is a risk of “profit-driven inflation”, where companies could raise prices beyond the direct impact of the tariff, capitalizing on consumer expectations that prices should rise by the full percentage of the tariff.

Overall, higher tariffs are expected to slow economic growth. UBS analysts suggest the tariffs may reduce domestic consumption by raising the cost of goods, particularly those relied on by lower-income households.

In addition, tariffs increase production costs for domestic firms that use imported components, thereby reducing their competitiveness vis-à-vis foreign manufacturers. This can lead to a decrease in economic activity and potentially a decrease in employment.

In scenarios where selective or universal tariffs are imposed, UBS forecasts a cumulative negative impact on GDP over a three-year period. For example, US GDP could fall by 1.0% to 1.5% in a universal tariff scenario.

The wider the application of tariffs, the more severe the economic impact, as rerouting supply chains becomes less feasible and the costs are felt more widely throughout the economy.

Another economic consequence of higher tariffs is the likelihood of retaliation from trading partners. This vicious escalation could further depress global trade, slow economic growth and lead to higher costs for both consumers and businesses.

Retaliatory tariffs by other countries could specifically target politically sensitive industries, thus amplifying the negative impact on the US economy.

UBS analysts anticipate that higher tariffs, particularly if applied universally, would put downward pressure on US stocks. The imposition of a universal 10% tariff, along with corresponding retaliatory measures, could send US equity markets down about 10%.

“A higher cost of imports would most likely impact retailers, automakers, technology hardware, semiconductors and industrial parts,” analysts said.

Conversely, sectors that are more domestically focused and less exposed to imports, such as US steelmakers, could benefit from reduced foreign competition.

However, overall market sentiment is likely to be negative, especially if the tariffs lead to wider economic downturns and increased political uncertainty.

In response to the economic challenges posed by higher rates, UBS expects the Federal Reserve to take a more cautious approach, likely cutting interest rates to prevent a recession.

While the tariffs may initially boost inflation, the overall impact on economic growth is expected to push long-term interest rates lower as the Fed focuses on maintaining economic stability in the face of near-term inflation concerns.

UBS predicts that in a universal tariff scenario, the yield could fall to around 2.5% to 3% as investors seek the relative safety of government bonds amid economic uncertainty.

The immediate reaction of currency markets to the imposition of higher tariffs is likely to be an appreciation of the US dollar, driven by the flight to safety and the negative impact on the economies of major trading partners.

However, UBS analysts warn that this strength may be short-lived. As the US trade deficit widens due to reduced exports and higher import costs, the dollar could be under pressure in the long term.