History shows that higher tariffs have been painful for the stock markets to digest, but President-elect Donald Trump‘s stand on increasing the tariffs seems undeterred, while some analysts call it a negotiating tool, others think that combining it with tax cuts could be good for the economy.
History Of Tariffs
The U.S. has a history of protectionism, with mixed results. The 1930 Smoot-Hawley Tariff Act raised tariffs on many goods with the intention to shield American industries, instead sparked global retaliation and contributed to the deepening of the Great Depression. The Dow Jones Industrial Average plummeted 40% in the year following its passage.
In 1922 Fordney-McCumber Tariff Act aimed to protect American factories and farms. The year was followed by a 10% fall in the Dow Jones.
While Trump also raised tariffs in 2018, it did not deeply affect the market. This is because the 2018 move was a targeted measure and not as broad as what Trump has proposed in his current term.
How Does Higher Tariff Affect The Market?
An increase in tariffs reduces the demand for imported goods and increases the domestic producer surplus and government tax revenue. However, it also lifts domestic prices above the free trade price, gradually stoking inflation.
Consumers suffer a loss of consumer surplus because of the increase in prices of goods.
However, higher tariffs are positive for the domestic currency as its supply decreases and more money flows into the economy.
What Do Analysts Make Of This?
Taking 2015-16 as an example, former Goldman Sachs FX strategist and senior fellow at Brookings Institution, Robin Brooks said in an X post dated Nov. 17 that if the U.S. were to increase the tariffs, China may devalue its currency in response which could lead to monies flowing out of the U.S. economy and into China.
Citing a specific example, Brooks, in a post dated Nov. 18 highlighted how the Chinese Yuan fell in 2018 and did not affect inflation in the U.S.
This move by Trump is also being looked at as a negotiating tool to curb unauthorized immigration from Mexico and Canada. But Spencer Hakimian, the founder of Tolou Capital Management said if the policies were to be implemented it may also lead to increased labor costs, aiding to inflation.
Also read: Wall Street’s December Surprise: What Investors Need to Know Now
As tariffs increase producer surplus by promoting domestic production of goods, tax cuts could additionally aid the companies to allocate more to profitability. “Tariffs in exchange for tax cuts could have a positive trade-off and it could speed up the innovation,” said ARK Invest’s, chief executive officer and chief investment officer, Cathie D Wood in an X post dated Nov. 12.
Price Action: Markets have been trading higher than their pre-election levels and the expectations of a further 25 basis point rate cut in December rose to just 66%, according to CME Group’s FedWatch tool. This indicates a further upside in the stock markets.
In premarket trading on Friday, the Benzinga Pro data showed the SPDR S&P 500 ETF Trust (NYSE:SPY) was up 0.31% to $600.69 and the Invesco QQQ Trust ETF (NYSE:QQQ) rose 0.44% to $507.50.
The S&P 500 index has risen 26.48% year-to-date to basis. Whereas, the Nasdaq 100, Dow Jones, and Russell 200 Index have returned 25.39%, 18.58%, and 20.54%, respectively. SPY ETF was up by 26.7% and the Invesco ETF advanced by 23.39%, according to Benzinga Pro data.
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