What does UK deal tell us about tariffs?

With much fanfare, President Trump and Prime Minister Starmer announced a “historic” trade deal between the US and UK on Thursday. The main points for the UK are a reduction in auto tariffs from 27.5% to 10% for the first 100,000 cars that enter the US, and the removal of steel and aluminium tariffs. For the US, the main benefits are no tariffs for ethanol, a tariff-free 13,000 metric tonnes of US beef imported to the UK (which does not include hormone-treated beef), and British Airways owner IAG putting in an order for 32 Boeing planes.

Markets did not move too much on the news, though risk assets did have a day in the green. Even if a deal with the UK was deemed to be an “easy” one (thanks to not running a large trade deficit in goods with the US), we can nevertheless extract some conclusions about how the whole tariff situation might evolve in the near future.

First, this is more of an agreement on certain points related to trade than it is a trade deal. Many more details are yet to be ironed out, and in any case, it does not look like a truly comprehensive deal is being discussed. The agreement involves a handful of sectors, but there are far more that aren’t included than those that are. This is not a surprise as comprehensive trade deals usually take years to negotiate. Future deals with other countries will probably take the same form.

Second, a 10% tariff seems to be the floor. While this sounds like a small number compared to the announcements at the beginning of April, it is still significantly worse than expectations at the beginning of the year. This validates the fact that growth projections have been revised down, particularly for the US, as the US is seeking to reset trading relationships with all its trading partners while the rest of world only resets one (admittedly important) relationship. It is also important to keep in mind that the assumption of a 10% floor does not mean all countries will end up at that level. We need to wait and see what sort of deal is available for countries that run a trade surplus in goods with the US. If the tariff number is a lot higher than 10%, then growth projections might be revised down again.

Third, markets did not move much on the news. This suggests current prices are accounting for an expected reduction in tariffs, but not to zero, with the final number in the region of 10% or slightly higher on average, excluding China. It follows that if we do not see tangible progress in deals with other countries, with the European Union (EU) and China being the most important ones, risk asset valuations seem somewhat vulnerable. The size of any potential correction will depend on the assessment of the likelihood of a “no deal” scenario. In other words, markets might expect negotiations with China and the EU to be more difficult, and therefore corrections might be limited if negative headlines are deemed to be part of the negotiation rather than a complete rejection. On the other hand, and considering that some asset classes are back to their highs of the year, sizeable rallies from here are unlikely in the scenario of tariffs ending up in the 10% region.

Finally, the micro impact might be larger than the macro impact for countries excluding the US. Autos, steel and other sectors directly affected will remain volatile and some companies might face existential challenges. But considering that the UK derives 80% of its GDP from the services sector, which has been excluded from the tariff saga, the macro impact is likely to be negative but limited. For us, as fixed income investors whose best-case scenario is to collect coupons and principal, we would rather not have large exposures to sectors directly implicated in the trade war.

Markets hope this is the beginning of the end of the tariff story. While this could well be the case, the upside in terms of capital gains from here in risk assets appears to be limited given where valuations are. For fixed income investors this should not present a problem as yields remain attractive, but we do remain cautious in our asset allocation as the most significant deals – with China and the EU – are yet to show progress. The outcome of these will have a significant impact on inflation and growth projections and therefore on what the Federal Reserve will (or will not) do next.