Jonathan Davis:

Hello and welcome to the PineBridge Investments Podcast. I'm Jonathan Davis, Fixed Income Client Portfolio Manager, and I'm joined today by Alfonso de la Torre, an economist on our Global Sovereigns and Economics Team.

We're here today to discuss US tariffs and their impact on the global economy, recording this on March 7th, and the presumption was that at this point we'd have a bit more clarity on tariff policy, at least with respect to implementation in Mexico, Canada and China. And as has been the case with so much policy and macro discussions this year, we were a bit overshadowed by other developments earlier in the week in terms of defense spending in Europe and market moves related to that. And I think that's a good lens to then view the ultimate goals and all these policy conversations really zero in on what's the impact on the global economy, and where do we stand?

And with that said, maybe we should start this conversation on tariffs and get your thoughts Alfonso on the global economy, global growth, inflation, et cetera, and how you think those factors can be influenced by tariffs? And what's your outlook, both for the global economy and global capital markets moving forward?

Alfonso de la Torre:

Sure. Thank you, happy to be here. To take a view of the entire global economy, I think it's worth looking at the three major economies and that would be the United States, Europe and China. And it would be also useful to start by thinking about how this looked at the beginning of the year. So, at the beginning of the year, for the US, the expectation from markets was that the strong growth would continue. There was enthusiasm about AI investment and the potential for de-regulation at the end of the year. In Europe on the other hand, there was this perception that Germany was continuing to face stagnation, and France was facing budget and political troubles. And finally, on China, in addition to the domestic struggles with the economy, the tech sector seemed to be losing a bit of step relative to the development of artificial intelligence technologies.

Now forward to two months now in March, and you realize that when narratives change, they do so not gently, but by jumping in leaps and bounds. We are looking at a US economy that is slowing down. We still believe that the US economy is headed for a soft landing, but nonetheless, there are growing concerns about both private and public spending.

In the case of Europe, on the other hand, we have seen as you mentioned, during the past week, what I would call a tectonic shift in German fiscal policy that will not only involve defense spending, but also greater infrastructure spending, and which would be positive for growth.

And then finally, in China, we had the surprise at the beginning of the year of DeepSeek, which was a reminder for everyone in the market that when it comes to a technological race, you should never count China out.

So in this context, what we have is tariffs, which have raised policy uncertainty, particularly in the United States, but also across the world, because it's the world that is going to be facing tariff changes from the world's largest economy.

Jonathan Davis:

Now sticking on tariffs specifically, one of the things that we can at least have some degree of confidence in, is the platform upon which President Trump campaigned seems to be guiding policy direction this year. The implementation might be a bit of the less known factor. So, as you said, we came into this year with expectations of increased trade restriction into the US, and certainly that's a reality.

However, the implementation still remains up in the air, with many tariffs threatened and batted around, very few so far, in effect. From your perspective, where do you think things are headed?

Maybe we could start, first and foremost with Mexico and Canada and the delay, yet again, of 25% tax on imports from those two countries. China seems to be the one area where we're confident going forward, at least on a broad country basis, where do we see the rate on China imports kind of settling at with respect to those three high profile first round suspects?

Alfonso de la Torre:

Correct. And it's no coincidence that we're focusing on these three economies first, because these three are the top sources of imports for the United States. Combined, China, Mexico and Canada account for around 45% of US imports, roughly 15 percentage points each. On some years, Mexico is ahead of Canada or vice versa.

The important thing is that when it comes to China, there's a clear consensus that these tariffs are coming in, they are staying and they're not going to be removed. So we've had already 10 percentage points imposed in the first week of February, and now this week, we had an additional 10 percentage points, so a net increase this year of 20 percentage points of the US against Chinese imports. We expect that these tariffs can increase further to up to 40 percentage points of increases.

The range of our base scenario has always contemplated between 20 and 40 percentage points. We're now at the lower end of that range, and we see room for those tariffs to increase, which, however, would fall short of what President Trump mentioned at certain points in the campaign, where he talked about tariffs going as high as 60 percentage points.

Now, in the case of Mexico and Canada, there's been a lot more back and forth. So we had 25% tariffs on imports from Mexico and imports from China with this special exception of oil that would only be tariffed at 10%. Those were delayed in February or March, and came through on Tuesday, March 4th.

However, we've already seen some changes and some exceptions. So what the White House has announced is that these tariffs would be delayed for the month for all goods that are USMCA compliant. Now, USMCA compliance has to do with the free trade agreement that these three countries signed during the first Trump administration, and that imposes a series of requirements on the goods that would be subject to zero tariffs, including, most importantly, rules of origin, in terms of the amount of content in the goods that are exported and imported that belong to either Mexico, Canada or the United States.

The reality is that, as of today, only 50% of Mexican exports are USMCA compliant, and only 38% of Canadian exports are USMCA compliant. Now, we expect that those numbers will adjust as some exporters and importers decide to move their shipments under the USMCA umbrella, but that still means that there's a significant amount of exports from these two countries into the United States that will be subject to 25% tariffs moving forward, and that especially hits aspects like oil, which would be, as I said, in the case of Canada, subject to 10% but also some vehicle parts coming from Mexico, which, as of now, would still face a 25% tariff.

Jonathan Davis:

Sticking with those three countries, Canada, Mexico and China, all three have actually experienced an appreciation of their currencies this year, despite the tariff noise, and much of that is to do with the depreciation of the US dollar. When we look closer again at the currency comps, the dollar has underperformed other G10 currencies. The Mexican peso has underperformed other Latin currencies. While in Asia, the FX performance has been a bit more mixed with some other currencies outperforming the Renminbi, and others coming in below the Renminbi year to date.

Within credit markets, however, there's a more defined trend of wider spreads for both Mexican and Canadian corporate borrowers, while Chinese corporate spreads have compressed and outperformed corporate spreads in other Asian jurisdictions. How do you see the relative vulnerability of these three countries to US tariffs and their potential for policy response playing out in the market reaction thus far?

Alfonso de la Torre:

Sure. So taking China first, that's certainly a category of its own, because, of course, China is a much larger economy, and the direct dependence to the US is not only smaller than that of Mexico and Canada, but it's actually been decreasing since the first Trump administration, where China was also the focus of tariffs. And I should mention that right now, at 20% tariffs, the tariff action of the Trump administration against China already exceeds all the tariffs implemented against China during the first Trump administration. So we've already escalated beyond what we saw between 2017 and 2020.

Now, when it comes to China, there is room for some retaliation, but it's also worth keeping in mind that the country running the trade deficits has the scale dominance in a trade war, because that's the country that has more room to keep increasing tariffs and expanding it to more products.

So the approach that China has taken is to be more surgical and focus on specific products that would create maximum pain and potentially political consequences for President Trump and for the Republican Party to which he belongs. That has been the approach of China and trying to focus on standing firm and retaliating to tariffs coming from the US, as opposed to coming right away to the negotiating table. And they can afford that because they are much larger economy that has significant trade linkages across the world.

Canada and Mexico, on the other hand, cannot do that. 80% of Mexican exports go to the US, just to cite one number. So Mexico has to negotiate because it doesn't have a lot of room to either retaliate, because, again, the trade balance is a surplus for Mexico, meaning that the US can retaliate more, but also because it doesn't have room to redirect its shipments in a meaningful way right away. With that in mind, what Mexico has been doing is trying to talk to the Trump administration behind closed doors, try to understand what the demands are coming, to see if they can get some kind of reprieve. That proved to be successful in February and has proved to be successful to some degree this time around in March as well. It is worth highlighting that the exceptions about USMCA compliance for about half of the Mexican exports that are subject to tariffs came right after Mexican President Sheinbaum had a call with US President Trump.

Now the Canadian approach has been a bit more aggressive in the sense of already announcing retaliatory tariffs, again with a focus on producing maximum pain, since de-escalation dominance lies on the side of the US. But again, Canada and Mexico, as opposed to China, don't have a lot of room, or are not as resilient in terms of a trade war, because they are much, much more exposed to the United States. They are the two countries in the world that are most exposed to the United States.

Jonathan Davis:

It’s funny that we're still having this conversation on March 7th. The thought was that as of March 4th, we'd have a bit more of a clear picture of that first question, right? Where do the levels end up? What's exempt? What's not exempt? What's the ultimate impact, at least on Mexico and Canada? Certainly we'll be looking ahead to next month to get more clarity with those two countries.

But of course, there is another deadline of April 1st, which would be the findings of the Commerce Department in terms of helping to set retaliatory or reciprocal tariffs for the US to guide policy with respect to the rest of the world.

What are your thoughts there in terms of feasibility and how that might look if we're having this conversation in a couple weeks’ time, where do you see more vulnerability? Where do you see more room for negotiation and an evening of trade terms? And I understand that's probably a conversation that might take us way past the time that we have intended for today. But what are your initial thoughts on the potential for reciprocal tariffs in a few weeks?

Alfonso de la Torre:

Sure, so here at PineBridge, we have done detailed data work understanding how retaliatory tariffs may play out. We do think it is something that is coming, and it's likely to take place after April. For our listeners, the logic basically is that wherever a country is charging higher tariff than what the United States is charging them, the United States will raise the tariff to meet them, right. And that creates a series of complicated dynamics, because tariffs change by product and by country, meaning that what we're really looking at here are country sector specific shocks, as opposed to country level shocks, right.

For example, in the case of Brazil, where there has been a lot of talks, and even President Trump has, at times, mentioned Brazil specifically, the impact of retaliatory tariffs, while negative, for the Brazilian economy, it's to some degree manageable, and the pain focuses on specific sectors, like, for example, coffee, where the average tariff could increase by 10 percentage points. But on average for Brazil, the average trade weighted tariff would increase by six percentage points.

And it's also worth remembering that Brazil lies on the other spectrum of Mexico, where only 10% of its exports go to the United States. So the overall macroeconomic impact is much, much less severe than for Mexico, while understanding at the same time that in specific sectors it could be material. And doing this specific, detailed data work, it allows us to identify those asymmetries across country sector pairings.

Another example is India, where Prime Minister Modi in India has signaled willingness to not only lower tariffs to prevent the shock from higher duties coming from the US, but also has floated the idea with the Trump administration of starting to negotiate a free trade agreement. Now, in the case of India, for example, the impacts are very different. Unlike Brazil, which you would be faulted for thinking, has more exposure to the US by being closer geographically in Latin America, however India’s exports to the US represent 20% of the total, so twice the share of Brazil and exports as a whole while, not a huge share of the economy are still a larger percentage of total GDP than it is for Brazil.

So India is more exposed than Brazil to retaliatory tariffs from the US. And when we do the actual data work, we find that the average trade weighted tariff for India would increase 10 percentage points, as opposed to just six percentage points in Brazil. Moreover, the impact would not be on coffee like it is on Brazil, but say, for example, on pharmaceutical products.

So again, doing this detailed data work at PineBridge is allowing us also to try to understand where is the real stress being put from this massive change in trade policy and global economic relations, to understand where the opportunities can lie ahead.

Jonathan Davis:

That's a great point, Alfonso. I think one of the things for us as investment managers will be to really dig into the specific impacts on industries and companies as the details of these reciprocal tariffs are available, and finding out the direct impacts on the actual bond issuers that we're looking at. Because, as you say, there is not just a one sweeping characterization or rate that we can apply across geographies or even industries.

Sticking on that theme of credit, one thing that makes us a bit more comfortable in this environment than maybe our colleagues on the equity side of the aisle is save for an extreme tail risk scenario for global growth, credit fundamentals remain relatively robust, and so whether we're talking about a slowdown in US GDP growth of 50 basis points, even 100 basis points for the year, I don't think that really shakes us out of the tree, so much in terms of liking to own credit risk, it might have a bigger impact on equity valuations and perhaps spreads come a little bit off what are historically tight levels.

But by and large, the companies that we're looking at, the bonds that we're investing in, we take a very stringent approach to credit underwriting, and then for the most part, we're quite comfortable that the investments we're making are money good, regardless of how tariffs might impact the economic outlook, barring, as I said, of course, a tail risk scenario.

With that in mind, perhaps I can ask, what are your three key takeaways as an economist that you would like our listeners to bring with them from this conversation?

Alfonso de la Torre:

Sure, I think that the three main things to keep in mind is, when it comes to tariffs, is number one, that, as I said, this is a stagflationary shock. The way to think about tariffs is not too dissimilar to the way we should be thinking about oil price shocks. They reduce productive capacity in the short term and erode incomes by reducing purchasing power. That's the first takeaway.

The second takeaway is that not every country out there is Mexico or Canada, and not every sector out there is the auto industry. The degree of exposure to the US, and therefore the impact of US tariffs, varies widely across the world, both across countries as well as sectors. And that's where the credit selection becomes very important.

And third and related to that is that the value we can find in credit has to do a lot with credit selection, right, and understanding by having a sector by sector and country by country approach is where the opportunities lie in an admittedly more uncertain global environment.

Jonathan Davis:

That's a great summary. Thank you very much Alfonso for joining us today.

Alfonso de la Torre:

Thank you, Jonathan. Pleasure to be here.

Jonathan Davis:

And thanks, of course, to our listeners. For more of our market insights, please head to PineBridge.com.

ENDS