The agreement between the European Union and the U.S. on a framework trade deal was the most recent resolution on the talks with some of the main U.S. trade partners. With a 15% import tariff ceiling on most EU goods, the new tariff is half of what the White House proposed in April, but significantly higher than the rate of about 2.5% last year.?
?
The U.S. has reached similar deals recently with Japan, the U.K., Indonesia, Vietnam and the Philippines. Markets initially reacted positively to these announcements, mainly because the final tariffs are well below targets disclosed on “Liberation Day” in April, but those gains faded days after the announcements.?
?
Morgan Stanley Research sees many tariff-related uncertainties on the horizon. Discussions with China, Mexico and Canada – countries with whom the U.S. maintains some of its important trade relationships – are underway and could drag on. There are questions about the longevity of deals, as they can be challenged in courts, and implementation is not always straightforward. Even more important, tariffs are still likely to hit the economy.?
?
“The immediate risk of higher tariffs may be off the table, but trade policy uncertainty is still high,?with the potential for future frictions as these agreements are difficult to implement and track,” says Morgan Stanley Senior Global Economist Rajeev Sibal. “We do not believe any particular deal can bring closure to the tariff narrative.”?
?
Clarity – for Now
Officials from the U.S. and the EU will continue discussing the details of their deal, but the announced bodes well for sectors that will become exempt from tariffs, including aircraft and their components, some generic pharmaceuticals and chemicals. For autos, the import tariff was reduced from 27.5% to 15%.?
?
“While a return to a zero-tariff environment for aerospace was highly anticipated by the market, having it formalized is still positive,” says Ross Law, who leads European Aerospace and Defense equity research at Morgan Stanley. “We would therefore expect aerospace stocks to outperform the broader sector.”
?
The EU also agreed to add $600 billion in investments in the U.S. and increase purchases of energy to $750 billion over the next three years, including liquified natural gas (LNG) and nuclear power.??
?
Still, the agreement does not signal the end of trade tensions between the U.S. and the EU, according to Sibal.
?
“We expect the risk for tariff escalation could re-emerge if Europe and/or the U.S. are unable to maintain their commitments to the agreement,” Sibal says.?
?
A Lagging Economic Impact
U.S. import data in May showed that the effective tariff rate was at 8.3%, much lower than Morgan Stanley’s baseline estimate of a rate in the low- to mid-teens, but there should be a convergence to the forecast in June and July.
?
Shipping delays, higher-than-expected USMCA imports from Mexico and Canada, and a sharp drop in purchases from China are among the reasons for the lower-than-expected rate.?
?
As data for June and July are likely to show a higher effective tariff rate, the pass through to U.S. inflation should be more apparent. Historically, the real impact on consumer prices appears three to five months after the tariff implementation, and the knock-on to growth comes one quarter later.
?
“We?expect tariffs could add up to 1 percentage point in prices in the coming months before subsiding as demand softens in reaction,” Sibal says.?
?
The FX Factor for Asia
After initial deals with four Asian nations, the effective U.S. tariff rate on imports from the region should rise to 24% from 5% in January 2025. Additionally, the depreciation of the U.S. dollar this year could represent an extra cost on all imports. The dollar index, which measures the greenback against a basket of currencies of the U.S.’s major trading partners, fell about 11% in the first half of the year.?
?
As in the U.S., the direct and indirect effects of higher tariffs for Asian economies are still unclear, but the drag on corporate confidence is likely to translate to weaker capital expenditures, while the dollar depreciation could have a significant impact on sales and margins of Asian exporters.?
?
“Investors are drawing comfort from the fact that trade deals are helping to provide clarity on the specific levels of tariffs that will be imposed, as well as the fact that the incoming economic data are still holding up,” says Morgan Stanley Chief Asia Economist Chetan Ahya. “However, someone still needs to pay the bill for higher tariffs.”
