Tariffs and strategic dependencies: two sides of the same coin

Having passed the half-way point of the year, the list of open topics in the international economy folder remains considerable (final tariff levels, geopolitical risk, reduction of US inflation, weakening of the dollar, etc.). This limits our visibility of how economic activity will behave in the short term, just as we are entering a time of the year with high sensitivity in the financial channel to any negative surprises. The balance, therefore, remains unstable, although the resilience of the business cycle and of the financial markets to the distortions caused by ever-increasing geopolitical risk remains surprising. For the time being, factors such as the strength of the labour market, the solid financial position of the private sector, the buoyancy of the tech sector and the return of interest rates to neutral territory (with the exception of the US) seem to be offsetting the effect of the disturbances accumulated since January. However, in the short term, uncertainty may continue to affect consumer and business decisions, as well as the movements of the central banks.

Therefore, the final outcome of the tariff negotiations will determine what path the international economy takes over the coming quarters and could open up a wide variety of scenarios, influenced not only by the final destination, but also by how and when it is reached. For now, and while there are still many details yet to be clarified ahead of the new deadline for the negotiations (1 August), the final average US tariff rate may end up close to 15%, which would be consistent with the assumptions behind most baseline forecasting scenarios. In our case, this would place global growth this year at 2.9%, just one notch below the activity rate forecast prior to the tariff saga. In this regard, although the Q2 activity data due to be published at the end of July will provide a little more visibility to assess the impact of the tariff tensions on growth – through the trade, price and expectation channels – there is a feeling that the net effect during the first half of the year will have been moderate and lower than that anticipated by the confidence indicators. Also, the publication of the June inflation data, as well as Q2 business earnings, will shed some light on how the cost of the US tariff hikes is being distributed among consumers, businesses and exporters. The most important thing, however, is that nothing has been definitively broken, as the risk of non-linear effects with a very high potential impact, such as the breakdown of supply chains, has been minimised.

It will be harder to extrapolate long-term trends, although the current events are leading us towards a more fragmented world, with increased barriers between trading blocs and a widespread search for strategic autonomy, a concept initially focused on security and defence that is now shifting towards an eminently economic orientation. The problem is that, given the economic connections that have formed over the past few decades (see «Import dependencies and competitive emergencies for Europe’s industry» in this same Monthly Report), trade policy decisions are not going to be harmless for future potential growth. In the case of Europe, the share of the supply of manufactured (non-energy) products that is covered by non-EU imports has increased from 15% to 25% in the last 20 years, and this includes an ever-increasing dependency in industrial products with a high technological content, such as electronic components (64.8%) and telecommunications equipment (82.5%). All this reflects the loss of competitiveness of Europe’s manufacturing sector (and the greater complexity of Chinese exports, which are increasingly similar to European exports), which has generated significant strategic dependencies, highlighting the need to accelerate the European Commission’s roadmap (Competitiveness Compass) based on the Draghi and Letta reports. In this context, the urgency that countries like Germany are showing to reach a quick agreement with the US is also understandable, because not only is a key market for a range of highly sensitive European products (automotive, agricultural sector, etc.) at stake, but also dependencies on the US, although moderate (3% of the total supply), affect strategic sectors (pharmaceuticals, transport equipment, etc.). This search for the lost competitiveness of Europe’s industry, while attempting to optimise trade relations with the two major economic powers in the post-globalisation world, will shape Europe’s future in the medium term. In short, while it is difficult to believe that «tariff» is the most beautiful word in the dictionary after love, as Trump thinks, it will continue to be the most important one for our economic scenarios in the short term – and for the behaviour of the financial markets at a highly sensitive time of the year.