Beyond Bulls & Bears

Fixed Income

On My Mind: T-Day

Franklin Templeton Fixed Income CIO Sonal Desai shares her thoughts on US President Donald Trump’s “Liberation Day” tariff policy announcement. Sonal cautions that significant uncertainty remains on the global repercussions and risks of a broader trade war. However, she believes that at this stage the impact of these tariffs on US growth and inflation should be manageable, assuming they are tempered by the US administration’s planned tax cuts and deregulation. Find out what the latest developments mean for investors going forward.

US President Donald Trump’s “Liberation Day” announcement is a step toward some greater clarity on tariff policy, after months of disruptive uncertainty. The announcement sets the stage for potential bilateral negotiations, so the uncertainty is not over, but it has at least put the worst-case scenario on the table.

We could more properly call it T-Day, for “Tariff Day.” The highlights: an average additional 34% tariff on Chinese imports (bringing the total tariff to 54%); 20% on imports from the European Union; for Canada and Mexico, United States-Mexico-Canada Agreement (USMCA) goods remain exempt, while the remainder will be subject to duties; tariffs on other countries will vary, but with a minimum of 10%. And there will be an across-the-board 25% tariff on cars.

The uncertainty we have faced so far has caused companies to put investment plans on hold, and has held back growth in the first quarter of the year. The emerging clarity should gradually allow businesses to start reformulating their plans. However, uncertainty remains significant, especially as concerns potential retaliations that might spill over into a broader trade war.

I thought it would nonetheless be useful to get a sense of the impact of these tariffs, starting with a few simple back-of-the-envelope calculations.

The Trump administration expects the new tariffs to raise about US$600 billion per year. Some are skeptical that this target can be achieved, so let’s take that as a ceiling and also consider an alternative scenario with a lower intake of US$400 billion.

Tariffs are a tax; they increase government revenue, but, like all taxes, they have an adverse impact on growth. They are a tax on consumption, specifically on the consumption of imports. How big of a tax increase are we looking at here? Based on 2024 national accounts figures (Source: Bureau of Economic Analysis), US gross domestic product (GDP) amounted to US$29 trillion. Consumption accounted for almost 70% of it, or close to US$20 trillion.

The expected US$400 billion-US$600 billion in revenue, therefore, would be equivalent to a 2%-3% tax on total consumption of goods and services. It would also correspond to a 12%-18% average tariff on all imports of goods (as 2024 goods imports amounted to about US$3.3 trillion). The numbers are summarized in the table below. As I have noted in past articles, imports are a very small share of US GDP; therefore large tariff rates hit only a small share of overall US consumption, and are equivalent to fairly low overall sales tax rates.

Suppose that the government had announced a 2%-3% across-the-board sales tax. I think the reaction among analysts and the market would be perhaps less panicked than some of the headlines we see. There would be some concern about the negative growth impact, but few would predict a recession, and I don’t think anyone would question the idea that the bump to inflation would be temporary. We have estimated that the temporary impact of these tariffs on inflation would be in the region of 1.25-1.50 percentage points (pp).

Who will ultimately bear the burden of this tariff tax, US consumers, or foreign producers? Tariffs are always paid by the importer. The United States, however, has substantial bargaining power. The US consumer has always been regarded as the main engine of global growth, and for many foreign countries the United States is a key export market. Foreign producers should therefore be willing to absorb some of the tariff by compressing their profit margins to maintain market share. After all, many companies have been willing to see their intellectual property “taxed” away by Chinese competitors to access the large China market. But if competition is working, the scope for profit margin compression should be limited, so US consumers will pay the largest share of the added tax burden.

A 2%-3% sales tax would raise few eyebrows. Most economists and public finance experts agree that a consumption tax is the most efficient way to collect significant amounts of revenue—preferable to either income taxes or taxes on capital. This is why European countries with government expenditure ratios in the range of 45%-50% of GDP rely on Value Added Taxes (VAT).

Import duties, however, are an inefficient way of taxing consumption. By taxing some goods but not others, they distort consumption decisions. And by imposing an additional burden on foreign producers, they reduce competition. Domestic US producers will have less of an incentive to increase productivity. The result would likely be slower productivity growth and somewhat higher underlying inflation pressures in the goods sector.

Like any tax, tariffs need to be assessed in the context of overall fiscal policy. Trump indicated that the focus will now shift toward tax and spending cuts. Incremental reductions in personal and corporate income taxes would mitigate the adverse impact of tariffs on growth. But there is a trade-off here: Larger income tax cuts would also offset some of the revenue impact of tariffs. To put the budget deficits on a more sustainable path, I continue to believe that the United States needs significant reductions in expenditures, well beyond what the department of government efficiency can realistically achieve.

Over time, in theory, import tariffs might lead some companies to relocate production to the United States. However, the extent and speed at which this happens will also depend on other factors including regulations, the stability and predictability of the overall macro environment, the quality of infrastructure, energy costs, and the availability of workers with the necessary skills. Relocation of production will take time, in many cases, at least a 3–5-year horizon.

Tariffs are certainly not my preferred policy instrument. My back-of-the envelope numbers suggest that the impact on US growth and inflation should be manageable. There is still significant uncertainty on the potential global repercussions, however. First of all, the growth impact will be much more significant on foreign countries that rely more heavily on exports as engines of growth. Secondly, trade redirection might trigger broader tariff increases and trigger a wider trade war with escalating tit-for-tat tariffs. The adverse implications for both global and US growth would then be more severe.

While the next round of trade discussions plays out, however, it’s time for the administration—and for investors—to shift attention and focus to taxes and deregulation. Progress in these areas would be crucial to offset the damage from tariffs. Against this background, I do see US GDP growth lower this year given the damage already done in the first quarter and the weakness likely to persist into the early second quarter. I also see upside risks to inflation, albeit as a temporary shock of 1.25-1.50 pp. On balance, I maintain my Federal Reserve (Fed) call of at maximum one rate cut for the remainder of the year. Assuming we will see concrete action on deregulation and incremental tax cuts, I think the balance of inflation and growth risks will counsel the Fed to refrain from greater rate cuts. On this basis, and with the caveat on global growth uncertainty mentioned above, risks to US Treasury yields appear to be to the upside.

 

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. 

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

 

IMPORTANT LEGAL INFORMATION

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S.: Franklin Resources, Inc. and its subsidiaries offer investment management services through multiple investment advisers registered with the SEC. Franklin Distributors, LLC and Putnam Retail Management LP, members FINRA/SIPC, are Franklin Templeton broker/dealers, which provide registered representative services. Franklin Templeton, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com.

Brazil: Issued by Franklin Templeton Investimentos (Brasil) Ltda., authorized to render investment management services by CVM per Declaratory Act n. 6.534, issued on October 1, 2001. Canada: Issued by Franklin Templeton Investments Corp., 200 King Street West, Suite 1500 Toronto, ON, M5H3T4, Fax: (416) 364-1163, (800) 387-0830, www.franklintempleton.ca. Offshore Americas: In the US, this publication is made available by Franklin Templeton, One Franklin Parkway, San Mateo, California 94403-1906. Tel: (800) 239-3894 (USA Toll-Free), (877) 389-0076 (Canada Toll-Free) and Fax: (727) 299-8736. US: Franklin Templeton, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com. Investments are not FDIC insured;  may lose value; and are not bank guaranteed. Issued in Europe by: Franklin Templeton International Services S.à r.l. – Supervised by the Commission de Surveillance du Secteur Financier – 8A, rue Albert Borschette, L-1246 Luxembourg –  Tel: +352-46 66 67-1, Fax: +352-46 66 76. Poland: Issued by Templeton Asset Management (Poland) TFI S.A.; Rondo ONZ 1; 00-124 Warsaw. South Africa: Issued by Franklin Templeton Investments SA (PTY) Ltd, which is an authorized Financial Services Provider. Tel: +27 (21) 831 7400, Fax: +27 (21) 831 7422. Switzerland: Issued by Franklin Templeton Switzerland Ltd, Stockerstrasse 38, CH-8002 Zurich. United Arab Emirates: Issued by Franklin Templeton Investments (ME) Limited, authorized and regulated by the Dubai Financial Services Authority. Dubai office: Franklin Templeton,  The Gate, East Wing, Level 2, Dubai International Financial Centre, P.O. Box 506613, Dubai, U.A.E. Tel: +9714-4284100, Fax: +9714-4284140. UK: Issued by Franklin Templeton Investment Management Limited (FTIML), registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. Tel: +44 (0)20 7073 8500. Authorized and regulated in the United Kingdom by the Financial Conduct Authority. Australia: Issued by Franklin Templeton Australia Limited (ABN 76 004 835 849) (Australian Financial Services License Holder No. 240827), Level 47, 120 Collins Street, Melbourne, Victoria 3000. Hong Kong: Issued by Franklin Templeton Investments (Asia) Limited, 62/F, Two IFC, 8 Finance Street, Central, Hong Kong. Japan: Issued by Franklin Templeton Investments Japan Limited. Korea: Issued by Franklin Templeton Investment Trust Management Co., Ltd., 3rd fl., CCMM Building, 12 Youido-Dong, Youngdungpo-Gu, Seoul, Korea 150-968. Malaysia: Issued by Franklin Templeton Asset Management (Malaysia) Sdn. Bhd. & Franklin Templeton GSC Asset Management Sdn. Bhd. This document has not been reviewed by Securities Commission Malaysia. Singapore: Issued by Templeton Asset Management Ltd. Registration No. (UEN) 199205211E and Legg Mason Asset Management Singapore Pte. Limited, Registration Number (UEN) 200007942R.  Legg Mason Asset Management Singapore Pte. Limited is an indirect wholly owned subsidiary of Franklin Resources, Inc. 7 Temasek Boulevard, #38-03 Suntec Tower One, 038987, Singapore.

The views and opinions expressed are not necessarily those of the broker/dealer; or any affiliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules and guidelines.

Please visit www.franklinresources.com to be directed to your local Franklin Templeton website.

Copyright © 2025 Franklin Templeton. All rights reserved.

Get Content Alerts in My Inbox

Receive email alerts when a new blog is posted.

Leave a reply

Your email address will not be published. Required fields are marked *