Portfolio Intelligence podcast: how might tariffs affect U.S. growth and the Fed’s approach to rates?

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John P. Bryson

Hello and welcome to the Portfolio Intelligence Podcast. I'm your host, John Bryson, head of investment consulting and education savings at John Hancock Investment Management. Today is February 3, 2025, and the talk of the day is tariffs. The goal of this podcast, as always, is to help investment professionals deliver better outcomes for their clients in their practice. Part of that goal involves around investment education.

So I decided to take a deep dive on the topic of tariffs to help me with that. I've invited Alex Grassino, chief economist at Manulife Investment Management. Alex is the chief economist and leads the macro strategy team, which forecasts macroeconomic and financial trends, and analyzes the economy and capital markets for potential opportunities and risks. He's also a key contributor to thought leadership, both within the firm and externally, and is an active participant in various internal investment and risk committees. Alex, welcome to the podcast.

Alex Grassino

Hey, John, thanks for having me on today.

John P. Bryson

You got it! Hot topic … certainly here in the States. I want to start basic, though. I want to start with what are tariffs and what are the primary goals of imposing tariffs?

Alex Grassino

Back to economics 101. Basically, tariffs are a tax that are placed on corporations for bringing goods into, in this case, the United States from another country. Usually there is pretty straightforward reason for doing it. It is to help with helping the industry usually provide a measure of competitive advantage within your country … if you want to support it. Sometimes, it's for national security reasons as well.

John P. Bryson

Okay. All right. So how do tariffs impact domestic consumers and businesses in both the short run in the long run?

Alex Grassino

Sure. Well, short answer is the prices go up. Obviously, if it costs more to bring something into the country, the price will go up for both the consumer, and to some extent, the business. Normally, what happens in this case is that the business will try to pass on as much of the price as it possibly can to the consumer. But in some cases, they will also accept compressed margins so that they can actually minimize the cost impact and continue to sell the good in question.

John P. Bryson

Is that it had the same impact short-term versus- long term, or other differences there?

Alex Grassino

Sure. Excellent question. So short term is a little counterintuitive because you might not actually see the full impact short term. What could happen over the short term is that, one, if they have stock of whatever good is being tariffed on their shelves, the price might be slower to move up because they're just going through their existing inventory.

And part of what you might have seen in the United States is a pull-forward of goods going into the country ahead of the tariffs being announced. So basically, get as much into the country as possible at the old price. And once you’ve work through that supply, and once you work through how much companies are willing to eat into their profits, that's when you see the prices start to move up.

Over the long term, what actually can happen, somewhat counterintuitively, is prices start to go down as demand for a specific good actually goes down as well. So, as people find other substitutes for it, you can start to see their willingness to buy it go down, and then you can start to see an actual disinflationary impact as the overall economy cools a little bit as a result.

John P. Bryson

Really insightful there. So let's talk about the international impact. How did tariffs affect international trade relationships and how do they impact global supply chains?

Alex Grassino

Well, they're bad for trade relationships clearly. If you had … you know, in the case of USMCA, a pretty clear cut agreement that is currently in question, tight trading partners certainly start to eye each other with suspicion. So over the short term, it can be damaging to relations between countries. As you're probably seeing with some of the saber-rattling you see at this point. Longer term, you know, when you look at North America specifically, I would suspect that the relationship will repair itself.

You know, I view this as a spat between siblings instead of something more pervasive. Longer term, the other thing that can happen, though, is supply chains start to realign. For example, if you know that … when you look at what happened with the United States and China a couple of administrations ago when Trump was in office the first time, you started to see a lot more activity in other areas that were able to benefit.

So the idea of  friend-shoring popped up. Another thing that's important. When you look at the United States specifically in this case, is the volatility around what trade relationships are, is potentially beneficial for the domestic manufacturing sector because if you're a company and you're trying to decide where you want to put your next plant and you're not quite sure what the tariff situation is going to be like for a place like Canada or Mexico. If the cost is close, you might just decide, you know what, I'll put it in the United States instead because then I don't have to worry about this stuff.

John P. Bryson

And I think that's a big part of the current plan right now. Okay. So let's, let's talk about the … the impact. You mentioned the impact on relationships. How do retaliatory tariffs impact economic growth and inflation?

Alex Grassino

So what you're going to start seeing is―if you're talking about retaliatory tariffs specifically―what you'll see is weaker demand for goods that come out of the countries that has them imposed on them. So, basically the same thing, just in reverse. And then what happens is demand for the good goes down. Inflation goes up initially, but after… after the initial shock, you sort of start to see it roll off after a year.

So you model in the impact of tariffs, if you assume that it's a one-time deal. So if you assume that … say what happened over the weekend happens once and you don't see cascading or rolling tariffs going on and ad infinitum, what you'll see is a sudden move up in inflation and that then the inflation goes down about a year later as the base effects start to roll off.

And that's really important from the central bank reaction function because it allows the central banks leeway to look through the initial price shocks in a higher inflation. They get to use the “T” word, transitory, which I'm sure everybody got fed up of hearing during the pandemic and sort of look at the actual growth impact, which is negative. So somewhat counterintuitively, you could see inflation go up a little bit, and then you could actually see central banks start to ease more.

And you see this very explicitly with the Bank of Canada. Sorry for talking about Canada. I am Canadian, so, you know, I'll focus on that for a minute. But the idea there is even against the backdrop of potentially much higher inflationary pressure in Canada, the Bank of Canada's decision last week talked a lot about easing, and they came off as very dovish as they prepare for the growth shock instead … because the more permanent shock than the one-off move higher … and then sort of corresponding move down and inflation growth year later.

John P. Bryson

So really interesting. Commentary on Canada. Can you apply the same concept here in the States? I'm interested specifically around if inflation rises but settles down, we'll call it in a year. How would the U.S. Fed kind of factor that into their rate decisions going forward?

Alex Grassino

It's an excellent question and it's something that everybody is asking right now. If we hadn't had the pandemic, I would have said the answer would be pretty straightforward, which is basically they looked through it, they'd use the “T word “that I talked about, and they just say, “look, this is going to be hit on growth. We're going to get slightly weaker.” We're going to see unemployment rise a little bit. So let's move. The question on the United States, what's really important, though, is how much of an impact these tariffs will have on the country. And when we look at the models we've done, you can see it very clearly hurts Canada, but the effect on the United States is negative but a little more ambiguous. So in that case, is a slightly weaker growth profile and the risk of more lasting inflationary pressure something the Fed is willing to look through? We suspect that ultimately, they do. But there's certainly going to be a lot more rumbling around potential hikes, which we don't think we're going to see at this stage.

John P. Bryson

Okay. Really insightful. Thank you. A couple more questions. What are some of the unintended consequences, potentially, for imposing, tariffs on key imports?

Alex Grassino

Well, I think one of the things you'll see is, first off, there is a confidence shock around,both the market from the producers’ perspective, and both … and also from what you would see … from the consumer. So one obviously … the expected consequence …reduced demand or, you know, generating money through these in, through these, inputs. The thing is though, that if the producer starts to think about this as a permanent situation where they're just not going to be competitive, they might start to look to other markets. So you might actually see a scarcity of product in that case as it comes through. That could be one. The other one is clearly, and I would suspect this is at least partly intended, but there is that confidence factor about being able to leverage your supply chain and get the goods that you want on time and at the price point you want. So that long term shock and sort of skepticism around just how reliable your supply chain is something that could probably affect companies’ ability to do business in general.

John P. Bryson

And then we mentioned kind of unintended consequences. What are some of the common myths around tariffs that investors might … might assume that we want to clarify?

Alex Grassino

Well, I think one of the most obvious things that, you know, people will hear is that Canada is paying for tariffs. You know, if you're looking specifically at what happened over the course of the weekend. The reality is that the end user is the person who ultimately pays. It's a tax on the person who brings the goods in. So the burden is effectively shared by both the company and the consumer. And then it becomes the consumer or end-users’ decision as to whether or not they want to use the goods, or maybe pivot to another place. So there is an inflationary dynamic. And the other thing I think that is important to remember is that people talk about tariffs ... They think about inflationary pressure just going up and to the right. The reality is that yes, over the short term that's probably true. But longer term, you can actually see disinflationary impacts from tariffs. If you go out far enough. And if you assume that’s a one-off shock. … So the qualifier on that I'll just get the qualifier on that.

That I just say as well is one of the things you don't want to see as a sort of rolling situation where more tariffs just keep getting announced, because at some point your ability to rely on, “well, it'll be over in a year” goes away. So, for example they announced tariffs now, in six months, and another six months, and another six months, after that it becomes more of a feature in inflation than just a one off shock that you can look through. So it's something to be careful with.

John P. Bryson

That's really helpful. One of the things we talk a lot about on this podcast is kind of separating, the nonsense from the real information, and you're really helping us parse what we should be paying attention to and what we shouldn't get too caught up on, so I appreciate that. You've touched on it a little bit, but I kind of want to give you your opportunity to talk about, you know, going forward, how do you see the current tariffs imposed recently by the U.S. and then the response we're seeing from Canada and Mexico. How do you see that, impacting investment markets?

Alex Grassino

Well, I think at the moment the answer is pretty clear. When you look at it, equity markets are off pretty sharply, although they've rebounded slightly, I think, on slightly less, aggressive rhetoric coming out this morning. Basically, you're going to see a weaker Canadian dollar, at least over the short term, you probably see yields move down, as you saw in Canada very clearly, equity markets are moving down because generally speaking, uncertainty is not a positive.

And I think really what will happen though is, over time, as people have more certainty around what you actually see, markets will be able to act in a more measured way, and you'll start to see people take clearer bets around what does and doesn't make sense from an investment perspective. I tend to use an analogy around this thing.

It is a bit tortured. I love tortured analogies. And it relates to poker, which is basically if you have a bad hand, you can still play it. The problem is, when you look at tariffs right now and the uncertainty around government, it's sort of like trying to play a hand of poker without actually being able to flip over the cards that you've been dealt.

If you don't even know the cards you've been dealt, it's really hard to make clear decisions, in which case you see a flight to safety, which is sort of what we're seeing at this point. But as that clarity starts to seep in, people will be able to make more measured decisions.

John P. Bryson

That’s a good analogy, certainly for these times, it's … it's tough to know what you have and it's tough to know what's coming at you. But what the good news is, we're always on top of this. Folks like you are on top of it, and you're updating your insights on a regular basis. Alex, I want to thank you for joining, the podcast.

Folks, I want to encourage you to follow Alex on LinkedIn. I also want you to check out his research on our website, JHinvestments.com, you can follow him and others, and you can also subscribe to the portfolio Intelligence, podcast here and wherever else you like to download your favorite podcast. As always, thanks for listening to the show.

Alex Grassino

Thanks for having me on, John. It was a pleasure.