Column miles rather than column inches have been devoted over the last few weeks to what the second Trump presidency means for the world. Now, one week after his inauguration, we take stock. The opening days have been filled with more than 100 executive orders, some referencing obscure American laws. However so far most have primarily impacted the domestic scene from promoting fossil fuels and deporting undocumented migrants to challenging diversity initiatives. We await the first round of promised tariffs on Mexico, Canada and China on Saturday. In this blog, we distil the potential risks to UK companies.
We find ourselves in a geopolitical climate where many fundamental truths and relationships between countries and political systems that were taken for granted are being tested and in some cases re-written. But what risks should UK CFOs and Boards focus on when horizon scanning?
Trump’s narrative pre- and post-election as well as the announcements over the last week that re relevant to the US (and thus global) economy can be categorised into three themes:
Other themes such as stopping the wars in the Middle East and Ukraine and removing DEI as a consideration when making government or commercial decisions are expected to have only a small economic impact, if any, on the UK.
In determining the impact on UK plc, we need to consider the UK’s current challenges and whether the scope of possible actions by the new US administration would exacerbate or alleviate these challenges and indeed what new opportunities or pitfalls may be created.
The UK continues to face serious economic challenges: low productivity compared to its peer group now for a sustained period of time since 2008 and more recently, low growth as well. In fact, since Q4 2019, UK economic growth has only been 10% of that of the US. On this metric we have fared worse than the Eurozone (39%) and China (55%). And this trend of sustained US economic outperformance is expected to continue with the IMF recently upgrading their forecast of 2025 US growth by a material 0.5% to 2.7% while downgrading EU growth for the same period.
The UK also has longstanding structural vulnerabilities such as a twin deficit (budget deficit + trade deficit) and very limited fiscal room left to stimulate growth in the economy. And yet again last year, the UK delivered the lowest level of business investment of any G7 country.
Reports show that a full blown 20% tariff on all imports to the US and 60% on those from China would reduce UK exports by 2.6% or £22bn. The UK is fortunate in that it only has a small trade surplus (£2.5bn) in goods with the US. The decline in trade would equate to a 0.8% hit to GDP. Big losers would be fishing, petroleum and mining with exports dropping by around 20%. Pharmaceutical and electrical sectors would also be hit. Even companies that are not exporters themselves may be hit if there is a contraction in trade flows (such as transportation and logistics) or an increase in the cost of imported input goods. There may be some winners (such as textile and clothing) if Chinese goods become relatively more expensive. These figures assume a unilateral imposition of US tariffs without retaliation. The IMF sized up a full-scale trade war as costing 7% of global GDP.
The UK also has major advantages in dealing with direct tariffs from the US. We only have a small goods trade surplus that could be neutralised by buying more American energy. We are historically close to the US and could plead for exemption. And importantly, the focus is on goods rather than services where the UK has a much larger surplus with the US.
The European Council for Foreign Relations published a poll asking citizens of other countries whether they thought a Trump presidency would be good for their country. What was startling about the results was that close allies of the US are most disturbed: with only 22% of EU citizens and 15% of UK citizens believing his return is good news. Contrast this with 84% of Indians, 61% of Saudi Arabians and a whopping 49% of Russians and 46% of Chinese who think it is good for their respective countries.
These results show that the UK public has already built in more pessimism than many other countries about the Trump presidency which provides scope for an upside surprise if things simply turn out less bad than these expectations. Public expectations and sentiment indicators matter when consumers make spending decisions and companies consider their expansion plans and capex.
The broader impact will come from the economic metrics important to companies: inflation, interest rates and the currency. So, let’s deal with each in turn and discuss the impact of the Trump themes on the US economy and the potential for pass through effects on the UK.
The most obvious immediate effect on inflation may be from tariffs and many economists fear the direct inflationary impact of raising prices of imported goods for the American consumer (and consumers in other countries in the event of retaliatory tariffs). The whole point of tariffs is to achieve this in an attempt to make American made goods more competitive. This leads to a second potential inflationary effect: boosting the wages of American manufacturing workers. Should retaliatory tariffs be imposed on the US by affected countries, then the impact could be greater.
However, tariffs also have disinflationary potential. If US consumers don’t move to buying American (or cannot) but instead pay the increased price of imports, the tariffs would act as a tax increase on consumers and thus as a one time increase in price levels leading to a temporary spike in inflation but no persistent inflation acceleration, rather a longer term cooling of demand driven inflation. A 20% goods tariff is equivalent to a tax increase of about 2% of GDP, and thus also shrink the budget deficit. Moreover, if tariffs precipitate investment by foreign companies into producing locally in the US, the increased inward investment could appreciate the USD and thus hold import prices down, partially negating the inflationary impact of tariffs (even as it reduces earnings of American exporters).
So, what exactly happened in Trump 1.0? Well, more the latter. Customs revenues rose, US manufacturing took a hit and inflation remained tame. The tariffs then were limited to steel and aluminium except for China. A broader based tariff regime and multiple rounds of retaliation may yield different results.
It is now also well understood that US immigration played a large role in bringing inflation down by providing a supply of labour. Mass deportations are nothing new and have occurred under every US administration. But the scale and speed of what is proposed could reverse the disinflationary benefit that immigration previously provided.
The UK is currently particularly susceptible to bouts of inflation because we suffer from the unholy trinity of:
1) less resilient supply chains due to the loss of frictionless trading in a wide economic area post Brexit;
2) tight labour markets, again due to the impact of foreign workers leaving the UK after Brexit (in contrast to the US and EU); and
3) exposure to spikes in energy prices compared to the US which is a substantial oil producer and set to become more so (“drill baby, drill”).
And inflation matters because it is the most significant driver of interest rates.
All other things being equal, higher inflation leads central banks to raise rates in an attempt to suppress demand and lower inflation. Rates are visible in real time through traded prices and yields of bonds. The US rates market is the deepest and most liquid in the world and movements in US rates affect all other rates markets. The outperformance of the US can aggravate the challenges of countries with poorer growth, productivity and investment. This was stark from mid-September where US 10 year government bond yields increased by 1% to 4.75% and the USD strengthened. Ominously, UK yields actually increased more, to a 16 year high of 4.93% and GBP weakened amid anxiety over the UK economy. Although not a fair comparison due to its closed capital account, Chinese yields fell by 0.5% in the same period.
Interest rate movements (and particularly medium-term bond yields) are real-time indicators of economic strength (as a stronger economy needs higher rates to prevent runaway inflation) but also the credibility of government policies (thus the ability to sustain deficits) and that of the central bank (acting promptly to control short and medium-term inflation to prevent it becoming a longer term problem). Decomposing the “good” reason for higher rates (strong economic growth) from the “bad” ones (loss of credibility) requires examination of the simultaneous movement of currencies.
Currencies are a relative game (you exchange one for another). There are some simple rules when deciphering what currency markets are telling us. Expectations of economic strength mean higher interest rates and returns on investment. Thus capital is attracted to that country leading to a currency appreciation. This market dynamic was clear with US interest rates rising and the USD appreciation since mid-September against all currencies. The UK also saw interest rates rise (and more so than the US). But this was against a backdrop of currency depreciation against the USD.
There are other developments to keep an eye on:
What are the key takeaways?
The range of possible outcomes for the UK is very wide with a high level of uncertainty. The brunt of a deterioration in global trade may initially be felt more by mid-market businesses with customers, suppliers, employees or contractors outside the UK. Larger listed companies are more resilient because they can rely on more diversified revenue streams and funding sources. Smaller businesses with a purely domestic business are somewhat insulated unless a broader UK crisis develops.
In this climate of significant unavoidable macro risks, mid-market companies should therefore remove avoidable sources of risk in their revenue streams, cost bases and funding profiles through an active program of risk and liquidity management. If one already exists, it should be carefully reviewed for ongoing appropriateness. CFOs, as the primary risk managers of their companies, should bring this topic to their Boards pre-emptively for active discussion.
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