U.S. Tariff Negotiations: What to Watch Next?

In a new Citi Research note, global macro strategist Giammarco Miani and team look at what may lie ahead for U.S. tariff negotiations. With the U.S. effective tariff rate still at historic levels, China negotiations remain key for markets, but we look elsewhere given how high U.S. –China tensions are. We think Japan and South Korea are the best candidates for a first tariff deal; reaching a deal with the European Union (EU) may prove tougher, with the EU’s anti-coercion instrument (ACI) possibly used as leverage in negotiations.

Markets are looking for evidence of signs of progress in tariff talks or evidence of a “Fed put.” The White House’s 90-day pause on reciprocal tariffs for countries that didn’t retaliate against U.S. tariffs gave markets a sigh of relief, but continued escalation between the U.S. and China has markets looking to the U.S. and the rest of the world for hopeful signals, as well as signs that tariff levels are heading lower. As the U.S. bond market struggles to fully normalize, the White House may need to announce some wins on the tariff front.

The other thing markets are looking for is evidence of some sort of Fed put — the belief that the Fed will react to a steep drop in stock prices by taking measures to support markets. A rate cut isn’t seen as the most likely such measure; instead, the Fed could issue an exemption for the Supplementary Leverage Ratio, which is a capital requirement for banks, or make Treasury purchases. We doubt the Fed will step in on purchases, as several Fed policymakers have noted that funding stress isn’t apparent. That makes tariff negotiations the more likely development.

Who might make a deal?

We think China is the key factor. Even with the 90-day pause, the U.S. effective tariff rate on goods has only dropped by 3% to a rise of 21% year to date. This is because of the huge U.S. trade deficit with China. We don’t have confidence about timing of U.S. –China negotiations, as tensions are high. But we do think a Fed put and/or progress on trade deals would cause U.S. Treasurys and global equities to rally sharply, given the “dash for cash” and stagflation fears that seem to have been driving the idiosyncratic weakness for both.

Japan and South Korea look to us like the best candidates for a first deal. The two countries seem to have been among the first to reach out, and the White House has expressed optimism on this front. 

Negotiations with the EU could be tougher, with the ACI coming into play. The EU has leverage over U.S. services exports, particularly digital services. This could mean tariffs are eventually lowered from the initially announced 20%. 

In negotiating, the EU is likely to feel emboldened by the White House’s recent U-turn on tariffs following bond-market jitters. But this raises the question of whether conditions for using the ACI would be met.

The question of coercion is a legal one, but we note that while tariffs have been imposed simply to close the U.S. trade deficit, there’s been an implicit ask from the White House to scrap the EU’s value-added tax and adjust tech regulation. As for whether countermeasures would find a majority, we note that all EU member states stand to lose out economically by simply accepting the tariff status quo; we think reaching the 65% threshold is doable.

The White House’s recent U-turn and the tools at the EU’s disposal leave us leaning toward thinking we’ll eventually see a deal. While tariffs remain very high and could be reimposed, we think the U-turn signals the possibility of more room for negotiations, at least for the rest of the world apart from China. And while the ACI is unlikely to be used, it gives the EU significant leverage, and room for more favorable outcomes.

Our new report, Global Macro Strategy: US tariff negotiations – what to watch next? Views & Trades, also includes investment strategies offered in conjunction with our analysis. It’s available in full to existing Citi Research clients here.