Hello and welcome to our latest video #MacroMemo. As always, there's a lot to cover. It's a very U.S.- focused, policy-focused edition. We're going to talk an awful lot about tariffs, tariff developments, new threats, a deal, questions of legality, of tariffs, whether we're seeing tariff effects in the economy and inflation. So we'll talk about all of that.

We will also spend a moment on the fiscal side, again with a U.S. focus. And so we'll just talk about that U.S. debt rating downgrade, and some more longstanding fiscal concerns. And then this new budget bill that has passed the House of Representatives and is now wending its way through the Senate, and what that might mean.

Okay, let's start on the tariff side. Tariffs, of course, still very much front and centre. And I will say over the last 1-1/2 to now approaching two months, the general trend, it hasn't been only in one direction, but the general trend has been of tentative improvement or reducing tariffs or reducing risks. You can think back, of course, to early to mid-April, when a big chunk of the reciprocal tariffs affecting much of the world were delayed and reduced. We can think of a U.S.-China de-escalation that took place just a few weeks ago.

Now China subjected just to a 30% type tariff instead of 145% type of tariff. And indeed there’s a U.S.-UK trade deal, which is certainly relevant to those two countries, but also quite useful for getting a bit of a sense for where things might go from here vis-a-vis negotiations with other countries. So all of that is of significant relevance, and generally quite welcome.

It should also be noted that although the Fed (U.S. Federal Reserve) ‘put,’ the so-called Fed put, which is to say that when things traditionally have gone wrong and markets are gone wrong and the economy, usually the U.S. Federal Reserve, the central bank, can be counted on to cut rates and save the day. That Fed put, as it's called, isn't actually all that visible these days, given that the Fed is concerned about inflation and isn't sure where tariffs go, and isn't quite sure what the tariff impact will be even if they knew where tariffs would go. And so the Fed isn't necessarily helping as much as normal. You can argue the White House does have a ‘put’ in place. In other words, the White House is now playing that supporting role.

And you think of the level of market concern that was expressed across, in particular, the month of April. And what happened while the White House did actually scale back some of its tariff plans and so on. So do keep that in mind. And that likely explains at least a fair chunk of why financial markets are feeling somewhat better as we are now in late May than they were a month or two months ago.

That said, there are some new tariff threats out there. In fact, it may even be that the White House is emboldened by stronger markets and it wants to revive U.S. manufacturing, and it wants some measure of tariffs. And it realized it can't go too aggressively or too fast because the market just couldn't handle that in April and May.

It is interesting, now that financial markets are a bit stronger, we're seeing the White House level protectionist threats and tariff threats again. We saw quite recently, as I'm recording this, a 50% tariff threat made against the European Union. I would challenge anyone to figure out where that 50% number came from. The EU is subjected to a 10% baseline tariff.

The reciprocal tariff threat had been a 20% rate. The 50% number is brand new and perhaps out of thin air. May be a negotiating tactic. But nevertheless, that threat was made. The plan was to put that new tariff on as of June 1st. Now that since been delayed until July 9th, which lines it up really with other reciprocal delayed tariff expiries.

Indeed, actually to the extent this may have been a negotiating tactic, we've now seen talk that actually there will be some fast-track negotiating between the U.S. and the European Union, but still a significant tariff threat made against the EU. President Trump also made a 25% tariff threat on cell phones made outside of the U.S., seemingly focused on iPhones, but theoretically applicable to all.

That would be very consequential to that industry if implemented. And it really is a pressure point to tell, I think you could say, “Apple, okay, your plan is to shift production from China to India. Maybe it should be from China to the United States instead.” And we'll see if that's even possible, just given labor costs and so on.

Nevertheless, that tariff threat is now out there. And then there is an earlier one from earlier in May. That was a plan to level a 100% tariff on foreign-made films. And so it's not quite clear where that will go. And indeed, it would be quite unconventional in the sense that that would be a tariff on a service.

And how do you collect it? Of course, services don't spend any time in customs offices and don't physically transit the border. So on a number of fronts, it's not quite clear how that plays out, but that threat was made too. So we do have some new tariff threats as well.

I would still say, as much as there's still considerable uncertainty of where things go, the level of trade uncertainty and trade policy uncertainty has declined from radically high levels to only maybe fairly high levels, you would say.

And perhaps we're getting a bit of a flavor for the guardrails that have come into view. It looks like the U.S. maybe doesn't actively want giant broad tariffs on everyone. There’s just too much economic and market pain associated with that. That's the guardrail that we're happy to see. Maybe the guardrail we're less happy to see on the other side of the road, though, is just that it doesn't look as though tariffs are going to go completely away.

Look, as an example, at this new UK-U.S. trade deal. And the UK, first of all, was not a particular offender from a U.S. perspective. The UK actually runs a goods trade deficit with the U.S. and so hardly a country the U.S. is most fussed about. Even with that, the deal still leaves in place that 10% baseline tariff.

In other words, the UK will still pay a non-trivial tariff on just about everything that it sells to the U.S.

The UK did manage to negotiate away some of the higher sector tariffs on auto exports, on steel and aluminum exports and so on. But even there, there aren't very clear quotas. So okay, the UK can sell cars to the U.S. without a tariff, but only 100,000 a year, which is about what they're currently doing.

And so I guess that's fine, but it doesn't leave any sort of room for growth. Limits on steel and aluminum as well. Some thought that future sector tariffs that the US. is planning to implement: I guess that's pharmaceuticals and copper and forestry and computer chips. Those are the ones most discussed. The UK might also get preferential treatment on those as well.

Again, the main takeaway is there's still a 10% baseline tariff on most of what the UK sells to the U.S. Notably, the UK accepted some limitations on China's involvement in key British sectors. And so that's securing the supply chain, from the American perspective. The whole notion that there is a team USA umbrella, there is a Team China umbrella.

And people have to choose which umbrella they go under. That looks like it will be proved true as these negotiations play out with other countries. And so the UK is choosing team USA. On the other hand, interestingly, it's also worth talking about what the UK didn't have to give up and what concessions it didn't have to make.

The UK didn't have to get rid of its back tax, its sales tax, which I mean would have been quite a strange thing to do. Most people would say it had no connection at all to trade. But the U.S. had tentatively argued that countries with VAT taxes are treating American businesses unfairly, which I would personally quibble with, but nevertheless, so that didn't have to go away.

The U.S. didn't insist on getting rid of the British digital services tax, which largely hits U.S. tech giants. More on that a bit later, because there's a different pressure tactic the U.S. is using on all of the world's digital services taxes, but didn't force that as part of the trade negotiations. There were no hard defense targets.

The UK was not forced to increase its military spending to 5% of GDP. It’s certainly growing and not a low number, but nevertheless nothing there.

Maybe most importantly, the U.S. didn't try to meddle in the UK service sectors. There had been some murmurs here and there over the last several months that the White House might not be pleased with certain service sector industries in various countries.

And that just didn't seem to come up. So that does provide some useful insight. The takeaway is, again, the guardrail is there will be tariffs on almost everyone going forward. But, you know, some of the more difficult asks were not actually made in the UK didn't have to commit to them, at least in a non-tariff sense.

One tariff question that has come up repeatedly is just the legality of the U.S. tariffs that are in place and that are planned. The White House has been quite expansive in its use of existing legislation. There are a number of court challenges in place, attempting to push back. And so you can ask, is it a national emergency or is national security critical when you're talking about products that aren't steel and aluminum and other products that are so clearly linked to the military industrial complex?

The answer there is that the White House likely is stretching the limits of some of these pieces of legislation. There may yet be injunctions that are issued. However, there can be pauses on those injunctions, and the White House is likely to receive those. Indeed, there are other pieces of trade legislation out there that are a bit more of a headache to implement and require delays and require studies and so on.

But I would say our attitude is that if you were to fast forward to the end of the year, even if judges do object to certain things that the White House is doing, there are other paths that the White House could take to get to largely where it wants to go. So we don't think it will change the big picture.

But it certainly could add some complexity for a period of time.

Now just looking a bit a bit more broadly in the trade space, it’s heartening that we are getting some trade deals. And so of course, we've talked briefly about the UK-U.S. deal. The UK has been busy though and has struck a deal with India, a free trade deal, not that long ago.

It has also now struck a deal with the European Union. And so you're not hearing things incorrectly: that is a UK-EU deal. That is effectively undoing a part of Brexit. Not completely by any means. And the UK is not part of the European Union or anything quite like that. Nevertheless some of the divide has been diminished.

Some of the pain points are being reduced. The two countries seem to be going in together in terms of a common defense arrangement whereby the UK will commit to defense spending under that EU umbrella, in this case. But then the UK contractors and military producers will be in a position to benefit as well.

We've seen some barriers broken down with regard to the agricultural sectors in the two economies. We've seen some fishing restrictions not eliminated, but the reduction in those restrictions maintained for a period of more than a decade. And there is some expectation that young people might be in a position to work more easily in the other jurisdiction going forward.

So worthwhile, but certainly not fully undoing the Brexit damage.

Then maybe the last tariff comment is just on the economic impact. And so I would have to say both from an economic and inflation standpoint, we are not seeing that large of an effect from tariffs yet. So the tariffs have been in place really since March to April, depending on the metric.

We do see some front loading happening still. In fact, there's another wave of that happening given that Chinese tariffs recently declined. So inventories building and import surging and that sort of thing. We can see that so-called survey data or soft data, as it's called, is weak. So sentiment and expectations are quite grim. So people are expecting weakness ahead.

But the actual economic data is holding together. And for the U.S., the latest round of monthly data has actually been above consensus. And the real-time economic indicators we look at are really, at worst, only a hair softer than their prior trajectory. And we're seeing, of course, some industries like U.S. steel production that's outright stronger.

Of course, that's because the U.S. steel production is no longer competing quite so hard against other foreign producers. And so not to say that tariffs therefore don't matter, but just simply to say that we're not seeing the damage so far. It looks like it may accrue somewhat later. Maybe it'll even be a little bit lighter as well.

But we will have to see on that front. And then it's very similar on the inflation side, which is to say that we've had the inflation numbers for April out. There really wasn't much that was tariff-related on that front. We do see some signs that perhaps some impact could accrue down the road. But ultimately, it's also looking lighter than expected and perhaps more delayed than expected.

So far, I'm not sure if so good is quite the way to put it. So far the damage looks to be fairly limited, and we'll stay tuned for more later.

Okay, now we're going to pivot from tariffs to just the U.S. fiscal position. I guess the big news would have been at least one of the bits of big news would have been that Moody's, one of the three main ratings agencies, did downgrade the U.S. to what they might call a double A+ rating.

So just a notch below that pristine AAA rating that countries aspire to. Really that is overdue. And Moody's just catching up to the other two ratings agencies who in some cases made that downgrade as long as, I guess it's now 14 years ago. And so that's Moody's catching up. It does reflect fiscal concerns. It also reflects, I think, this latest budget plan that increases the deficit.

I will just say, when we look at the U.S. fiscal position, it's a challenging one. The U.S. deficit is quite large. It's in the realm of 6 or 7% of GDP. The U.S. public debt load is quite high. It's well over 120%, debt-to-GDP ratio. We run a fiscal health index. It really combines those sorts of metrics and some other things.

It concludes that the U.S. actually is in the most difficult position of the major developed and emerging market economies when it comes to its fiscal position. Indeed, we were doing work just in the last week or two on fiscal flexibility. When you look at the fraction of U.S. government spending that is dedicated to really just non-negotiable things, and we're talking about entitlements, obviously talking about interest payments.

And then I guess maybe you throw in military spending, which perhaps is a bit negotiable, but nevertheless tends to be fairly fixed and resistant to decline. The U.S. has the largest fraction of government spending of any country that we could look at that is pretty much locked in place, which means they have much less flexibility to fix those fiscal excesses, if they wanted to.

Now we're in a position where the budget bill is wending its way through Congress. And so the House of Representatives has approved that. It still does need to pass the Senate. And there may yet be some tweaks, and that may yet complicate things, because it passed the House by a single vote. And so that could yet undermine that.

Nevertheless, we think it's more likely than not that a variation on this budget does ultimately survive. And it does plan – and this has been a big Trump objective – to extend and in some cases expand tax cuts, including eliminating the tax on tips and on overtime, as well. There is also some additional military spending, some additional border spending.

Conversely, there are some cuts. So famously some Medicaid cuts, some food stamp cuts as well, phasing out a clean energy tax incentive or a set of those incentives that were implemented under Biden. So there are some spending cuts. There are some tax cuts. On the net, though, the U.S. deficit gets bigger, not smaller. In fact, the deficit should be cumulatively, this is the total amount over the next decade, $3-$5 trillion larger than it otherwise would have been.

That’s in the context of a deficit that's already quite large. It's actually running at $1.9 trillion just for this year. And so it makes that deficit even larger.

If you want to be an optimist and focus on the economic implications, well, that's providing economic support. And so the economy gets to run a little bit faster than it might otherwise run, perhaps, in 2026, and some of the years after that.

It is also though, and this is putting on the fiscal hat, it is also a source of fiscal concern. And so, doesn't fix the deficit. The deficit gets worse. It doesn't fix the debt, doesn't fix these sorts of things. And we're already in a position where the U.S. dollar has weakened notably over the span of the last several months.

We think there's scope for more, in part for fiscal reasons. We're already in a position where U.S.  borrowing costs, particularly longer dated bond yields, have gone up quite a bit. And so not predicting necessarily that they rise a whole lot more, but certainly thinking that a term premium and a risk premium is appropriate in the context of these fiscal excesses.

We're seeing some movement and we're seeing actually some other countries also looked at more closely, through a fiscal lens. And so actually Japanese yields and some other countries have also seen their bond yields rise, too. We may be in a period where bond market so-called vigilantes are back at it again. And so fiscal excesses may need to be reined in over time.

One little aside is one component in this enormous thousand-plus page budget bill is a tax on international investors and indeed, to some extent, international businesses, depending on the structure of their business. And so essentially, it would create a less generous withholding tax on the flow of dividends, either from a company subsidiary to it to its owner corporation abroad, or on foreign investors --

and ‘foreign’ could be a Canadian, by the way, investing into the U.S. and earning dividend income. And so countries that have digital services taxes – and Canada has one, the UK has one, France has one, a few other countries have them – would be subjected to a significantly higher withholding tax, which of course is not at all attractive for investors, or businesses operating in the U.S. who are domiciled elsewhere.

We think that as a result, it's fairly likely that Canada and other countries will ultimately eliminate their digital services tax. We were already thinking that that it would be a pressure point just during trade negotiations. But let the record show that there is this danger of a higher tax rate if that doesn't happen, and people should be aware that risk is present right now.

Okay, on that not-so-happy note, maybe I'll stop there. And so I'll say thanks very much for your time. I hope you found this interesting and useful, and please consider tuning in again next time.