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The U.S. announcement of a wave of substantial additional tariffs, far broader and more severe than expected, threatens to upend global trade, with implications for economies, financial markets, supply chains, and geopolitics more broadly.

What We're Watching

The tariffs announced by the U.S. administration on April 2 represent a material escalation in trade tensions. They will likely weigh on global credit conditions, which have until now remained supportive. While S&P Global Ratings highlighted elevated trade tensions as the top risk in its latest Credit Conditions publications and already incorporated moderate tariff assumptions, the recent announcements go far beyond.

Fortunately, underlying credit fundamentals have been broadly improving in the past couple of years as businesses and households hunkered down after dealing with the pandemic and benefited from supportive conditions. Rating actions have been balanced, refinancing activity has been robust, and the net negative outlook bias has been well below five-year averages—apart from a few tariff-targeted sectors and those energy-intensive industries exposed to relatively expensive gas and power prices (such as in Europe).

But that was then. The U.S. imposition of a baseline tariff on goods of 10% on all countries plus additional—substantial—levies on more than 60 countries risks causing a full-fledged global trade war. The economic effects will ultimately depend on how structural they are, the form of any countermeasures, and what other mitigants (such as economic stimulus) affected countries can deploy.

What We Think And Why

For starters, these developments mean that our recent macroeconomic forecasts need to be revisited. An effective average U.S. import tariff rate of more than 20%, and the risk of targeted countermeasures, may lead to across-the-board slower GDP growth, rising unemployment, and higher inflation—with outsized effects on smaller and relatively trade-dependent economies.

Credit conditions appear to be taking a hit too. Financial markets have reacted negatively to the scale of the trade shock. This is likely to further undermine business and financial confidence, amplifying concerns around investment, employment, and growth. Furthermore, in our view, uncertainty will continue to weigh on growth prospects even after the pronouncement. One reason is that these "reciprocal" tariff rates may be viewed largely as structural and unlikely to be easily negotiated down.

Rating implications may come from near-term changes in market conditions. But we will also consider the implications—positive or negative—of the longer-term reshuffling of global trade and supply chains that is at play for specific issuers, industries, and countries.

The worsening of global trade tensions, expectations for a global economic slowdown, and increased investor risk-aversion will likely affect our expectations of a continued gradual decline in speculative-grade defaults. This means defaults could trend closer to our downside scenario of 6% in the U.S. and 6.25% in Europe by December (compared with our baseline forecasts of 3.5% and 3.75%, respectively).

In North America, borrowers entered the year with notable tailwinds, with many having taken advantage of historically low spreads to push out maturities—and benefiting from surprising economic resilience. But amplified uncertainty, along with policy shifts by the U.S. administration, threaten to ignite investor risk aversion, especially if significant economic disruption occurs as a result.

Similarly, European credit fundamentals started the year on solid footing. However, increasing protectionism in the U.S. has triggered a transatlantic rift that has upset the global order and could create investor risk-aversion, disrupt supply chains, and shift European governments' spending priorities.

Supportive financing conditions and domestic consumption have steadied Asia-Pacific credit conditions, too. But some countries in the region are among those exposed to the largest tariff hikes. We anticipate that investment in key emerging markets (EMs) will be subdued—or could reverse—until there is greater clarity regarding the effects of protectionism on economic growth, inflation, and interest rates. We expect the pace of monetary-policy easing among EM central banks to be constrained by elevated U.S. policy rates, as the widening of the gap can trigger abrupt capital outflows, which can weaken exchange rates, and consequently increase inflation expectations.

What Could Change

The latest U.S. tariffs on nearly all the country's trade partners may strain consumer sentiment, business investment, and government budgets. Companies most exposed to global supply chains (e.g., automakers, generic-drug manufacturers, retailers) will face rising input costs at a time when passing them through to customers and consumers has become more difficult. The effects on economies will vary, but many households around the world will likely end up worse off given the inflationary pressures.

Broader geopolitical tensions also threaten supply chains, market sentiment, and budgets. The U.S. is distancing itself from many international alliances—including, notably, NATO—forcing other countries to explore alternative alliances and increase defense spending. This shift in priorities could force reductions in other areas of fiscal spending, potentially leading to political unease, or require increased debt issuance, pushing up borrowing costs.

A sharper-than-expected global economic slowdown would lead to greater credit stress. The chance of a U.S. recession is rising, and consumer sentiment is showing some cracks, with increased delinquencies in the U.S. alongside still low consumer confidence in China.

In Europe, short-term growth prospects will be pressured by the more hostile global trade environment. But fiscal spending should gradually boost GDP, with material plans in Germany and the EU to increase infrastructure and defense expenditures. For example, the incoming German government has proposed spending up to €900 billion (almost 20% of German GDP and about 5% of EU GDP) on infrastructure and defense.

In China, the challenge is to sufficiently restore confidence, but an increased focus of fiscal policy on households may be needed.

But tariffs could both weigh on economic activity and underpin inflation, complicating central banks' approach to monetary policy. Established central banks can cut rates, but policy rates may rise in some emerging markets. Similarly, volatility in long-term rates could occur as markets balance risk to growth and inflation.

Writers: Joe Maguire and Molly Mintz