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The outcomes of the start-stop nature of ongoing tariff policies and trade tensions will affect credit quality across the global automotive sector—prompting automakers firstly and suppliers later on to absorb extra costs and putting profit margins and cash flow generation under pressure.

What We're Watching

The uncertainty surrounding the unfolding trade conflict complicates strategic responses from auto original equipment manufacturers (OEMs) and their suppliers.

Prior to the onset of the geopolitical situation, market participants prioritized capital allocation strategies aimed at reducing costs, countering Chinese manufacturers' expansion through product innovation, and managing the transition to electric vehicles (EVs).

Those issues remain pressing. But while relocating production to the U.S. to avoid exposure to tariffs is theoretically possible for the auto industry, management teams are now also confronting whether to rebalance costly investments—knowing that auto product cycles typically outlast political cycles, and the tariff situation may have significantly evolved by the time assets have been relocated.

The main challenge of relocating the production of a vehicle model is the reorganization of related supply chains and access to skilled labor. That task is made harder by the uncertainties surrounding the conditions under which companies will operate. Further revisions to the scope and level of tariffs seem likely, given the U.S. administration's developments on negotiating bilateral trade deals (for example, with the U.K.) and/or complexity rising from trading partners' retaliation (such as China's export restrictions on seven rare earth elements, effective from April 4).

President Trump's executive orders signed on April 29 only partially relieve the disruption we anticipate for light vehicle OEMs. Permanent U.S. tariffs would affect credit quality across the global auto sector and call for a recalibration of the industry credit metrics. Headroom built into the credit ratings of auto equipment manufacturers and their suppliers has significantly diminished across all issuers. Incremental downside to our expectations stems from supply chain disruptions (primarily related to China's export ban) and weaker-than-expected volumes linked to increasing pricing as a way to partly absorb tariff costs.

What We Think And Why

The trade dispute, the organization of a strategic response by industry participants, and supply-side disruption risks will all weigh on light vehicle production. We now consider it very unlikely that light vehicle sales and production will return to their previous pinnacle of 90 million units in the next three years.

We factor in mitigating actions from automakers including the relocation of certain duplicative production capacity in Canada and Mexico back into the U.S, localized production of battery modules, more efficient supply chain management to ensure higher United States-Mexico-Canada Agreement compliance, and potentially leveraging suppliers with excess capacity within the U.S.

OEMs and suppliers are inevitably likely to pass at least some of the cost of tariffs through to consumers via higher prices—which we expect will dampen demand and result in a rapid downward adjustment in production. Higher prices are also unlikely to completely offset weaker sales volumes, may result in a trend toward declining revenues over the next two years, and require increased capital expenditure to adjust issuers' footprint to the new trade landscape.

The implications are stark across regions. Prolonged tariffs on all auto imports into the U.S. will have a multi-billion-dollar impact on the earnings of the bulk of our rated automakers.

The numerous negative rating actions on European auto suppliers since the beginning of the year is evidence of the many challenges these players have had to absorb (including inflationary pressures, supply disruptions, and the migration towards electric vehicles) since the pandemic, absent global growth of volumes. This leaves suppliers vulnerable to weakening volumes as a result of tariffs, even though they might not be directly affected as their clients.

Although the U.S. has significantly lowered its tariffs on China, the incremental tariff on imported vehicles and parts to the U.S. will weigh on exports at a time where domestic prices may make market conditions unsustainable. We expect to see pressure on the cash flows of rated Chinese entities over the next 12-24 months.

Other economies also face significant vulnerabilities. The automotive sector is the biggest Korean export to the U.S. (accounting for approximately $35 billion in 2024). As such, the severity of profitability decline from the high-tariff environment will depend on U.S. policy, competitors' strategy, and consumer demand. Meanwhile, large gaps in the profitability and cash flow of some Japanese major automakers (mainly Nissan and Honda) will be hard to remedy over the next one to two years. This would be filtered through competitiveness and credit quality, given investments required for new product and technological development.

What Could Change

We acknowledge that the scenarios which currently underpin our assessment are subject to change. Exemptions remain possible for selected OEMs, while the tariffs applied to different parts and components may change in scope and scale.

While we expect auto suppliers will seek to recover the vast majority of direct tariff-related costs from OEMs, we believe the main risk for auto suppliers is related to lower volumes. Given that many suppliers' rating headroom is already tighter than those of OEMs, we maintain our view that suppliers will remain vulnerable eve if less directly affected than OEMs.

Our revised scenario for EVs reflects weaker consumer sentiment over 2025-2027 outside China—mainly due to the persistent price differential between electric and traditional propulsion, consumers' expectations that more affordable electric models will be delivered by virtually all OEMs (emerging and legacy) over the next two years, and hybrids' (both full and mild) growing appeal as an acceptable technology and price compromise for consumers in Europe and the U.S.

EV growth in the first quarter of this year in the EU was evidence of consumer readiness to consider the switch to electric, subject to a wider model choice and vehicles at more affordable prices.

Despite near-term sluggishness, we continue to expect EV penetration will accelerate towards the end of the decade. At the same time, we also see a risk that EV growth will prove slower than anticipated, primarily due to the potential for supply chain disruption linked to geopolitical events that affect sourcing from China.

Writer: Molly Mintz