The Big One

By Bas van Geffen, senior macro strategist at Rabobank

He may not like the Fed’s policies much, but President Trump sure seems to like the central bank’s methods. Yesterday was “THE BIG ONE: RECIPROCAL TARIFFS!!! MAKE AMERICA GREAT AGAIN!!!” Trump had flagged earlier that his team was working on reciprocal tariffs, and before the actual press announcement, this Truth gave another bit of forward guidance.

And, in fact, the entire announcement felt a little like forward guidance from the US President: the reciprocal tariffs will only be brought into effect some weeks from now, leaving room for countries to negotiate, or perhaps, lower their own tariff rates in order to avoid being hit by these new reciprocal rates.

The complexity of determining reciprocal tariffs on thousands of products from more than 150 countries could be another reason for the delay. And its not as easy as comparing current tariff rates: President Trump also explicitly mentions non-trade barriers. The US probably does not want to copy these one-for-one, since that would put part of US’ trade policies under the control of its trading partners. But discounting non-trade barriers into a fair tariff rate will be more challenging.

Furthermore, the plans include “examining non-reciprocal trade relationships, […] including any unfair, discriminatory, or extraterritorial taxes […], including a value added tax” Extraterritorial taxes is a clear hint at the Digital Services Taxes imposed by several European Union member states. But his inclusion of value-added taxes is a bit more curious, perhaps.

Why is VAT so important in reciprocal tariffs? Here is the tariff increase with and without VAT. Trump just said he will include VAT. pic.twitter.com/pdJDhYmZwT

— zerohedge (@zerohedge) February 13, 2025

In a Truth, he again underscored that “for purposes of this United States Policy, we will consider Countries that use the VAT System, which is far more punitive than a Tariff, to be similar to that of a Tariff.” Does this mean that any country that charges a higher VAT than the US will see the difference added on in the form of an import tariff? Note that the United States do not charge a VAT; there are sales taxes that can differ per state.

Moreover, one can certainly wonder what Trump finds so unfair about VAT. The system is commonly applied on all goods sold, whether imported or domestically produced. So it appears that, within any country, a VAT does not favor domestic products over US exports.

But there may be some method to this madness. The US President wants to rebalance trade flows, and nudging countries off the VAT system might be a means to that end. If the US forces its trading partners to adopt lower VAT rates, the respective governments would have to generate revenue from other sources, say corporate or income taxes. This accomplishes two things. First, it may raise the relative costs of production in the foreign country – especially if the US is deregulating and cutting taxes at the same time. Secondly, even if the average tax rate does not change when the country switches from VAT to income tax, the relative cost of consumption decreases. And higher consumption in the trading partner might benefit US net exports to the country.

Whether this forward guidance was Trump’s plan all along, or just happy coincidence, the April 1 deadline (not a joke!) appears to be far enough away for markets to shrug most of the tariff news off. Although the tariffs could cause upheaval in global trade, there is still plenty of hopium that world leaders will try to strike a deal with the US president.

Dialogue and negotiations are certainly one element of the European Union’s response. But one of the EU’s top officials reportedly already tried this angle ahead of the steel and aluminium tariffs, and failed to de-escalate the trade tensions. So the bloc is also preparing to hit back hard. A first package of counter-tariffs is reportedly ready to be deployed, as a response to Trump’s planned tariff hike on steel and aluminium. On March 31, the suspension of counter-tariffs to Trump’s 2018 aluminium and steel tariffs expires. If the EU does not vote to extend this, these tariffs will automatically come into force again.

Moreover, since Trump’s first term, the EU has significantly extended its options to respond to any trade tensions. For example, the European Union’s new ‘Anti-Coercion Instrument’ could be deployed if Brussels believes that tariffs and other trade policies are being used to coerce a policy change elsewhere. Tariffs in order to get European countries to drop their digital services taxes, or to change their VAT system, arguably both fall into this category. The instrument is yet untested, but potentially very powerful. In addition to import and export restrictions on goods and services, it would also allow the EU to block certain foreign-direct investments and to suspend international obligations in numerous fields, including property rights.

The tariff announcement almost makes one forget that just the day before Trump blindsided European leaders by re-opening communications with President Putin. And the initial outlines of a potential agreement sketched by US Defense Secretary Hegseth led to much dismay in European capitals. The US is pivoting to the Pacific, and Europe now faces the choice to quickly scale up its own defense capabilities, or to let others decide the bloc’s future for it.

According to Politico, European leaders are still in a state that’s a “mix of fear and denial.” So far, denial also appears to be the markets’ coping mechanism for the big shifts that are afoot.