Let the tariff games begin

Steven Abrahams | April 4, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Liberation Day kicked off with all the ceremony becoming of any good sporting event. The US has played its tariff hand, and now scores of others around the global trade table get to play theirs. Fold, fight or find strategic partners. All of it will matter for their economies and for markets.

The stakes in the game

Each player already has the immediate stakes in front of them. Those are the trade flows, both the goods and services each player exports to the US and those the US exports to the player. The US on Liberation Day hit each player around the table with a tariff, hurting the player’s exporters and also hurting the US consumers of those exports.

Let’s get concrete. China was the largest exporter to the US in 2022, the last year of comprehensive data from the World Bank’s World Integrated Trade Solution database. China exported $576 billion of goods and services to the US. That was equivalent to 3.2% of China GDP that year and 2.3% of US GDP. If we give ourselves license to use share of GDP as a measure of economic pain, then the Liberation Day tariff was 1.4 times more painful for China’s exporters than it was for US consumers.

Take that, China.

It turns out that China got off much more easily than any of the United States’ other 30 largest trading partners (Exhibit 1). Take Mexico, the second largest exporter to the US in 2022. Mexico’s exports amounted to 32.5% of its own GDP but only 1.8% of US GDP, a pain ratio of 18 times. Canada, the third largest, has a pain ratio approaching 12. Japan at fourth and Germany at fifth have ratios around 6. Vietnam at seventh comes in above 60. Ouch.

Exhibit 1: US tariffs tend to hurt partners’ exporters more than US consumers

Note: Data shows the ratio between each country’s 2022 exports to the US as a percent of local GDP and those exports as a percent of US GDP.
Source: World Bank, Santander US Capital Markets.

Fold, if able and willing

The appeal of tariffs as a trade weapon for the US is clear from the trade flows. The US can inflict more pain than any of its trading partners. The pained player presumably has incentives to fold their hand at this point and look for ways to accommodate the US and bring the game to a close. The greater the pain ratio, the greater the incentive. But a player’s ability and willingness to fold and accommodate depends on the specifics of the US trade complaint and the player’s tolerance for pain.

Some players may not have the ability to accommodate US demands if the player’s trade barriers are protecting a strategic industry, such as ones viewed as critical to national defense, or protecting politically powerful interests unwilling to compromise. The player also may simply have a high tolerance for pain out of national pride or precisely because the player is protecting strategically important or politically powerful interests. Where the player can’t accommodate or is willing to bear the pain, there’s no reason to fold.

Fight, otherwise

That brings us to the alternative to folding: the fight. The player looks at the Liberation Day tariff from the US and imposes a tariff right back. That now hurts US exporters and also hurts the player’s own consumers of US exports.

Let’s return here to China. The US in 2022 exported $154 billion in goods and services to China, equivalent to 0.9% of China’s GDP and 0.6% of US GDP. If China retaliates against the US, its consumers bear 1.5 times the pain of US exporters, not really different from the pain ratio derived from China’s exports to the US. It turns out for almost all countries that the pain ratio derived from the player’s exports to the US or US exports to the player end up in about the same place.

Whether looking at the game through the players exports to the US or US exports to the player, the advantage goes to the US mitigated by the players ability and willingness to fold and accommodate.

Find your strategic partners

That brings us to one more important consideration in the game: strategic partnerships. The US on Liberation Day imposed tariffs ranging from 10% at the low end to 49%–lucky Cambodia—at the high end (full list of tariffs by country here). This creates some intriguing incentives for players that view Liberation Day as the start of a multi-round game. Players at the low end have every incentive to make sure the US allows them to remain the low-cost point of departure for exports to the US. Holding that status makes the player a potentially valuable strategic partner for players subject to higher tariffs. Players hit with higher tariffs can either route exports through low-cost points of departure or, if local infrastructure allows, can move production to low-cost points of departure. The high tariff player should be willing to pay anything less than the difference between their tariff rate and 10%. For example, Cambodia should in the extreme be willing to pay a low-cost player anything less than 39% to serve as a through point for export. Those kinds of revenues to the low-cost players could reduce their effective cost of export below 10% or even into a profit. Access to low-costs partners lowers the pain of players hit with higher US tariffs and allows them to continue their fight longer.

Of course, strategic partnerships will get undone if the US has good tools for policing trade flows. The tools will have to be better than the ones used to police Russian oil.

Expectations from the sidelines

The starting conditions for the tariff game—Liberation Day tariffs, exports to the US, exports from the US, shares of GDP, pain ratios—are in a table at the end of this note for the Top 35 exporters to the US (Exhibit 2).

Based only on these starting conditions, and admittedly blind to other important nuances, I would expect a sizable share of players with high pain ratios and other reasons to want good relations with the US—mutual defense, for instance, or status as a low-cost point of departure—to fold and accommodate. That would include Australia, Brazil, Chile, Colombia, Costa Rica, Ecuador, Peru, Turkey, Saudi Arabia, Singapore, the UAE and the UK, all with 10% tariffs after Liberation Day and at least some good will toward the US.

Other countries are tougher calls with high pain ratios and interest in good US relations but possibly unable to accommodate all US trade demands. Canada, Israel, Indonesia, Japan, Mexico and the Philippines, are a few examples. Those countries could be on the bubble.

Countries inclined to fight seem likely to include China, Germany, India and France. Other countries, including many in Europe, have high pain ratios, high tariffs after Liberation Day and strong political ties to other countries inclined to fight.

The short and long timelines

Although the US may get some early wins—if mutual relief of pain on exporters and consumers qualifies—other hands look likely to stay in the game a long time. One of the stated aims of Liberation Day is to bring manufacturing back to the US, and building new factories and new supply chains takes years to organize and then recoup costs. Companies considering those moves need certainty that the US will stay engaged in the game long enough to cover required timelines. Other countries will likely need to do the same. For countries that choose to fight, it looks likely to be a long one.

Exhibit 2: Starting conditions for the tariff game

Note: Some calculations across a row may not match due to rounding.
Source: World Bank World Integrated Trade Solution, White House, Santander US Capital Markets.

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The view in rates

After Liberation Day, the market has added another cut to its expectations for the Fed and sees funds at 3.31% to end the year, two more cuts than the Fed’s March dots. The market has the first cut priced for June, a second cut in July and others in the fall. That will likely require the Fed to look through the inflationary impact of the administrations new tariffs and focus on the risks to growth.

Other key market levels:

• Fed RRP balances closed at $184 billion as of Friday, down $102 billion in the last week. The Treasury General Account has dropped $515 billion since mid-February, reflecting maturity of Treasury bills and the return of cash to money market funds, leaving repo lenders long on cash. At the end of March, banks protected their balance sheets by limiting matched-book repo and pushing cash to the RRP. Balance sheet pressures have eased, so cash is flowing away from RRP and back to triparty and bilateral repo.
• Setting on 3-month term SOFR closed Friday at 428 bp, down 2 bp on the week.
• Further out the curve, the 2-year note traded Friday at 3.65%, down 25 bp in the last week. The 10-year note traded at 3.99%, down 26 bp in the last week.
• The Treasury yield curve traded Friday with 2s10s at 34 bp, unchanged in the last week. The 5s30s traded Friday at 70 bp, steeper by 5 bp over the same period
• Breakeven 10-year inflation traded Friday at 219 bp, down 18 bp in the last week. The 10-year real rate finished the week at 180 bp, down 8 bp in the last week.

The view in spreads

Bearish on credit spreads with US trade policy in flux. The Bloomberg US investment grade corporate bond index OAS traded on Friday at 102 bp, wider by 11 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 150 bp, wider by 7 bp in the last week. Par 30-year MBS TOAS closed Friday at 37 bp, tighter by 2 bp in the last week.

The view in credit

Tariffs should weaken most credits assuming slower growth, and hit specific credits hard based on exposure to cross-border trade flows. We have been watching cracks in credit quality at the weaker end of the credit distribution for months. Fundamentals for the average of the distribution continue to look stable. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. Consumer debt service coverage is roughly at 2019 levels. However, serious delinquencies in FHA mortgages and in credit cards held by consumers with the lowest credit scores have been accelerating. Consumers in the lowest tier of income look vulnerable. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks. If the Fed only eases slowly this year, fewer leveraged companies will be able to outrun interest rates, and signs of stress should increase. LMEs are very opaque transactions, so a material increase could make important parts of the leveraged loan market hard to evaluate.