Expeditors International of Washington, Inc. (EXPD) Earnings Call Transcript & Summary

Hello, good morning, good afternoon, everyone. Thank you for joining us today. This is part of our monthly series of webinars that we're offering in 2024. Today's session is called The Road Ahead in 2024: Fed Policy, Trade Tariffs and the Global Economy. We'll be providing a global macro update. We'll take a look at the U.S. Federal Reserve as well and what to expect ahead for the policies there. And as it is a big election year globally and including in the U.S. this fall, we're going to model some scenarios that could emerge. We've heard from at least one of the candidates on levying trade tariffs on China and potentially other countries. So we'll be looking at some of those scenarios and modeling how that could play out for the global economy. So thank you for joining us. My name is Nicholas Beehler and I'll be the host and moderate any discussion. I'd like to just remind you that we have about an hour of content here that includes Q&A. If you have questions, please use the Q&A feature of Zoom, should be at the bottom of your screen. Just submit those questions in writing and we may address them throughout the presentation. We'll try to leave time at the end, but we'll definitely jump in with our speakers and ask them questions. So get them in early, don't wait until the end to make sure we have time to ask our speakers. And then lastly, at the end of the event today, you will get an e-mail. It will come from me. And there'll be a short survey so please fill that out. We'd love to hear your feedback. It helps us decide what to feature for our topics and just how we're doing on our webinars as well. Once you fill that survey out, you'll be taken to a page that will have a copy of this presentation as well as the recording of the event today. All right. Before we get to today's event, we always want to inform you of our next one coming up. And for April, the topic will be Friendshoring to Southeast Asia, myth or reality? With many companies looking at derisking from China for various reasons, there's been a lot of attention focused on Southeast Asia. And in the sense that this is done to align with so-called friendlier trading nations, it's often used -- the term is often used Friendshoring. So we're going to dive into that trend and examine what's going on and provide our assessment of the dynamic. So I'll try to drop a link of this registration page and the chat here in a bit, too. You can use the QR code right there on your phone and sign up early for the event later in April. All right. A little bit about Onyx, who we are in a nutshell. We are a division of expeditors and we are a consulting firm that offers guidance to clients around geopolitical issues, managing risk. But we bring a certain sort of quantitative economic angle to that analysis. So we work with clients to understand what's on your mind? What concerns do you have? What markets are you in or looking to be in or potentially get out of certain markets? So we work very closely with clients on your needs, scope out projects. We also do ongoing retainer work for clients who need more of that regular monitoring and just kind of need someone on an ongoing basis. So different types of engagements we offer at Onyx. All right. Now I'd like to transition to introduce our speakers. We have two great speakers today. First of all, we have Adam Karson, who is the Chief Economist of Onyx Strategic Insights. Adam has more than 20 years of experience as an economic adviser to global leaders across a range of industries. He has extensive experience in the U.S., Europe and Middle East. Adam most recently worked at Chevron as a senior economist and he is responsible for Onyx's macroeconomic analysis and forecasting. We also have today Heidi Obermeyer, Senior Analyst of Technology for Onyx. Heidi is -- Heidi focuses on the technology area as well as U.S. policy in general. Her work focuses on tracking different geopolitical trends and notably the impact on the tech industry. Prior to joining Onyx, she worked at Tech Industry Trade Associations in Washington, D.C., collaborating with member companies on a range of policy issues, including AI, cybersecurity and data. All right. So with that said, I'd like to hand it over to Adam to get us started with the first section today.

All right. Thank you, Nick. Good morning and good afternoon, everyone. Thanks for joining us today. We have -- as Nick mentioned, we have a couple of topics we want to cover. As we're entering now the end of the first quarter already and about 1/3 of the way to the U.S. elections, we thought this would be a good opportunity to provide a quick update on our latest global macro views. In particular, what we see the Federal Reserve doing with interest rates middle of this year and then round out with some scenarios based on potential outcomes for the U.S. Election. So starting off with just some -- a quick summary of where we see things. The global macro outlook hasn't changed much from our December, January call which previewed a slowdown in global growth and unbalanced growth between major markets where the U.S. is still a little bit more resilient than other as well. China and the EU, in particular, were -- are struggling against some really serious headwinds. And in the U.S. in particular, consumers continue to carry the story where they're still fairly resilient, but the growth is slowing to a pace that's in a more sustainable trend as some of the COVID era tailwinds are fading. We'll talk about that in a little more detail. And you can juxtapose that against China and EU where China is very preoccupied with its ailing property sector at the moment. It's really sucking up a lot of resources. And China is going to need to basically spend its way to hit its 4.5% to 5% growth target this year. And then the EU remains pretty weak, really led by a recession in Germany right now where it's -- the manufacturing sector, in particular, across Europe is really struggling in this sort of era of high energy costs. But we do believe that Europe will avoid a broader contraction and there are some glimmers of momentum returning in the later part of this year. In terms of what the Federal Reserve is likely to do, we have held pretty firm on our outlook for U.S. monetary policy in that, we think the Fed will begin cutting rates in June. And we basically held that view for the past 1.5 years or 2 years. Inflation is trending in the right direction. There's been some choppiness in some of the data recently, but the underlying momentum is still moving towards the Fed's 2% inflation target. At the same time, labor markets are pretty firm. So the Fed has a window here to begin cutting rates in the next couple of months. And then there's -- when you dig into the details a little bit, there's some divergence on some of the particular aspects of monetary policy, we'll talk about the so-called neutral rate, what that means for the long term and how quickly the Fed will begin cutting rates -- sorry, how quickly they'll move to that neutral rate rather. And then we're going to move on to -- Heidi is going to present some information on some scenarios that we've been running on -- related to the U.S. presidential election, in particular, on trade policy. And there's definitely some rhetoric coming out of both campaigns, both Biden and Trump campaigns around trade. And we're focusing on the impacts of the potential for a retaliatory cycle of tariffs between the U.S. and its major trading partners. Now what Heidi will walk you through is that a scale-up of tariffs between major trading partners and major economies, is objectively bad for the global economy. There are no winners in that scenario. However, we wanted to look at a range of possibilities to understand whether or not there are tipping points in this kind of situation of whether -- if you get tariffs above a certain level, that's where the economic impacts really become material. Heidi will walk you through this in detail. But long story short, we're looking at -- once tariffs get to that 20% mark or higher, that's when the U.S. economy and global economy really start to feel the weight of that situation. And interestingly enough, there are some counterintuitive results in this modeling exercise around the resilience of the U.S. economy and some various disinflationary and inflationary impacts around the world as we look at the impacts of the supply chains in a tariff scenario. But let's jump into the global macro outlook. And just a little bit of kind of context here for hoping you think about the macro outlook, vis-a-vis supply chains. Like why do these things matter? It's more than just demand. I mean, the macro outlook obviously has a significant impact on in-demand but it can impact really the entire supply chain. And when we think about geopolitical events impacting oil and other input prices, various policy decisions around the world impacting the relative attractiveness of sourcing markets, geopolitical events, creating bottlenecks and distribution networks, you can see how macro when you consider economic and geopolitical factors together really cuts across the entire value chain. And today, we're going to focus on the things in blue where the U.S. election scenario, trade policy scenarios is more on the sort of input and sourcing side also impacts demand, and then the macro outlook, really, we're going to talk about impacts to end demand focusing on U.S., China and EU and some of the particulars around what's driving the outlook. So let's jump into some of the numbers, just kind of -- so you can anchor yourself in where we see growth trending. As I mentioned earlier, growth is slowing. 2023 was a pretty resilient year and 2024 is going to test that resilience. And particularly in the U.S., but at the same time, as I mentioned, we see China slowing and the EU on the brink of recession. In terms of our actual forecast, we're looking at the U.S. growing in the low 2s. We've been pointed at 2.2% growth, which is a mild deceleration from 2023. Really led by the slowdown in consumer spending as households steal the full weight of high interest rates and inflation, and the tailwinds from COVID era are the stimulus effects of various programs are kind of -- are weaning off. And then China, we've -- we bumped up our forecast a few tenths of a percent to reflect the latest policy target of hitting 5% growth this year. There's a chance they'll hit 5%, but they're going to need to spend their way to do that and even introduce even more physical stimulus than has already been announced. And that's going to be challenging amid really significant headwinds from the property sector that is diverting a lot of capital and attention to that specific problem. And then longer term, China is really facing a number of structural headwinds that's going to cause growth to decelerate, we think, by the end of this decade, somewhere between 3.5% and 4%. And then the EU, again, fighting off recession coming off of a pretty low base in 2023, growth will tick up a little bit, but 0.8% growth is still pretty anemic and the first half of the year is going to be a struggle. We're looking at potentially a bit of a rebound in the second half of the year. We'll get into some of those details of why, but largely, it's the effects of some real wage growth that is finally kicking in and interest rate cuts that will help alleviate some of that pressure that we're seeing among businesses and households there. So a little more detail on the U.S. outlook. Just to reiterate some of the points I've already made so far. 2023 momentum carries into this first quarter. So this is a really important point that we'll highlight on the next slide, but that momentum from Q4 into Q1 really sets the stage for growth for this year. However, tailwinds are fading. So when you think about the pent-up savings that -- from the COVID era, that's, by and large, kind of been worked off. And so now consumers are back to basics and have to finance consumption out of current income. So that's going to mean a deceleration of growth from this point forward. The medium to long term, we're quite optimistic about the U.S. economy. It remains highly dynamic, the most dynamic large economy in the world, tons of investment going into an innovation like AI. There's a lot of investment going into manufacturing capacity, really driven by industrial policy. We think this is going to propel productivity growth. A recent report by the Bureau of Labor Statistics already suggests that we're seeing the beginning stages of some productivity growth related to investments in AI and other high-tech areas. On the downside, we see fiscal deficits could become a bit of a challenge, politically, if not economically. That's going to be an issue that keeps popping up as the U.S. runs pretty high structural deficits for the foreseeable future. In terms of uncertainties, we're really looking at monetary policy, the timing and lag of that. Some would argue that the Fed is already behind the curve and should have been cutting rates already. We're not necessarily in that camp, but it is a risk. The election poses significant risk to policy and growth outcomes in the U.S. and globally. And then you have various geopolitical events, including what's going on in the Middle East and potential impacts to oil prices. And then we want to keep -- we also want to keep an eye on the U.S. banking system. We feel like we have averted a crisis, any kind of credit crunch in this rate tightening cycle. But the bank system is still a little bit on edge and profitability is not great. Lending standards are kind of tight and the commercial real estate sector is in a deep recession that poses risks to smaller and medium-sized banks in particular. So digging a little bit deeper. I talked about momentum carrying from last year into this year. And just a little bit about sort of GDP math, if you will, the two most important quarters for current year growth are the first quarter and the fourth quarter from the prior year. That sets the stage and sort of sets the baseline level of GDP for the year. And so with growth at 3.2% in Q4, and it looks like we're trending in the low 2s for Q1 were basically baked in 2% growth for the U.S. economy this year. I won't go so far as to say it doesn't matter what happens in Q2 through Q4. But there's a lot of leeway in how those quarters can kind of play out and will still come around 2% growth. And there's actually -- there's actually upside potential lift there. So if the later half of the year actually gains momentum, then we're going to be above our 2.2% forecast for 2024, potentially into the 2.3%, 2.4% range. Underlying this is the consumer resilience, which is starting to show a few cracks and we see that really in the high-frequency data, the retail sales data coming at in January and February. Total retail sales contracted in January on a month-to-month basis, rebounded a little bit in February, but the so-called control group, which is a subgroup of retail sales, which really correlates more with the consumption component of GDP contracted in January and was flat in February. So it's not -- that's pointing to some weakness in the consumer story. And when we look at the drivers of consumer spending, the things that were tailwinds in 2022, 2023 are now turning into a mild headwind. So the employment rate is ticking up, nominal wage growth is coming down. Our average weekly hours is coming down. You can see all those things listed on the left-hand side and red. On the right-hand side, you still have some decent job growth and layoffs are still pretty well contained. So that's kind of counterbalancing things and we suspect consumption is going to kind of move in a sideways pattern from here. And then on the sort of business activity side, thinking about what's happening with industrial production, manufacturing and services as well. Things are looking decent, I would say. High-frequency data for both manufacturing and services is in a mild expansionary territory, which hasn't been the case very consistently over the past year. Sentiment is turning decently positive both current sentiment and the outlook for the next 6 months. But I would counterbalance that by saying that inventories are in a pretty comfortable place. So with the consumption story, kind of a little bit fragile, a little bit uncertain and inventories fairly comfortable. We're not seeing a big pickup in new orders which is really a signal for the next 3 to 6 months where sort of industrial momentum is heading. So that looks also like it's kind of moving sideways and another indicator that momentum maybe fading a little bit from the resilient 2023. So pivoting a little bit, what does this story tell us about inflation and what the Federal Reserve might do over the next, say, 3 to 6 months? Well, long story short, inflation in the U.S. is decelerating pretty much in line with our expectations. The Fed has this measure -- the so-called super core metric, which is one of their favorite ways to measure the underlying momentum of prices related to -- mostly related to services. And that's really nearing the target of 2%. Now the broader measure of core PCE inflation is running at about 2.8%, but also trending -- mildly trending down. So things are moving in the right direction. January and February saw a little bit of choppy data. There's some kind of funky seasonality that happens early in the year that the Fed is more or less overlooking, but wants to see a couple more months of data to really be sure that this disinflationary trend is going to continue. And on the right-hand side, we've just listed out what we think are the major inflation or disinflation channels, also say the major channels that could influence price levels and the rate of increase. And all of these things are generally trending in a disinflationary pattern. So again, labor market is softening a little bit. We see consumer demand slowing. Interestingly enough, expectation -- inflation expectations have been firmly anchored at 2% to 2.5% during this entire COVID era. It's one of the less talked about, but one of the most important sort of objectives that the Fed has met over the past couple of years is to keep expectations anchored. And as you kind of go down the list, money and credit and energy commodities, input prices, all of these things are putting mild downward pressure on the inflation rate. So this opens the door for the Fed to begin cutting rates. With inflation normalizing, looks like the labor market is in a pretty decent position. The Fed is ready to start cutting pretty soon. And there are four key questions to kind of focus on when we think about Fed policy. One is when will rate cuts start? Generally, everyone is in agreement on June. Second, how fast will rate -- the Fed cut rates? We've been holding to about 100 basis points of rate cuts this year, the Fed's most recent outlook presented here on the left suggests more like 75 basis points. But we're not quite ready to change our forecast there. What -- and then third question is what is the long-term neutral rate? There's a lot of debate over what the endpoint will be for the Fed. The Fed is -- the latest signals to suggest that they're going to cut to about 2.5% at a nominal rate. We're kind of more in the camp of about 3%. We think this neutral rate has risen a little bit over the past couple of years for a number of factors that I'm happy to go into if folks have questions about that. And then finally, when will the Fed return to neutral? They're signaling 2027. I think that's a little bit slow. I think -- we think that 2026 is a more likely kind of endpoint for this cutting cycle. That's it in a nutshell. I think the -- our view on interest rates has held pretty firm over the past year or so. There's a lot of movements in the market trying to anticipate exactly when they're going to cut. Markets have been probably on the more optimistic side of a cut sooner than later, but have ultimately come back to this idea that we're looking at June for an initiation of rate cuts. Nick, maybe before I finish off with China and EU, maybe I'll pause there to see if there are any questions about the U.S. outlook or Fed policy.

Yes. Thanks, Adam. Really interesting. Maybe just one question. So looking at what's happened in the U.S., what's happening now, it's clear that the U.S. has managed to reduce high inflation without triggering a recession, and it used the phrase cleared for landing earlier. So it's heading towards the soft landing. Any thoughts on how that come to be? Is there something the U.S. did that other economies haven't done or we may look at the U.S. for what the government did here to kind of navigate that?

Yes, it's a great question. I think the U.S. has done a couple of things that have been unique during this cycle. There's been a -- again, a unique combination of monetary and fiscal policy that has occurred over the past couple of years. In addition to, I think, just the nature of this inflationary cycle, the Fed has benefited from in a way and gotten -- in some ways got credit for inflation coming down when inflation would probably come down a good degree on its own. So if you recall just sort of what created inflation, it was a mixture of supply chain issues, bottlenecks, the war in Ukraine drove energy and commodity prices through the roof. And the Fed began cutting rates -- or sorry, raising rates, it was inevitable that the sort of the commodities and goods side of the inflation equation that was going to roll over and turn this inflationary. The Fed's policy really now is aimed at tackling wage inflation and the services side of the economy. Really, the way the U.S. has been able to navigate this era of high inflation without causing a recession, I think has also been largely due to the fiscal policy that came out of the pandemic. The $2 trillion or so stimulus that went directly to households, which helped prop up spending, the various industrial policy programs, the IRA, the [ CHIPS ] Act, et cetera, have driven a wave of manufacturing construction in the U.S. So there's been a lot of fiscal support propping up spending at a time when inflation -- the good side again, naturally turned over, and now the Fed is fighting a much smaller problem than they were a couple of years ago. I juxtapose that with other countries where they did not have that fiscal stimulus, and we look at -- we're going to look at China and Europe in a moment here where growth is struggling in large part because consumers don't have the help that U.S. consumers have had.

Yes, I was just thinking the same. It's going to be interesting to see the case of China and then Europe broadly in maybe particular countries. And so yes, let's I guess, [indiscernible] you go to that now.

All right. Great. So moving on to China. A lot of the headwinds around China are pretty doom and gloom related to property sector and whether it's going to basically collapse and cause sort of the U.S. South interventional crisis or a Japan crisis of the late '80s or '90s. We think the story is much more nuanced than that and the central mass of like the gravity of risks is really around a more protracted -- a milder but more protracted slowdown for China. Just quickly on where we see the short-term. Really, growth started off with a decent bump early this year across a number of metrics, growth ticked up a little bit. We think that's going to be short lived. And really to hit the 5% growth target that the central government has set more fiscal stimulus is going to be needed. In the medium to long term, I think we're a little more -- we're -- have a measured pessimism around China's trajectory. The property sector is going to be a drag on growth in the next 3 to 5 years. And then there's just multiple structural headwinds that we don't feel like China is effectively dealing with related to slower urbanization rates, [indiscernible] poor demographics and multiple policies that result in a lower return on capital than it could otherwise be achieved. And a number of key uncertainties here, leading with the property sector. That's the biggest risk to the Chinese economy and the biggest risk to the global economy. We're looking at the property sector, full value chain, downstream all the way all through upstream is 25% to 30% of Chinese GDP which makes it a pretty significant part of even the global economy. Add on to that multiple other risks related to deflation, geopolitical tensions, a fairly slow and sputtering transition to consumer-led growth. So China has its work cut out for it to continue to grow at a decent pace. But let's start with the good news. The good news is that the early data of this year, however opaque it is because of Chinese New Year and some and reporting issues in the first month or two. The data is pretty decent. And we look across a number of metrics, manufacturing is slightly positive and trending sideways. SOE, state-owned enterprises are propping up CapEx growth. Confidence is maybe coming off of a bottom. It's been really depressed for a long time. And we see retail sales decelerating but in a sustainable way. This sort of 5.5% growth is rate from where we sort of expected retail sales growth to be. So that's all generally positive, but how do we -- as I mentioned, we feel kind of short-lived. The risk is really to the property sector. This is a huge hang -- a huge sort of overhang or fog over the Chinese economy. Across any metric you look at, the property sector is in trouble, whether you look at a broad measure of overall real estate activity, you look at sales, construction, prices, you name it. All trending in a very negative direction and the effects are pretty widespread across the country. So what's the solution? How does China get itself out of this really sticky situation where 25% to 30% of the economy is in a deep recession? So far, they've tried a number of policies really aimed at making housing more affordable. So lowering mortgage rates and lowering down payment requirements. That has had and will only have a marginal impact on moving things in the right direction. When you're in this kind of downward spiral of weak sales, stalling prices, leading to developer liquidity, which means they can't finish projects, which mean confidence falls more, sales fall more, et cetera, simply changing interest rates is not going to change that equation. You need to alter -- you need to really alter that equation in a more fundamental way by either injecting capital directly into the developers or injecting capital into households to help simulate demand. We think that the immediate remedy really here is to inject capital into the developers and backstop them, restore the confidence, allow them to finish the thousands of projects that are currently on the shelves. That will set -- in our view, that will set sort of a baseline for them things to begin to recover. But longer term, this is a long-term issue where there's so much overcapacity in the property sector that the current level of capacity just right now would take several years to burn off, and that's with no more building. So really, this requires a long-term solution of trying to drive more urbanization, pushing more people into the city centers where capacity is -- where there's so much excess capacity, but then also [for anything] less building. So that means that the construction and the property sector is going to be less of an engine of growth for the Chinese economy going forward. In addition to the -- just the sheer amount of capital that needs to be utilized, estimates are ranging between $250 billion to $300 billion needs to be transferred to developers just merely to finish current projects, that's 1.5% of GDP. So that's a massive, massive problem. And so much capital that would have -- that's basically going to have very little return on investment that could have been used in much more productive means. So long story short, China is in the midst of a long cycle here. What they need to do is restore confidence and get on a footing of being able to manage the deleveraging cycle and the downshift in construction activity that needs to take place for them to rebalance growth. So it's a very challenging situation that is not going to be resolved anytime soon in our view. And then finally, I want to just shift to the EU quickly and wrap up with our outlook here, which really hasn't changed a whole lot from our December, January outlook. I'll just highlight a couple kind of updates to the data. Short term, really, the manufacturing sector in Europe is really struggling with higher energy prices stemming from the war in Ukraine. However, we do think the current cycle is bottoming out and that the disinflationary trends that we're seeing in addition to forthcoming rate cuts, and real wage growth will start to kick in and we'll see a little bit of life in consumer spending in the second half of this year. Medium to long term, however, we're pretty pessimistic on Europe. There are many structural issues here, including -- the high energy -- high energy costs are not going to go away. It's really eroded competitiveness in the continent. We think pro-growth policies are lagging behind the major competitors like the U.S. and China. And some climate policies actually the investment that needs to take place is actually taking a back seat in Germany, in particular. And then a number of key uncertainties and the biggest uncertainty here for Europe is Russia, Ukraine and just -- and energy prices in general. Anything that could send energy prices significantly higher is going to really put Europe in a tough bind. As a quick update on the latest data coming out of Europe, when we look at the manufacturing sector, it's improved a little bit in Spain. But generally, manufacturing remains in a recession across European markets. 2023 ended on a really weak note, really across the board. Most indicators were contracting and 2024 is off to a pretty slow start. These PMIs are an example of some of these higher frequency and forward-looking indicators that are looking pretty rough. And as I mentioned, though, we do see a rebound in the second half of the year. There's some pretty tight financial conditions right now. Those will remain for the next few months that are going to ease up. Moderating inflation or some real wage growth that is built into the European system that is going to start to kick in here. But ultimately, growth is still going to be pretty anemic this year. So we're looking really into 2025 to return to a more normal growth rate of, say, 1.5%. In terms of European Central Bank policy, pretty similar situation to the U.S. in a lot of ways where we're seeing disinflationary trends that will continue. The easy work, so to speak, has been done with goods prices falling off, and now we're down to core services, which are really driven by wages. And so we see core inflation more or less kind of moving in a modest downward trend here over the next, say, 9 to 12 months, along with the weakness that we're seeing in the European economy, we think the ECB is really poised to begin cutting rates and could likely cut rates at a more aggressive rate than the Federal Reserve. We're looking at over 100 basis points of cuts this year in Europe. So that's China and Europe in a nutshell. Nick, is there any quick questions, I can answer one or two, but rather want to move on to Heidi's scenarios as well.

Yes. Maybe a real quick clarification. You had the term secular stagnation on the EU outlook. Yes, on uncertainties. Could you just quickly define that?

Yes. Generally speaking, this is a situation in which savings, the savings [block] and exceeds investment. So you have the structural imbalance between savings and investment. It's not exactly a textbook term, but has been a popularized term over the past decade. And long story short, we could see a situation in Europe where if you have low demand for investment in the European economy because of all of these headwinds and loss of competitiveness vis-a-vis other markets, you could see investment being flowing to other areas and end up in a situation where you have disinflationary or deflationary pressures in Europe, low interest rate, perpetually low interest rates and loan growth. So without further ado, I'll hand it off to Heidi to talk about our tariff scenarios.

Sounds great. Thanks, Adam. So we've got a lot of data on these slides. If you take a survey after the webinar, you can get access to them. So we might move through this a little bit quickly, but you have an ability to check them out afterwards when we're done. So as mentioned, we're going to run through a scenario today on U.S.-led tariff escalation. And as we're heading into the selection in November of 2024 in the U.S., we've kind of seen this broader trend away from international trading system from leaders in both parties in the U.S. On the tariff side of things, one of the key examples of this was $370 billion worth of tariffs from President Trump [indiscernible] during his previous term on various Chinese goods, including steel and aluminum. And that the Biden administration maintained those tariffs when the President entered office in 2021 came is kind of a surprise to many and just goes to show the level of convergence that we're seeing between Republicans and Democrats on trade policy and particularly on trade policy towards China. So against this backdrop, President Trump recently floated the idea of applying large tariffs of 60% on China and 10% on the rest of the world if he wins the second term in November. And in this scenario, we've laid out the potential impacts of those levels of tariffs. We've broken the scenario into kind of four parameters. So scale and scope, which requires like mapping out various levels of tariffs on the way to a full 60% on China and then level of retaliation where we've looked at what would happen if China and the rest of the world retaliated with tariffs against the United States at varying levels and then by looking at market reactions. So how financial markets react to the potential trade war? And finally, what is the real economy response? So looking at what extent consumers and businesses react to applying tariffs. So we'll move on to the next slide. So given these key parameters, we've broken down the impacted areas into supply side and demand side impacts. So on the supply side, we have things like producer prices, unemployment, level of production and exports. And we focused on geographies, typically thought of as sourcing regions. So that includes China, India, the ASEAN 5, Mexico and Eastern Europe. And then on the demand side, we have more traditional demand indicators. So that includes GDP, personal consumption, investment imports and inflation, and here, we're focused on geographies that are traditionally large markets. So the United States, China, the EU and Japan. [Then] to next slide. So here, we've laid out how we build up these scenarios. And this is a fairly complex scenario. The potential for 60% tariffs is quite a dramatic change in policy, obviously. So we've created kind of a layered approach with four stages of buildup. And we wanted to build this up from the most simple approach to the most complex to kind of understand what drives these results and see if there are any thresholds that we should be aware of. So the first stage is unilateral U.S. tariffs on China that run through 6 iterations that are ranging from 10% to 60%. 60% is kind of just an idea. There's multiple iterations that could actually take place. So we looked at tariffs on China and increments of 10%. In the second approach, we layered on a 10% tariff on all other imports around the world and added in some market volatility and confidence shocks that we think would go hand-in-hand with this type of trade policy. And then in the third and fourth stages, we looked at different ranges of retaliation. In number three, at China and the rest of the world, applying tariffs to the U.S. at 50% of the rate of U.S. tariffs and then in number four, we ran full retaliation and let everything go full tilt. Every country responding in time to whatever policy the U.S. initiates. So from left to right, the impact gets more negative and then highly negative as you get out to this full retaliation scenario. So let's walk through some charts and see what this all looks like. So this is the first step in the scenario that's looking at tariffs on China specifically. So no impacts on other economy variables and here's -- here we're mainly looking for a threshold indicator in the ramp-up of tariffs. So the left side is U.S. GDP and U.S. consumer prices. And the right side is China's GDP and exports. And on these charts, 0 can be considered kind of the baseline forecast and the percentages that are shown as deviations. So what immediately jumps out here kind of unsurprisingly is that 60% tariffs are worse than 10%. But there are a few things that we would note here. So first is that the impact to the U.S. economy spikes kind of in that first year that tariffs are implemented, but then tends to ease over time as the U.S. economy responds and evolves to this new reality of tariffs to U.S. imports. The U.S. economy is then able to kind of find other ways to extract demand on the world, so finding new outlets for demand. And that means that imports from China declined but imports from other countries would increase. So the loss of consumption in 2025 has been made up for in subsequent years. It appears to us that the impacts become material kind of at or around 20%. We're not like advocating for 10%, but the impacts there are kind of minimal. But once you get up to 20%, you get a 0.5 percentage point impact on GDP, inflation ticking up several tens of percent and staying there, it feels much more material to the economy. And then anything above 20% could be really challenging. So meanwhile, if we take a look at China, China feels the full brunt of these tariffs and the impacts don't go away over time. So the impact to growth continues to grow over time, and that impact on growth is the same as exports. China's economy is kind of objectively worse off in this scenario. And their ability to grow is significantly weaker because the Chinese economy is so dependent on these exports in the United States. These level of tariffs make them very uncompetitive and exports declined significantly. So for China, really, if this export engine is cut off, it bleeds back through their economy into an investment, production, et cetera, in ways that are really quite negative. Next slide. So let's take a look then at the second stage, where we've added some of these confidence and volatility shocks. These kind of shocks tend to happen in any major economic crisis. So like global financial crisis, COVID, et cetera, and they create an impact not only on the real economy, but also an impact on certainty and declining confidence that then impacts consumer behavior. So when we layer the tariff shocks on top of this volatility effect, we got even more significant impacts. And the degree to which this plays out is somewhat subjective and kind of almost impossible to predict, but we've assumed that these shocks grow commensurate with the level of tariffs. So a 10% tariff might have very little volatility shock. The market kind of shrug it off after expecting 60%. But even a 20% tariff with a mild volatility shock shaves 0.7 percentage point off of GDP growth. And once you get past 30%, you're definitely in a recession. So we've built this up, so the shock gets worse as the tariffs get larger and larger. And by the time you get to 60%, the size of the shock is kind of a fraction of what we saw during COVID, actually. And we just want to highlight that these numbers are based on a fairly conservative set of assumptions, actually, but are kind of illustrative of this total combined impact. And as I said, volatility and confidence could be unpredictable. But what might be kind of helpful here is thinking about kind of what your own business would do. So how much less would your company invest if we're living in a full-blown trade war. Many companies might pause for a year, 6 months a quarter before investing more in capacity because you might not need it or the rules might change, and this is just kind of a crack at trying to gauge how much that uncertainty can be kind of an additional and sometimes even more significant drag than the actual trade war itself. Next slide. So staying on the second stage for a minute. If we layer on other tariffs on the rest of the world, that shaves another 0.5 percentage point off of economic growth. And here, a loss of demand in the U.S. kind of feeds back to China through lower demand for Chinese exports and this feeds into the Chinese economy facing more headwinds of 0.2%. These things really start to stack up on each other and result in kind of these pretty large impacts on GDP, both for China and the U.S. Next slide. And here, we get to Stages 3 and 4. So these retaliation scenarios that are laying out. First, a 50% retaliation from other countries and then full retaliation. So for 50% retaliation, we've used a 30% tariff from China on U.S. imports and then a 5% retaliatory tariff from the rest of the world on U.S. imports. And there's a few interesting things here. So as expected, full retaliation is worse than 50%. However, the impacts of retaliation are not that significant. Retaliation creates a drag for the U.S. economy, but not really as big as anticipated. The U.S. economy just isn't as export based as China. So the impact isn't as big. And for the U.S. -- the U.S. imposed tariffs and the volatility shocks, et cetera, are 90-plus percent of the impact. So in the lower left corner here, we can see that retaliation has little impact on U.S. consumer prices. And all of this tells us that China and the rest of the world can inflict pain but kind of not nearly as much as U.S. tariffs would on the rest of the world. We also see here on the right-hand side that imposing retaliatory tariffs on the U.S. doesn't have much of an impact on China because the U.S. exports so little to China. So retaliatory tariffs would be a low-cost way for China to retaliate without pushing their economy much further into the [red]. Next slide. And so finally, we kind of circle back to the supply chain impacts. So on the supply side, there are percentage changes in the baseline in 2020 and kind of a couple of interesting things to note. We would expect lots of deflation, and we kind of get that in some markets, particularly in China and Europe but we actually get inflation in Southeast Asia and some in Mexico. And this has lots to do with what happens with exchange rates. We kind of see a sharp devaluation of currency in countries with inflation, which then drives inflationary impacts. And in terms of unemployment, Eastern Europe is most effective and sees the rate jump 1.5 percentage points. And this really puts Eastern Europe in a dire situation here with the deflationary cycle and the weak labor market. And then looking at demand side, generally, these impacts are all negative. So we've got GDP declining across all major markets, personal consumption doing the same, particularly in the U.S. and in Japan, and Japan has hit the hardest there. Imports then are hit the hardest in the U.S. and China and looking at consumer price inflationary pressures built by the end of 2028 because the decline in demand feeds into deflationary pressures. So on this chart, Japan, in particular, is quite worrisome because they recently experienced a deflationary cycle. And that about does it on supply side challenges or supply chain challenges. I'm happy to answer any questions or see what folks are thinking.

It was really interesting. One question first is -- so in the retaliation scenario, you mentioned U.S. doesn't export as much to China. So it will -- China's retaliation against the U.S. isn't as impactful as the other way around. Are there any particular industries maybe that are exceptions there that U.S. producers, U.S. exporters might want to just be aware of?

Yes, definitely. I think pharma and agriculture are two industries that do a lot of export to China frequently. That interestingly also becomes a bit of a political issue for President Trump as he's campaigning and considering these kind of policy considerations because many potential VP candidates, for example, for him come from districts or areas that have huge agricultural communities that will be heavily impacted by tariffs like this.

Okay. Great. One question from the audience. So when Trump [ out ] of the 25% tariffs, there was behavior that happened from there with U.S. manufacturers. Looking at this scenario with 60% tariffs, do you have any sense of what manufacturers would do? I know you talked in the first scenario how U.S. economy would recover and maybe there's a hint there with what companies will do, they'll have to adjust -- force to adjust. But any crystal ball type of thoughts on what the U.S. manufacturers might do to adjust?

Adam, do you have any thoughts on this?

Yes, sure. I'll give it a shot. That's a great question. When it came to the 25% tariffs, there were a lot of exceptions, they weren't universally applied. If we truly get into a scenario with just blanket 60% tariffs, I find it a little more challenging for companies to pass on. I mean we'll try to pass on some of that, but I think it's challenging to pass on all of that to consumers. So you see that in the modeling results, inflation definitely picks up in the U.S. in these scenarios. But there -- I think it's going to force a lot of companies to find substitutes. In addition it's going to be a multipronged strategy of how do you -- what can you pass on to consumers? What substitutes can you find? Those options are going to be limited. You can't replace China as a source for intermediate or final goods in most supply chains. But companies will be [gullible] -- and that situation would be ultimately forced to look for those alternatives. I think you could also see some long -- like medium- to longer-term structural changes from a scenario like this that arguably the tensions between U.S. and China are helping drive some reshoring or near-shoring activity, investment in Mexico, investment in manufacturing capacity in the U.S. You can see that trying to pick up as well if we enter into this kind of escalatory tariff situation.

Great. Okay. Seen a few questions here. Maybe just a sort of a general question. Any advice recommendations or effective strategies, best practice for businesses that are currently implementing to manage and navigate through these uncertain conditions. Like I guess, just like a general question, any kind of strategies to navigate? We don't know if these scenarios are going to happen, but what should one or two things speed that a business should be doing right now?

Yes. I can give maybe a broad answer to that. It's going to be unique for each company and like your current supply chain and what your sort of industry footprint looks like as well. Generally, the way -- what we've been advising clients on over the past several months and throughout this year, is really to be -- to be prepared for these number of uncertainties is to do as much scenario planning as possible. So for example, one approach is to think about the U.S. elections in terms of the range of policy shifts that could happen and map that against your current supply chain to identify what potential risks or bottlenecks or pain points you might have. And then within the range of possibilities of policy changes, where do things overlap so that you can identify strategies that you would do in almost any situation. You're sort of [indiscernible] moves. And then what's on the periphery, what are the things that you need to be watching out for that are outside of those [indiscernible] moves, but have a material impact on your business and proactively prepare for that. So proactively look for alternative sourcing, for example, is one option that companies can kind of pursue if -- I mean, the tariff scenario is not the only scenario that could alter supply chains or other less dramatic but important scenarios that company should be preparing for as well.

Great. Yes, scenario planning, plan ahead. Don't wait until the thing happens, have a plan. Okay. So we're out of time. For those of you who had questions in the Q&A, feel free to reach out to me via e-mail. Sorry, we ran out of time for that. Just a reminder here for next month. I hope to see you on our next webinar. You can see the date and time there. And yes, thank you for your time today. Really appreciate you joining us. And again, look for the survey here in the next couple of hours. And once you fill that out, you will get a copy of these slides and the recording. I know there's a lot of content, so you'll be able to pace through that on your own time there. So thank you to our speakers. Thank you, Adam. Thank you, Heidi. Everyone else, have a great day.