2269853201
2269853201
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The Economic Impact of US tariffs on Canada and Mexico

Economic opinion

2269853201

Donald Trump notably didn’t sign any executive orders on trade. That said, he reissued several tariff threats during his inauguration week. Most concretely, he announced to implement a 25% blanket tariff on Mexican and Canadian imports. Both countries are highly dependent on US trade and will suffer markedly. Yet the US economy will be seriously impacted as well. Higher tariffs are expected to drive up prices and hurt consumer spending. The Fed is expected to respond by pausing its easing cycle, keeping rates longer in restrictive territory, hurting investment. Furthermore, a stronger dollar and retaliatory tariffs are expected to hurt US exporters. The EU economy may suffer less for now, though still impacted indirectly, as all three countries account for almost a third of global GDP.

Introduction

Donald Trump entered the White House with a bang. The 45th and 47th US president signed a total of 26 executive orders on Day 1. The orders touched on multiple campaign promises such as tightening border security, restoring access to TikTok, creating the Department of Government Efficiency (DOGE), and leaving the World Health Organization (WHO) and the Paris Climate Change agreement. Yet the so-called Tariff Man initially showed noticeable restraint on trade. Tariffs were not mentioned in the executive orders. Trump only signed a presidential memorandum asking for a review of unfair trade practices. Markets breathed a sigh of relief.

The relief was short-lasting, however. In later speeches and interviews, he reiterated several tariff threats. He (again) threatened a 100% tariff on BRICS countries if they undermined the dollar. He also threatened up to 100% tariffs on China if they failed to agree on TikTok’s potential divestment and stop the flow of fentanyl. He also promised to increase tariffs and sanctions on Russia if they don’t end the Ukraine war. Furthermore, he reiterated his threats to tax EU imports, if the EU fails to buy more US (energy) products. He also criticized EU trade surpluses, saying “the EU is very, very bad to us”.

However, his most concrete and immediate threats were issued towards his two neighbours and USMCA trading partners, Mexico and Canada. Trump announced 25% tariffs on all imports from both countries on 1 February. Both countries have vowed to retaliate if these tariffs are implemented.

High economic impact

Implementing such high tariffs would likely have damaging economic effects. This is especially the case for Mexico and Canada. Both countries are highly dependent on trade with the US. Exports to the US account for 27.4% and 20.6% of Mexican and Canadian GDP respectively. Tariffs of this magnitude could thus trigger a recession in both countries.

Yet the US is also likely to be severely impacted. Though only about 11% of consumer spending can be traced to imported goods, an outsized share of US imports come from both countries (23% combined, see figure 1). Indeed, implementing the 25% tariffs would increase US average tariffs by 5.8 percentage points (assuming no change in trade flows). 

Such a drastic tariff increase could jack up prices as companies are likely to largely pass through tariff costs to consumers. Furthermore, tariffs will insulate US producers from competition, increasing their pricing power. The Fed is likely to react by keeping rates higher for longer in order to fend off this new inflationary pressure. Indeed, in its December meeting, they have already struck a noticeably hawkish tone, likely in anticipation of tariff-induced inflation. This higher rate pressure will weigh on US investment in the near future.

Higher tariffs are not only expected to hit US consumer spending and investment, US exports are also likely to take a hit. Not only will exporters be hurt by retaliatory tariffs, the dollar strengthened last year in anticipation of tariff increases (see figure 2). That said, the US is not highly dependent on exports. US exports to USMCA countries only account for 2% of US GDP.

Impact on Europe

Though Europe seems to be off the hook in this first phase of the trade war, it is still likely to be indirectly affected. The USMCA economies account for 31% of the global economy. A slowdown there is likely to cause a ripple effect worldwide.

Furthermore, USCMA countries are important trading partners for the EU (see figure 3) and the EU will thus be impacted by slowing growth in North America. Member states like Ireland, Belgium, the Netherlands and Germany are particularly exposed. Southern and CEE countries face less trade exposure.

Conclusion

Donald Trump’s first salvo in the trade war is aimed at his direct neighbours. Though Canada and Mexico would probably suffer most from his 25% tariffs hike, the US economy would also be hit by higher inflation, higher rates and lower growth. Though the EU is spared in this first phase of the trade war, it could face indirect effects. This is especially the case for countries with higher USMCA exposure such as Ireland, Belgium, the Netherlands and Germany.

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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