I’d like to begin with the caveat that the situation relating to US tariffs on Canadian and Mexican imports, first announced on February 2, is evolving. As of the time of this writing, February 3, the Trump administration announced there would be a delay on tariffs imposed on Mexico, which speaks to the fact that the situation is fluid and subject to change. This said, I’d like to outline the original tariff plan and analyze the implications and potential economic outcomes.
In my view, in the 12 months prior to President Donald Trump’s inauguration, the economy had been experiencing a soft landing as a function of sharp improvement in the supply side of the economy—the labor force and productivity. But the new administration’s policy proposals increase the likelihood of a reversal in this supply/demand balance, and the onset of material tariffs toward the US’s largest trading partners, Canada and Mexico, heightens this probability. Assuming these tariffs hold for the next month, market-based inflation expectations for the coming year look too low.
Unpacking Trump’s Tariffs
On February 2, Trump invoked the International Emergency Economic Powers Act (IEEPA), which grants him wide authority on tariffs and trade policy, to announce tariffs on imports from Canada and Mexico for the stated reasons of inhibiting movement of fentanyl and illegal border crossings. These measures include an across-the-board 25% tariff on Mexican and Canadian imports, with a 10% tariff on Canadian energy, and a 10% tariff toward China. It’s worth nothing that further carveouts and exemptions are certainly possible before implementation.
Over the last 12 months, the US imported $410 billion in goods from Canada (1.3% of US GDP), $503 billion in goods from Mexico (1.7% of US GDP), and $440 billion from China (1.5% of US GDP). At face value, this implies an increase in core personal consumption expenditure (PCE)1 of 0.7 percentage points and a 0.5% hit to growth. However, I think appreciation in the US dollar, combined with more conservative assumptions about passthrough, implies about a 0.5 percentage points increase in core PCE—still an extremely large shock to the short-term inflation outlook.
Trump’s social-media post suggests these tariffs will take effect on February 4. His rhetoric on January 31 suggested there was little the three countries can do in the near term to stop the tariffs from taking place. However, IEEPA allows for immediate implementation and reversal of tariffs.
Therefore, there’s room for all countries to negotiate and potentially reverse tariffs in short order, which may require some creativity on the part of the countries subjected to these tariffs to appease Trump. So far, he’s shown no signs of backing down, but previous experience suggests this is probable, and, again, the IEEPA itself allows for a reversal if necessary.
While most are waiting for the reversal, there’s also another important risk. The stated tariff rate increases even further should zero progress be made on border security, movement of fentanyl, and/or bilateral trade balances. In separate but related news, Canada is highly unlikely to engage in 51st-state negotiations with the US, as Trump has pushed.