Trump fires first salvo in multifront trade war
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Trump fired the first shot in a multifront trade war on Saturday when tariffs on Mexico, Canada and China became a reality.
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The tariffs are linked to border security and thus could be removed or reduced following negotiations. However, there is also a risk we see a tit-for-tat escalation in the short term. We also expect to see more tariffs on China later this year and that EU and possibly other countries will be hit as well before long.
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US growth may take a moderate short-term hit but fiscal easing keeps the medium term outlook broadly unchanged for now. Inflation will see a modest one-off impulse.
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The biggest impact for now may be the uncertainty the global economy is faced with, and supply chain planning for businesses have only become more tricky.
What happened?
Donald Trump announced 25% tariffs covering all goods imports from Mexico and Canada, although energy imports from the latter will face only a 10% rate. In addition, Chinese tariff rates will be increased by 10%-points. The tariff changes will take effect from Tuesday 4th of February. While Trump had warned of the tariffs already in December, markets were not convinced and Polymarket only had a 25% probability of tariffs on Mexico and Canada before March. Hence, we saw a quite big market reaction with USD strengthening and US equity futures losing 3% from the peak on Friday.
Canada has already announced 25% counter-tariffs on CAD155bn of imports from the US, which cover roughly 1/3 of the trade. Tariffs on goods worth CAD30bn will take effect on the same day as the US measures, while the rest will be enacted 21 days later. At the time of writing, Mexico has not yet announced counter-measures of its own, but planning is reportedly under way. China has stated it will take “necessary counter-measures” but without specifying details.
Impact on US economy to be moderate for now
On conventional basis, the new tariffs are expected to increase US public revenues by USD110-120bn per year according to Tax Foundation. This is equal to fiscal tightening of 0.3-0.4% of GDP, and excluding any impact from counter-measures, Tax Foundation estimates the negative impact on real GDP at 0.4%. Canada’s counter-tariffs will add a further modest headwind to growth but note that while US accounts for nearly 75% of Canadian exports, Canada accounts for only around 16% of US exports.
The fiscal tightening effect will most likely be counteracted by Republicans’ planned easing to domestic taxation, even if we still know very little about its exact details. The Penn-Wharton Budget Model estimated earlier that Trump’s campaign proposals could end up widening public deficits by more than USD600bn per year from 2027 onwards, with majority of the increased spending coming from extensions to income tax cuts from the Tax Cuts and Jobs Act. We discussed the complicated interplay of funding domestic tax easing with import tariffs earlier in Reading the Markets USD - How much of an impact will a fiscal hawk have? 26 November.
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