On Saturday, President Donald Trump invoked the International Emergency Economic Powers Act (IEEPA) and authorized new tariffs on Canada, Mexico, and China; these tariffs are slated to go into effect on Tuesday, February 4th at 12:01 AM. More specifically, the edict applies a 25% tariff on goods coming in from Mexico; a 25% tariff on Canadian goods aside from energy products, which will be taxed at 10%; and a 10% tariff on goods from China. In aggregate, these actions are expected to impact approximately $1.3 trillion in goods, representing 43% of all U.S. imports and almost 5% of U.S. GDP.

The new tariffs are likely to increase the prices for U.S. consumers on a range of goods, most notably cars and trucks - through price increases on both parts and assembled vehicles - crude oil and petroleum products, cell phones, computers, toys and sporting goods, and apparel. To put the connectedness of the North American economy in perspective, it is worth noting that 47% of vegetables and almost 40% of fruits consumed by Americans, while approximately half of all car parts and assembled vehicles, make their way to the U.S. via our USMCA trading partners.

Overall, it is estimated that the average U.S. tariff rate will rise from 3% to over 10%. In aggregate, according to the Federal Reserve Model used to determine the impact of tariffs in Trump’s first term, U.S. GDP could decline by as much as -1.2%, with core PCE increasing by +0.7% based on the assumption that targeted countries will enact similar measures. Our view is that the impact will be much more muted, even if the tariffs are in place for several months.

With that said, the tariffs are likely to be much more damaging to Mexico and Canada than they are for the U.S. With 16% and 14% of Mexican and Canadian GDP, respectively, directly dependent on U.S. exports, any extended period of tariffs of this magnitude is likely to depress economic growth and the value of these currencies meaningfully. Should the tariffs remain in place for all of 2025, GDP could decline by as much mid-single digits for each Canada and Mexico, with a greater impact on Mexico.

It is not surprising, then, to see almost immediate retaliation from Canada, as Prime Minister Justin Trudeau encouraged Canadians to avoid U.S travel and announced a 25% tariff on the equivalent of $106 billion of U.S. goods over the course of the next four weeks. (Impacted goods include American beer, wine, and appliances.) Mexican President Claudia Sheinbaum has also announced plans to effect “corresponding countermeasures” which will likely be announced in the coming days.

As for China, the 10% tariff could represent only the starting volley in a longer-term engagement, as the main leg of tariffs on Chinese goods is likely to come closer to the beginning of April. To be fair, President Trump also closed a loophole that exempted packages valued at under $800 from tariffs; this will likely increase the scope of tariffs for Chinese apparel, which accounts for 30% of all apparel imported into the U.S. Admittedly, trade between the U.S. and China has declined over the last eight years, a trend that was accelerated by lingering supply chain dislocations following the Covid pandemic. Indeed, with Secretary of State Marco Rubio in Panama, and the current extension of TikTok availability hanging in the balance, President Trump may instead attempt to bring China to the table ahead of a more dramatic move.

While tariffs on Chinese goods were anticipated, the scope of the actions against Canada and Mexico were more of a bear case scenario for economists and investors. The Trump Administration is attempting to justify its decision to enact tariffs as a means to fulfill the President’s campaign commitment to deliver tighter borders to prevent illegal immigration and drug smuggling into the U.S.; the President is also calling for a rebalancing of global trade back towards the U.S. broadly and an increase in defense spending by our allies.

With that said, there is little evidence of widespread drug smuggling from Canada to the U.S., and the Mexican government has put forth meaningful mitigation measures over the last month to curb the inflows over the Southern border. The decision to tax energy imports from Canada, too, seems at odds with the recent proclamation of a National Energy Emergency by President Trump, as the U.S. is currently importing 40% of its crude oil usage annually. Interestingly, the fourth quarter U.S. GDP report showed signs that manufacturers were bracing for tariff activity, as a surge in imports swung the trade balance negative for the quarter.

There is still much for economists, investors, and policymakers to digest ahead of Tuesday’s deadline, and with stated asks from the Trump Administration to the governments of China, Mexico, and Canada, it appears to be a low probability that the tariffs would be averted by a negotiation before they go into effect tomorrow. In addition, the decision to enact the new tariff during the Chinese Lunar New Year celebration further delays a prescriptive response from the Chinese government. The legal foundation for the use of the IEEPA is in question, but an attempt to stay the outcome of President Trump’s decision is unlikely to come before the deadline. Finally, there could soon be a shift in attention to Europe, a long-time target of President Trump for what he views as an unequal commitment to both fair trade and defense outlays.

Our view is that there may be an attempt to negotiate the tariff terms between the U.S. and Canada/Mexico over the coming days, with the Trump Administration towing a hard line on commitment to further enhancement of border security and greater punishment for smuggling related crimes. The delicate dance with China is likely to extend out further, with expectations that tariffs will be ratcheted up over the coming months based on Beijing’s lack of follow through on its promise to purchase more American goods and agricultural products following the trade deal negotiated during Trump’s first term.

As for our outlook, we continue to believe that tariffs could result in modest shorter term inflationary effects, but substitution by U.S. consumers and producers’ attempts to cushion consumers from the full brunt of price increases could offset that risk. The one positive might be the impact on the U.S. fiscal situation, as tariff revenue could help to offset the cost of extending the 2017 Tax Cuts & Jobs Act (TCJA). However, with prices potentially on the rise, the U.S. government may need to cobble together additional support in the form of further tax breaks and lower energy prices to make the math work for U.S. consumers.

Equity markets are reacting negatively to this weekend’s news, as investors are already jittery following last week’s DeepSeek related selloff in AI stocks and looking ahead to potentially market moving U.S. manufacturing and jobs data later this week. The uneasy peace that investors enjoyed in the days following the inauguration has now descended into uncertainty, with gold, the VIX, oil, and the dollar on the rise, and U.S, developed non-U.S. and emerging markets equities all moving lower. Treasuries are reacting more to the threat of slower growth than higher inflation, with short term yields up slightly and longer term yields lower.

Despite the near term volatility that may result from these actions, we are not as of now anticipating a significant hit to U.S. growth or persistent increase in inflation; we expect that there will be discussions with Canada and Mexico in the near term given the potential impact to their economies of a protracted trade war. We also believe that the foundation for U.S. growth remains intact, underpinned by the strength of the U.S. consumer, and as such we continue to anchor to our current broad allocations – at target in equities, and overweight in investment grade fixed income – and encourage clients to revisit these allocations in light of these market fluctuations.