Last week, President Trump announced sweeping tariffs—25 per cent on all automotive imports into the US, alongside a blanket 10 per cent tariff on all incoming goods, with some countries facing even steeper “reciprocal tariffs.” The fallout has been swift.
In 2023, average tariffs levied by other countries on the US were 4.6 per cent higher than the 2.2 per cent levied by the US during the same period. If reciprocal tariffs had resulted in only a 2.4 per cent increase to the US tariff rates, the global economy could have adjusted relatively smoothly.
However, with the 10 per cent universal tariff and much higher ‘reciprocal tariffs,’ the average tariff rate soars to somewhere around 22-25 per cent. If sustained, these significantly higher tariffs will provoke retaliation, potentially triggering recessions both in the US and globally, while also boosting inflation and slowing productivity growth.
The rationale for these tariffs is based not on the tariffs other countries impose, but rather on a bizarre metric: the ratio of US net exports to imports. This view overlooks key factors, like the huge US budget deficit, which is a key contributor to the trade deficit, and the trade-weighted value of the US dollar, which is too high to achieve trade balance. As a result, American goods are too expensive for foreign buyers, while cheap foreign goods flood the US market.
While most countries are still determining a response, China has imposed an additional 34 per cent tariff on all US goods, along with other measures. Canada has imposed tariffs on US autos in response to those on Canadian-built autos. We expect other countries will retaliate, hopefully in a measured way. This could involve not applying tariffs on US intermediate goods necessary for production, imposing tariffs on goods for which more alternatives exist (e.g., agricultural commodities), or targeting machine tariffs, given that US machinery manufacturers are highly dependent on exports.
If these tariffs stick, the economic impact could be severe.
In 2024, US imports were about $3.3 trillion, or 11 per cent of nominal GDP. Assuming only half of tariff costs are passed on to consumers—which is a very optimistic scenario—the average tariff rate would rise from 2 per cent to 25 per cent, causing prices to increase by around 1.3 per cent. However, based on the supply chain disruptions experienced during COVID, I expect that price increases could be closer to 2 per cent.
The economic impact on the output side will be felt by consumers through higher prices, lower savings and reduced wealth as stock prices fall. Businesses will be reluctant to hire or commit capital in anticipation of a potential recession. They will also be reluctant to hold inventory for fear that, if tariffs are reversed, they could be stuck with expensive inputs. With this uncertainty, it is unlikely that businesses will invest in building the manufacturing facilities the President desires.
In a tweet on Friday, the President urged the Federal Reserve to cut rates immediately, accusing Fed Chairman Jerome Powell of playing politics by not doing so. However, in a speech a few hours later, Powell emphasized the uncertainty surrounding the impacts of tariffs and the administration’s other policies on inflation and economic growth, stating that it was too soon to determine the appropriate path for monetary policy. Despite this, markets are now betting on four 25-basis point rate cuts in 2025, with the first likely occurring at the Fed’s next meeting on May 7th.
However, accelerated monetary easing could worsen the situation if it’s seen as a sign of panic or a surrender of Fed independence. The Fed has only priced in two rate cuts, and the market expects the central bank to focus more on growth than inflation. Weaker oil prices have fuelled this view. Concerns about a global economic slowdown, combined with OPEC+’s surprising decision to increase production, have led to sharply lower oil prices, which should contribute to lower headline inflation.
Senate Budget Committee Chairman Lindsay Graham announced that he would use “current policy” as the baseline for scoring the reconciliation bill. This approach wouldn’t change actual spending or taxation levels but could create the impression of additional room for fiscal stimulus.
The third option is for a pivot on tariffs. The President could announce that, while retaining the 10 per cent universal tariff, he will suspend the broader reciprocal tariffs for six months to allow time for negotiations with trading partners. Even so, a 10 per cent tariff alone would leave the economy vulnerable to higher inflation and slower growth. The Bank of Montreal is expecting “an ebbing of the trade war within six months.”
Six months is a lifetime for markets. As of last Friday, the S&P 500 had fallen 16 per cent from its February high. Over the weekend, US administration officials issued contradictory statements on trade taxes, causing investors to question whether there is a coherent masterplan. The President, taking time from his golf weekend, posted twice that equity declines were “on purpose.” Unsurprisingly, Asian equity markets crashed. The downward momentum has continued, with North American indices down 2.0 per cent to 4.5 per cent by mid-Monday morning.
With a weaker growth outlook, US bond markets rallied, with 10-year rates now down below 4 per cent. Canadian rates have also moved lower, though not as sharply, given our lower starting point.
Canada was spared from the reciprocal tariff regime, and the initial 25 per cent tariffs were held in abeyance for USMCA-compliant goods. However, we still face 12.5 per cent tariffs on our second-largest exports—autos—and 25 per cent on steel, aluminum and non-compliant goods. In response to the auto tariffs, Canada has retaliated with a 25 per cent reciprocal tariff on US assembled vehicles, though not on auto parts.
While the ideal resolution would be an early off-ramp on tariffs, we can expect that ongoing trade irritants—such as lumber, identified as a flashpoint back in January—will remain a source of tension between Canada and the US in the months ahead.
Housing Affordability Watch
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The Liberal Party’s plan to tackle Canada’s housing affordability crisis promises bold solutions, but how realistic are they? From modular housing to a new government entity for affordable development, the plan is ambitious, but the details are unclear. Will these lofty targets lead to real change or fall short?
Read the latest Housing Affordability Watch to explore the key components and challenges of the proposed plan: The Liberal Affordable Housing Plan – Lofty Ideas, but Light on Details
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