This past weekend, President Trump announced plans to implement a 25% tariff on imports from Canada and Mexico, as well as an additional 10% tariff on imports from China. These tariffs are set to take effect on Tuesday, February 4. (As of this writing, tariffs directed toward Mexico and Canada are reported to have been delayed one month.) Additionally, the European Union may be next in line for similar tariff measures, according to the President’s statements. The tariffs are being introduced under the International Emergency Economic Powers Act, with the stated objective of addressing illegal immigration and fentanyl smuggling into the United States. This announcement has raised concerns about the potential for a global trade war, as these tariffs could provoke retaliatory measures from affected countries, further escalating tensions in international trade.
Impact on Canada and Mexico
The tariffs could have severe negative consequences for the Canadian and Mexican economies, potentially pushing both countries into recessions. Given their strong economic ties to the U.S., particularly in trade and manufacturing, there are concerns that these new tariffs could create substantial strain on their economic growth.
Impact on U.S. Inflation
For the U.S. economy, tariffs are expected to add to inflation pressure. Economists had been forecasting that the Federal Reserve’s primary inflation gauge, the core Personal Consumption Expenditures (PCE) index, would decline over the course of 2025 toward the Fed’s 2% target level. However, the tariffs could push inflation closer to 3%, which could reduce the likelihood of further interest rate cuts by the Federal Reserve. While the market had been expecting one to two rate cuts in 2025, there is now market chatter of whether the Fed might not only halt the plan to cut rates but may need to raise interest rates instead. At this time, we believe that a rate hike is unlikely in the near term, and that the Federal Reserve will likely maintain current rates until there is clear evidence that a rate hike is necessary.
Uncertainty Surrounding the Tariff Policy
Beyond the basics of the announcement, there are still many unknowns regarding the future of these tariffs. Key variables include the duration of the tariffs, whether they will increase over time, the possibility of further tariffs on additional countries, and potential retaliatory actions from other nations. Given these uncertainties, it is difficult to predict the precise economic impact, and caution is warranted in any forecasts.
The introduction of tariffs could lead to several negative outcomes for the U.S. economy:
In January 2025, the stock market largely ignored concerns surrounding the new tariffs, with the S&P 500 rising 2.8%. Several factors contributed to the strong performance, including continued positive economic data from the U.S., encouraging earnings reports, and supportive monetary policy from the Federal Reserve.
The first trading day of February saw increased volatility, as markets began to react to the news and digest the uncertainty surrounding tariff policies. President Trump is reportedly in discussions with Canadian and Mexican leaders, which could result in a last-minute concession and even a reversal of the tariff measures. We also recognize that if tariffs are implemented as planned, market volatility observed in early February could be the beginning of a more turbulent market environment, which is in line with our expectations for 2025 (as noted in our post, Year-End 2024 Investment Commentary).
While we are not intending specific portfolio changes in response to the tariff developments, we do want to discuss our current positioning and how tariffs affect our thinking.
Fixed Income:
In the current uncertain environment, we are maintaining a preference for short-term investment-grade bonds. These securities offer attractive yields with relatively limited fundamental risk. With rising inflation risks due to the tariffs, we believe that short-term bonds remain the safer option, as long-term interest rates may rise in response to inflationary pressures.
Equities:
We are working to add exposure in our portfolios to U.S. mid-cap stocks. We believe that mid-cap companies, which tend to be more domestic-focused, are better positioned to weather economic disruptions compared to large-cap companies that are more likely to derive significant revenue from international markets. In making room for this allocation we may trim smaller cap equities, as mid-cap stocks generally offer better operational flexibility than small-cap stocks, which are more vulnerable to debt and cost pressures.
The imposition of tariffs is a significant development that introduces uncertainties for global trade, the U.S. economy, and financial markets. While headlines will create volatility, we keep in mind that Trump is motivated by transactions and negotiations, understanding the advantageous position the U.S. is in when it comes to trade, and may use this as leverage, so negotiations could take many forms with varying results. With that said, tariffs that do get imposed could have far-reaching effects, particularly on inflation, corporate earnings, and global trade dynamics.
While sustained tariffs will have meaningful impacts on the Mexican and Canadian economies, the trade war situation with Europe and China will likely have a more material impact on financial markets. A key date we are watching is April 1, which is the deadline Trump has given for research to be completed on trade and trade deficits. We will continue to closely monitor the situation for further developments.
Please feel free to reach out to your advisor with any questions about this topic or your individual situation.