Market Wire: Trump Imposes Sweeping Tariffs on Canada and Mexico, Threatening to Ignite Global Trade War

Ending—and beginning—weeks of speculation, President Donald Trump has delivered details of his tariff plan to officials in Ottawa and Mexico City, raising taxes on most imports from Canada and Mexico to 25 percent, in a move that is likely to generate upheaval in the world’s largest integrated trading area and trigger another round of disruption in foreign exchange markets.

According to major Canadian news networks*, the president intends to authorise the implementation, as of Tuesday, of 25-percent tariffs on virtually all goods imports, alongside a 10 percent levy on Canadian oil and gas products. If deployed immediately, the increase would amount to the biggest one-year tariff increase since the Morrill Tariff of 1861, and would almost certainly invite retaliation from both countries.

All three countries have made last-ditch efforts to negotiate a delay. Many observers had hoped that pledges to increase border security and lift defence spending might deflect the threat, but Trump yesterday suggested that this was a lost cause. When asked if there was a chance that implementation could be averted for now, he said: "No, no. Not right now, no”... “It’s not a negotiating tool. It’s pure economic. We have big deficits with, as you know, with all three of them.”

If negotiations fail, Ottawa and Mexico City have reportedly prepared retaliatory measures, which are widely expected to include dollar-for-dollar tariffs on a wide range of politically-sensitive sectors, and would go into effect shortly, compounding upheaval at border crossings and shipping points over the coming weeks.

US trading partners face profound economic hardship.

If tariffs remain in place for a sustained period of time, Canada and Mexico stand to be disproportionately affected, given their heavy reliance on US markets.

Canada, which shipped 77 percent of its goods exports to the US in 2023, could see its manufacturing and energy sectors squeezed, while second-round effects might weaken business investment and consumer spending, putting upward pressure on unemployment rates even as imported goods prices rise. The Canadian dollar, which has depreciated roughly 5 percent since early October, could fall further in the coming days.

Mexico, which became the United State’s biggest import partner in 2023, could experience similar effects as exports are disrupted, investment crumples, and consumer spending falls. The Mexican peso, always sensitive to trade developments, is likely to come under renewed pressure as investors weigh the risk of slower economic growth and potential retaliatory tariffs.

Assuming that the country is also in scope, pain should be felt less acutely in China, where cost differentials are significantly wider, economies of scale are larger, and direct exports to the United States make up a far smaller share of gross domestic product.

The US economy could also suffer.

In the United States, the measures announced will provoke supply chain disruptions, push up consumer prices, and weigh on economic growth. Canada and Mexico account for approximately 14 percent of total US imports.

While they may provide some protection for certain domestic firms, tariffs will increase input costs for most importing businesses and create “bullwhip” effects across a number of industries. This is because importers themselves—not Canadian or Mexican exporters—will pay the higher taxes, forcing them to tighten margins or raise prices to consumers. Even where comparable in-country substitutes are available, supply chains will need re-routing, generating pandemic-like price effects as order and inventory cycles move in unpredictable ways.

The corporate sector will also take a hit to revenues: Canada is the largest single-country export market for US goods, absorbing $350 billion in sales in the year to November, Mexico is the second largest, buying $333 billion, and China is the third, with $143 billion. A significant share of S&P 500 earnings are generated in the three countries.

The president’s move to impose smaller duties on oil and gas movements could help lessen the blow, but almost 60 percent of the country’s crude imports come from Canada and 7 percent from Mexico, making up roughly a quarter of the oil US refiners turn into fuel: American consumers will undoubtedly pay more at the pump. Decades of evidence suggests that this will lift inflation expectations, forcing the Federal Reserve to move more cautiously in easing policy.

There are major uncertainties ahead as a series of complex economic interactions takes place, but an average of estimates prepared by non-partisan think tanks suggests that US gross domestic product could fall by a quarter percentage point while prices jump by a half a percent over the next year.

Tariffs are unlikely to deliver the desired results.

Trump has defended the measures as necessary to restore domestic manufacturing, reduce trade imbalances, and offset lower taxes in funding the US government, but mainstream economists—on both ends of the political spectrum—believe that tariffs are ill-suited to achieving any of these goals.

Relative to the services sector, US factory output has shrunk over the last three decades as automation has reduced returns to manufacturing physical goods. Although industrial policy choices in countries like China have tilted relative competitiveness levels against the US, the country’s trade deficit originates in domestic savings and spending imbalances and will not fall if import taxes are raised. Import volumes are not large enough to provide a tax base sufficient to significantly reduce the need for government income tax revenues.

Uncertainties have not been resolved.

More market volatility is in the offing, particularly if retaliatory measures are announced and the war of words between North American leaders escalates further.

Financial markets may undergo a painful adjustment process in the coming weeks as participants begin to take the president seriously and literally. Term premia in bond markets could rise as fixed income investors brace for a significant rise in issuance against a more volatile inflation backdrop. Equity markets are vulnerable to a correction as corporate earnings expectations are ratcheted lower.

We expect selling pressure to hit the peso and Canadian dollar at tomorrow’s Asia open, but it’s difficult to assess just how severe the move will be. Although the case for weakness in both currencies seems obvious, it is unclear how much has been priced-in in advance, and the potential for a quick turnaround is likely to weigh on speculative demand for longer term short positions. The immediate impact could be surprisingly modest, but exchange rates are likely to remain prone to violent and unpredictable moves as political developments outweigh underlying economic fundamentals in driving views on the future.

Bottom line: Turbulence is ahead. Please ensure your hedges are properly diversified, your cashflows are securely fastened, and all unnecessary exposures are safely stowed where they won’t cause injuries. Keep an eye on our market updates, and thank you for flying the Trump rollercoaster.

*Please see CBC here and CTV here. We have not viewed the documents directly, and will update you if we learn of any material discrepancies between news reports and what is formally announced.