US President elect Trump has promised to implement comprehensive tariff policies on Canada and Mexico. The proposed measures include imposing a 25% tariff on goods imported from Canada and Mexico, citing allegations that these two countries facilitated illegal immigration and facilitated fentanyl abuse. These measures mark a sharp escalation of trade policy and may have significant impacts on all parties involved.

The impact on Canada and Mexico

The unexpected tariffs on Canada and Mexico have raised concerns that Trump intends to restart the US Mexico Canada Agreement (USMCA), which has governed free trade among the three countries since 2020. Trump seems keen on expanding the scope of trade negotiations to include non trade issues such as immigration, security, and drug control.

For Mexico, the risk is particularly high because over 80% of its exports are to the United States, including fresh agricultural products, automotive parts, and steel. Similarly, Canada has deeply integrated into the US economy, providing important resources such as oil (accounting for 60% of US imported oil) and metals such as aluminum and steel. The interruption of these close economic ties will affect the entire industry, increasing costs for both businesses and consumers.

In the United States, tariffs may significantly increase the prices of imported goods, including Mexican agricultural products, Canadian timber, and automotive parts that cross borders multiple times during the production process. The automotive industry, which heavily relies on the Mexican supply chain, will be particularly vulnerable and face higher costs that will ultimately be passed on to consumers.

Potential retaliation from trading partners and broader economic risks

Both Mexico and Canada have a history of retaliating against US tariffs, as seen in 2018 when Mexico imposed tariffs on US steel, pork, cheese, and apples in response to steel tariffs. Mexican President Claudia Xienbaum has stated that if Trump fulfills his threats, Mexico is willing to retaliate. Mexico's tariffs may target major US export products such as corn, milk, and pork, which are crucial to Trump's support base.

Canada has more trade with the United States than China, Japan, France, and the United Kingdom combined, and Canada may also take retaliatory actions. Any interruption in Canadian oil or metal exports to the United States will affect energy prices and industrial costs, further putting pressure on the US economy.

The introduction of new tariffs may have a profound impact on the global economy, which is just beginning to recover from inflationary pressures and rising interest rates. The US Mexico Canada trade group achieved $1.6 trillion in trade in 2023, highlighting the deep integration of these economies. Disrupting these relationships will harm all parties involved, as businesses face higher costs, consumers bear the brunt of price increases, and exporters face the risk of losing market access.

The threat of US tariffs may threaten the progress of the Federal Reserve

Trump's tariff threats against Canada and Mexico are a high-risk gamble that could have wide-ranging consequences.

For the United States, these measures may drive up costs for businesses and consumers, while also inviting retaliation that threatens critical exports. These policies may push up inflation, thereby having a significant impact on the Federal Reserve's monetary decisions. American companies that rely on imports may experience significant cost increases due to tariffs and pass them on to consumers at higher prices.

The upward pressure of inflation may force the Federal Reserve to adopt a more cautious approach in cutting interest rates than initially expected. As a result, borrowing costs may remain high for a longer period of time, thereby increasing financial pressure on households and businesses.

For Canada and Mexico, which have close economic ties with the United States, this disruption could hinder economic growth and destabilize key industries.

Policy makers, business leaders, and consumers will closely monitor these developments, realizing that their consequences may reshape the trade dynamics of the coming years. Investors and traders can also leverage these dynamics to improve their portfolio allocation and take advantage of potential short-term trading opportunities brought about by rising volatility.