The effective U.S. tariff rate is now at its highest level since the 1940s after U.S. President Donald Trump signed an executive order to impose 25% tariffs on Canada and Mexico on March 4. A new order was also signed for China, increasing tariffs to 20% from 10%.
In our previous notes (here, here, and here), we estimated the potential shock to the North American economy resulting from a prolonged trade war. If these tariffs are kept in place in the months ahead, we expect to see slowing growth, an uptick in inflation, and a hit to consumer and business confidence. As we continue to monitor the situation, we have put together a list of frequently asked questions about the impact of these tariffs on the U.S. economy.
1. How important is U.S. trade with Canada, Mexico, and China?
Canada, Mexico, and China combined account for 40% of U.S. trade. These regions make up a sizeable share of essential imports for energy products and groceries, alongside automobiles and intermediate products necessary for U.S. manufacturing. American consumers rely on these imports since consumer demand exceeds domestic production for many goods. The implementation of tariffs is likely to have a significant near-term impact on the U.S. economy, because the U.S. is not able to immediately ramp up oil production, grow more produce or increase production capacity for many goods.
2. Will there be a recession and how will this impact U.S. growth?
We are not expecting the impact of tariffs to cause a recession in the U.S. However, if tariffs are left in place for three months or more, we will likely see no growth for the U.S. economy in 2025. We expect odds of a recession in Canada to climb rapidly in this scenario. For now, we don’t know how long the tariffs will last, especially since they are not solely economically motivated. But, if the current political climate is any indication, trade disruption will continue to be a key theme throughout the year and will add to uncertainty. That uncertainty will continue to weigh on investment activity as businesses struggle to make decisions amid a noisy and volatile backdrop.
3. Which sectors will be hit the hardest?
North America’s manufacturing sector is highly integrated and would, therefore, be hit the hardest from tariffs on imports with key trading partners. The auto manufacturing sector is, particularly, exposed. U.S. intermediate products account for a significant share of imported goods from Canada and Mexico as it crosses the border through multiple stages of auto production. Agriculture is another sector that would be significantly impacted since Canada, Mexico, and China account for roughly half of U.S. agricultural imports. China accounts for close to $100 billion of U.S. non-durable imports including chemicals, pharmaceuticals, paper products, and textiles.
4. How easy is it for the U.S. to “reshore” the most impacted sectors?
Reshoring is not as simple as it sounds. In fact, in the short term, reshoring is very difficult as significant levels of capital investment take years to plan and execute. The ability to produce goods domestically requires investment in land, factories, and machinery equipment and those decisions are challenging in a high-interest-rate environment. In the medium term, new supply chains would need to be established, adding to operating costs. In the longer term, the U.S. is facing labor supply constraints, limiting the production capacity of any new factories. The aging population is resulting in a record number of retirements. In particular, 26% of workers in manufacturing are over age 55. Added to this, the decline in immigration and notable geographic and skills mismatches in the manufacturing sector suggests reshoring activity may need to be capital intensive and could result in limited job creation.
5. How might tariffs show up in U.S. inflation measures?
Tariffs will very likely result in higher prices for U.S. consumers. Since it is difficult to substitute away from many imports from key trading partners, we expect to see the cost of tariffs passed on to domestic producers (as measured by the Producer Price Index), and ultimately, consumers (as measured by the Consumer Price Index). This would likely create sticky inflation above 3% through year-end. Prices for essentials will likely increase the most including groceries and energy. Goods prices will face upward pressure, removing much of the deflationary forces seen over the past year. We estimate that inflation could increase by 50 bps by year-end if tariffs are enforced beyond 3 months.
6. How will tariffs impact U.S. consumers?
Tariffs will impact all U.S. consumers, but the burden will be heavier for low-and-middle-income earners, who devote a greater share of their take-home pay to purchasing essentials. In the aftermath of the pandemic when inflation surged, the 25% uptick in energy prices felt more like 30% for America’s lower-and-middle income households. Tariff-driven price increases will add to the pressure these households are still contending with and will erode consumer confidence further.
7. How much revenue could tariffs generate for the U.S.?
Based on 2024 import data from Canada, Mexico, and China, the announced tariffs could boost total U.S. tariff revenues by about $300 billion, assuming demand remains unchanged. This would amount to roughly one-third of the annual cost of Trump’s proposed extension to the Tax Cuts and Jobs Act. However, this doesn’t take into account the fact that demand for imports from regions affected by tariffs is likely to shrink as producers attempt to source products from non-tariffed countries. This could be particularly acute for consumer-related sectors as U.S. consumers continue to be squeezed by inflation and look to reduce their demand for goods with rising prices. The ultimate boost to revenue is likely to be smaller than the $300 billion noted above, considering reduced demand and potential substitution effects.
8. How easy or difficult is it to substitute away from tariffed imports?
Many of the imported goods are not easily substituted in the U.S. economy. For example, Canada, Mexico, and China account for 60% of aluminum, lumber, and energy product imports. Energy infrastructure takes years to develop, and the U.S. is highly dependent on Canada for electricity imports (specifically in the Northeast) in addition to crude oil due to geographic proximity. Moreover, nearly one-third of fruits and vegetables consumed in by Americans are imported from Canada, Mexico, and China. Agricultural production is constrained by environmental factors, and the U.S. would need to import from other regions. Distance adds to logistical challenges, which would likely add to shipping costs.
9. How might the U.S. Federal Reserve respond?
The Fed is in a tough position since the U.S. will likely face both higher inflation and weaker demand for U.S. products from abroad and domestic consumers grappling with higher prices. According to our U.S. Rates Strategist, Blake Gwinn, “The downside risks of additional cuts have significantly increased. The longer these tariffs remain in place, and the broader the trade war gets, the more likely it gets that we will be adding cuts back into our 2025 outlook.”
