Trump’s tariff Playbook

How tariffs against top trading partners could backfire

• 25% tariffs on Mexico and Canada along with 10% tariffs on China would reduce US GDP by 1.5% in 2025 while raising inflation by 0.4 percentage points (ppt).
  
  
• Mexico and Canada would face a GDP loss of over 4% by 2026. 
   

President-elect Trump recently announced on social media that he would impose additional 10% tariffs on merchandise imports from China and 25% tariffs on merchandise imports from Mexico and Canada on day one of his presidency.

While many observers doubt that Trump will follow through on these tariffs, it does offer insights into his strategy. As we have previously noted, trade policy is expected to be transactional over the next four years with protectionist measures used to extract trade, immigration and other political concessions from trading partners and competitors.

The simultaneous targeting of Mexico and Canada with substantial 25% tariffs hints at a negotiation tactic. Historically, Trump has walked back from similar threats upon assessing the broader economic impact and financial markets’ reaction, hinting at a strategic use of tariff threats to secure concessions. The broad announcement is likely aimed at bolstering a tough trade stance and preparing the ground for intricate negotiations in the lead-up to the United States-Mexico-Canada Agreement (USMCA) joint review in 2026, rather than immediate tariff implementation.

The additional 10% tariff proposal on Chinese imports points to a more cautious approach and seems to align with ongoing diplomatic efforts rather than an outright economic confrontation. This calibrated approach suggests an opening gambit in a longer negotiation process. Trump’s strategy likely involves using tariff threats as leverage, providing China a “last chance” to align with the Phase One trade deal commitments, particularly in areas critical to US interests such as fentanyl control.

We have regularly stressed that steep tariff increases against US trading partners could lead to a stagflationary shock via a negative economic impact and a significant inflationary impulse, while also triggering financial market turbulences.

Building a scenario

To better comprehend the risk, we modeled a scenario factoring 10% tariffs on merchandise imports from China and 25% tariffs on merchandise imports from Mexico and Canada, assuming proportional retaliation against US exports. This scenario assumes that Trump would impose the tariffs using the International Emergency Economic Powers Act (IEEPA) in 2025 Q1.

The IEEPA gives the president the authority to regulate commerce after declaring a national emergency if they believe there is an “unusual and extraordinary threat” to the US's national security, foreign policy or economy.

President Richard Nixon levied a 10% across-the-board tariff on imports in August 1971 to force other countries to revalue their currencies against the dollar – using the Trading with the Enemy Act of 1917. But no prior president has used the IEEPA to impose tariffs on trading partners. Trump threatened to use the IEEPA to slap tariffs on Mexico during his first term, but he never followed through.

Economic consequences

The impact of these actions on the US economy would be significant, with US real GDP growth reduced by 1.5% in 2025 and 2.1% in 2026. The increased cost of imports would lift consumer price inflation by 0.7ppt in Q1 and an average of 0.4ppt in 2025. The upward pressure to inflation would be transitory as demand destruction, US dollar appreciation and a Fed only gradually reducing monetary policy restraint would be disinflationary.

Given that Mexico’s exports to the US represent about 30% of its GDP — exports represent about 37% of Mexican GDP and exports to the US represent about 80% of total exports — its economy would be significantly impacted, with real GDP lower by 1.6% in 2025 and 4.5% in 2026. Factoring retaliatory tariffs, Consumer Price Index (CPI) inflation would rise above the baseline by nearly 2ppt, lifted by higher import prices and a depreciated Mexican peso.

Canada’s significant exports to and imports from the US would lead to a notable hit to its economy with real GDP lower by 2.7% in 2025 and 4.3% in 2026. Factoring retaliatory tariffs, CPI inflation would rise above the baseline by nearly 4.5ppt, lifted by higher import prices and a depreciated Canadian dollar.

China would experience a smaller shock from lower tariffs (10% versus 25% for Mexico and Canada). Real GDP would be reduced by 0.3% in 2025 and 0.7% in 2026. Factoring retaliatory tariffs, CPI inflation would rise above the baseline by 0.1ppt, lifted by higher import prices and a depreciated renminbi.

At the global level, real GDP would be reduced by 0.6% in 2025 and 1.1% in 2026.

Translating tariff tactics
 

Trump’s tariff threats can be interpreted as diplomatic levers aimed at reshaping global economic dynamics including trade, immigration, defense spending, illicit drug trafficking and several other priorities. However, imposing broad tariffs on Mexico and Canada without justified cause would likely violate the USMCA — the very framework developed under the first Trump administration to replace the North American Free Trade Agreement (NAFTA) to govern free trade among the three nations.

The USMCA explicitly prohibits customs duties on goods originating in member countries. While the agreement does allow for certain exemptions, such as national security measures, these cannot be applied arbitrarily. Any misuse of these exemptions could trigger legal challenges.

As the global economic community watches closely, the stakes are high in terms of potential economic consequences. Whether these threats will materialize into action or be leveraged diplomatically remains to be seen.