Here come the tariffs: why it’s too soon to draw conclusions

Well, after much anticipation, it’s happened: Over the weekend of February 1–2, 2025, the Trump administration announced that it would levy 25% trade tariffs on imported goods from Mexico and Canada (10% on Canadian energy products) and an additional 10% tariff on imports from China. The good news for both Canada and Mexico is that they’ve been granted 30-day reprieves from the tariffs after agreeing to make some border-related concessions to the United States. China’s reaction to the announcement has, so far, been muted.

The question now looms: If we’re back here again in a month, where would we be focused?  

Until we get more details, we can’t be too sure

These latest developments were a lesson in just how fluid—and anxiety-inducing—the ongoing tariff negotiations can be. But let’s examine the deal as it stands now.

On the face of it, we believe tariffs of this magnitude would likely bring U.S. economic growth to sub-trend levels and push domestic inflation modestly higher for a time. The net impact on Canada’s economy could be much more pronounced: We’d expect a moderate to severe recession there, along with stronger inflationary pressures than in the United States, the peak effects of which would likely set in toward the end of 2025 and into early 2026. The Bank of Canada’s scenario analysis forecasts about a 4% hit to GDP over the next two years.  

However, there are pressing questions that still need to be answered, such as: (a) is what’s just been announced really what U.S.-imposed tariffs will ultimately look like (for better or for worse)?; and (b) if so, how long will these tariffs last?

At present, Wall Street’s broad expectation is that the U.S. tariffs in their current form are unlikely to persist and that a much scaled-back version of them will more realistically be the final landing spot. Moreover, if the impacts of said tariffs prove to be transitory, that would be a very different outcome than if we were to see a permanent shock to global economic demand. 

We believe tariffs of this magnitude would likely bring U.S. economic growth to sub-trend levels and push domestic inflation modestly higher for a time. The net impact on Canada’s economy could be much more pronounced.

Medium term, the Fed and the BoC may shift gears

In the medium term, we think the tariffs imply that the U.S. Federal Reserve (Fed) and the Bank of Canada (BoC) may cut their policy interest rates more than expected:

• The argument for the BoC to cut deeper is straightforward. While inflation in Canada would likely drift higher, the negative effect on its growth could far outweigh inflation risks, and the BoC would be inclined to approach its decision-making accordingly. The reason for this stance, in our view, is that an inflationary tariff shock would likely be short-lived, while the drag on economic demand could be more enduring. Against this backdrop, lower Canadian bond yields and a weaker Canadian dollar are likely to result.
• The argument for the Fed is less clear and more nuanced. That’s partly because the U.S. economy is in a far healthier state than Canada’s these days. Also, the impact of the tariffs on U.S. growth would be less severe than in Canada, potentially allowing the Fed to proceed at a more measured pace and perhaps prioritize keeping inflation down. Alternatively, the Fed could opt to deemphasize inflation, especially if indicators like wage growth and shelter-related inflation slow further.

At this juncture, while we think the Fed is unlikely to cut rates at its next policy meeting or two, we continue to expect the full monetary easing cycle to eventually lead to a terminal federal funds rate of about 3.50%, which we estimate to be slightly above the long-term neutral U.S. policy rate. 

Final thought: don’t overreact to tariff headlines

We would echo the tried-and-true guidance recently offered by our colleagues on the Capital Markets Strategy Team: Resist the urge to overreact to every breaking newsfeed or social media post—a market mantra that has been borne out time and time again over the years. We get the sense that the initial salvo in this brewing trade war is just that —an initial salvo, and that the actual implications for economies around the world may ultimately look very different from what we see in front of us right now.

Check out our 2025 global outlook, Five macroeconomic themes for 2025: a global economy in transition, to learn more.

Resist the urge to overreact to every breaking newsfeed or social media post— a market mantra that has been borne out time and time again over the years.