Trump’s tariffs: the first shot in a trade war

Market recap

• Equity markets rose this week despite a new round of tariff threats by President-elect Trump.

• The S&P 500 rose 1.1%, led by health care and consumer discretionary, while energy and technology lagged.

• That leaves the index sitting at a record level heading into the final month of the year.

Tariffs

Last week, U.S. president-elect Donald Trump sent shockwaves through markets with the announcement that he would be imposing a 25% tariff on products from both Mexico and Canada—two of the United States’ closest trading partners. We know going into a second Trump administration that “tariffs” are his favourite word, so it’s not surprising that he is pushing hard on this front. But we also know that in a negotiation, you never start where you want to end up—Trump thinks of himself as a great dealmaker, which indicates that this could be a negotiating tactic, at least in part. Our expectation is that the new administration will implement some kind of tariff on Canadian goods, but it’s more likely to be in the 10% range for certain items rather than 25% across the board. It’s probable that the United States-Mexico-Canada Agreement (USMCA), which superseded the North America Free Trade Agreement (NAFTA), is the reason why Canada is being lumped in with Mexico in this new policy. The tactic from Canadian political leadership thus far has been to stress the ways that Canada and Mexico are different, emphasizing that the Canada-U.S. border is not nearly as big of a problem as the U.S.-Mexico border when it comes to illegal border crossings and drug smuggling. We think this approach may work, because Canada does have a certain amount of leverage: we are the largest purchaser of U.S. goods¹ and the United States is reliant on us for energy to an extent, especially if Trump aims to increase supply. That said, border security is clearly a priority for Trump, so we will have to demonstrate to his satisfaction that we have strong border control policies. Generally, markets are also not believing in the 25% tariffs as both Canada and Mexico barely saw their markets and currencies react to this. There’s no question that if a 25% tariff were to be implemented, it would likely have a significant impact on the Canadian economy.

Bottom Line: While it’s unlikely that Trump will implement a 25% tariff on Canadian goods, we do think Canadians should brace themselves for a tariff on certain goods in the 10% range.

China & Europe

Beyond Canada and Mexico, Trump’s other obvious tariff target is China. During the presidential campaign, Trump has promised a 60% tariff on Chinese goods. We don’t think it’s likely to be quite that high, but we nonetheless expect heavy tariffs. Tariffs could also be industry-specific: the electric vehicle (EV) industry, for instance, could see a higher tariff. Trump is also likely to look at countries that support China and implement higher tariffs there as well—this is one of the reasons why Mexico, an important Chinese trading partner, is unlikely to get off as easy as Canada might. On the European front, the Trump administration is likely to push back on E.U. anti-trust actions against the Magnificent 7 (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla)—not necessarily because he is pro-Tech, but because he’s opposed to other countries sanctioning American companies. If the E.U. backs off, they could see tariffs more comparable to Canada than Mexico or China. All of these potential tariffs are likely to affect global trade patterns—in fact, we’ve already seen some companies looking for alternatives to China on the supply side. Ultimately, tariffs will cause input costs to rise, and companies will have to determine whether that additional cost can be passed along to consumers (in the form of higher prices) or whether they will simply eat into their profit margins. Our expectation is that it will be a combination of both, which could cause inflation to rise. In the short-term, we believe the U.S. will win from this dynamic, because inflationary pressures won’t have an impact immediately. But as other countries respond to Trump’s tariffs with tariffs of their own, market volatility is likely to increase. If markets do drop, we wouldn’t be surprised to see Trump temper his actions—because ultimately, Trump seems to view market sentiment as a measure of winning.

Bottom Line: The Trump administration is likely to implement tariffs anywhere they believe it would create a competitive advantage for the U.S. We view Mexico and China as the areas of greatest concern, while Canada and Europe could get off comparatively easy.

Geopolitical Conflict

Recently, there have been mixed signals when it comes to the geopolitical situation—on the one hand, there has been positive news about a potential ceasefire in Lebanon, while on the other, France’s minority government appears to be in danger of losing a no-confidence motion, which could bring about another election less than a year after the country’s last vote. Russia and Ukraine may eventually agree to a ceasefire, but it’s unclear whether that would truly end the now nearly three-year-old war—especially since Trump is unlikely to support any proposals introduced under President Joe Biden. Likewise, in the Middle East, it’s unclear whether a ceasefire in Lebanon would extend to the West Bank or Gaza. Overall, we expect 2025 to be a year of heightened geopolitical risks, and what we’re seeing now is some of those uncertainties begin to emerge more forcefully. In France and elsewhere, newly-elected leaders will be testing their negotiating power with Donald Trump and his administration, especially with regard to the trade issues discussed previously. In addition to the ongoing conflicts in Ukraine, the Middle East, and elsewhere, we expect an increase in political volatility in the coming year.

Bottom Line: Geopolitical risk is likely to rise in 2025, and despite some positive signs, it remains unclear when ongoing conflicts may be resolved.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled “Trump bump”: Why markets have rose-coloured glasses on, for now.