Macro Signposts | 26 March 2025
Trade Policy and the U.S. Economy in 2025
U.S. trade policy has rattled markets, unnerved trade partners, and put investors in a bind: They can hesitate and miss opportunities or act boldly and risk their strategies backfiring after the next policy pivot.
Next Wednesday is the Trump administration's deadline to release more details on its strategy to impose reciprocal tariffs that match trade barriers faced by U.S. exporters. Although hopes of a more targeted tariff strategy have buoyed the stock market this week, which had fallen about 10% since February, a troubling reality remains: The average effective tariff rate has already risen sharply and is likely to remain elevated if not rise further, creating a meaningful headwind to U.S. growth and an unwelcome tailwind to inflation.
Despite lots of volatility around the details of the administration's trade policy implementation (what and whom to tariff, and when), the administration has been incredibly consistent about its objectives: Reduce the U.S. trade deficit with the rest of the world, reduce federal fiscal deficits, and increase manufacturing investment in the United States. The administration views tariffs as a key policy tool to accomplish these goals.
The deadline on reciprocal tariffs
A 13 February executive order by President Donald Trump set 2 April as the deadline for agencies to investigate foreign trading practices that contribute to the nation's large and persistent trade deficit. The administration aims to impose reciprocal tariffs that match both tariff and non-tariff trade barriers faced by U.S. exporters. In our 20 February 2025 Macro Signposts, "Reciprocal Tariffs: The Trump Administration's New Trade Strategy," we viewed the order as foreshadowing a likely substantial increase in the effective average tariff on U.S. imports this year – especially imports from countries where the U.S. runs large trade deficits (Germany, Ireland, Vietnam, Korea, Japan, and others).
On Monday, President Trump reiterated comments from unnamed officials that product-specific tariffs are still in the works (though unlikely to be implemented next week), and that a lot of countries could get "breaks" on tariffs. Equity markets, which had been in correction territory, bounced higher after the news.
Whatever announcements are made next week or beyond, we believe that the U.S. effective average tariff rate on imports will rise further and remain higher than it was when Trump took office in January. We see several reasons for this.
Tariffs already enacted are likely to continue
The U.S. effective average tariff rate has already increased by about 6 percentage points (ppts) in 2025. This includes an additional 20 ppts on Chinese imports plus about 12–15 ppts on imports from Canada and Mexico. Specifically, tariffs on goods from Mexico and Canada that aren't compliant with the U.S.–Mexico–Canada Agreement (USMCA) jumped by 25%, affecting about 50%–60% of total goods imported from these countries.
Many producers never gained official USMCA compliance due to administrative costs, as most-favored-nation rates on many products were either low or zero. Many may now seek compliance to avoid new tariffs, while others will likely struggle. For example, Mexican assembly plants have enabled some Chinese firms to circumvent U.S. tariffs without having to comply with the USMCA rules of origin.
Eventually, these tariffs could subside as more producers gain USMCA compliance or the U.S. negotiates additional measures into the USMCA agreement. For example, the U.S. would like Mexico and Canada to match U.S. tariffs on China and/or block Chinese manufacturing investment designed to circumvent U.S. tariffs on China. However, in the meantime, a higher level of scrutiny on applications for USMCA compliance, which could lead to administrative delays, will keep the U.S. tariffs on Mexican and Canadian imports elevated for now. There is also a possibility that Trump decides to soften or eliminate these tariffs altogether; after all, tariffs on nontrade measures may not have the same longevity as those that strictly seek to address trade issues.
Further tariffs are expected, targeting more trade partners
The latest signals from the White House suggest that tariffs targeting trade partners with the largest deficits still remain a reasonable expectation and could further increase the average effective tariff rate. Many questions surround the exact substance and timing of tariffs; however, we think the end goal is to adjust U.S. import tariff rates based on the Trump administration's assessment of both tariff and non-tariff barriers. For non-tariff barriers, the devil will be in the details, but the administration has suggested that a country's value-added taxes, currency policy, and anything else that is deemed unfair to U.S. exporters could potentially be included.
In terms of the magnitude of the additional levies, if the U.S. levies an average 10% tariff on the non-USMCA countries with the largest trade deficits to replicate those countries' tariff and non-tariff barriers to U.S. exports, then the U.S. effective average tariff would increase by roughly 4 percentage points. The countries of focus are likely to be mainly in Asia (Japan, Vietnam, Korea, India, Malaysia, and Indonesia) and Europe (Germany, Italy, France, Austria, Sweden, Switzerland).
The timing of the actual tariff increase would depend on which section of U.S. trade law the administration uses to support actions. The International Emergency Economic Powers Act (IEEPA) was used to justify the quick implementation of higher tariffs on Mexico, Canada, and China based on national security grounds. However, to implement a broader range of reciprocal tariffs, the administration may turn to other sections of U.S. trade law (e.g., Section 301) that offer more flexibility for exceptions but require deeper investigations (which will inherently take longer) into unfair trading practices in order to withstand legal challenges. These investigations could take six months or more, putting likely implementation in the latter half of this year.
Product-specific tariffs would increase the overall rate
Though they are not likely to be implemented on 2 April, additional product-specific tariffs – beyond the steel and aluminum tariffs already announced – are still likely in the "near future," as Trump said on Monday, speaking about autos, pharmaceuticals, and semiconductors. Justifying product-level tariffs using Section 232 of the trade law, which provides more flexibility and legal durability, also requires extensive investigations and reports.
We estimate that levying tariffs on autos, pharmaceuticals, and semiconductors could add 3 percentage points to the U.S. average effective tariff rate, depending on exclusions and other details.
Net impact on U.S. economy
Taking a step back from the headlines, we continue to expect a substantial increase in the U.S. average effective tariff rate in 2025 and 2026 to weigh on U.S. growth and boost inflation. While Mexico and Canada tariffs could eventually diminish, they are likely to be offset by higher tariffs on countries with significant trade surpluses with the U.S., as well as tariffs on products where there are national security arguments to having domestic sources of production.
Although the potential medium-term benefit of all of this could be a more balanced global trading system, with more resilient supply chains, we expect it will come at a cost of some cyclical economic disruptions. Policies that raise the average effect tariff rate by 5–10 ppts would likely drag down U.S. real GDP growth by about 0.5–1.0 ppts annually and boost inflation by a similar amount. Producers and consumers would have to absorb the larger near-term costs of consuming and investment in the U.S. until higher levels of domestic production can be secured.
Investors should also keep in mind that regardless of the exact scope and timing of policy implementation, economic and specifically trade policy volatility and uncertainty are likely here to stay, and are also likely to continue to weigh on investment and hiring decisions.
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