11/27/2024
After initially proposing tariffs of 60% on China and ~10% for every other country, on Monday, President-elect Trump changed his mind and promised he would slap a 25% tariff on all products from Mexico and Canada as well as an extra 10% on China when he takes office on January 20. In today’s strategy incubator, we analyse the possible impact of both scenarios on the Canadian dollar and US inflation. Here are our key findings:
Why a 25% tariff on all Canadian products appears unlikely. Looking at Canadian exports to the US by product, energy comes on top at ~29% (Figure 1). Honestly, we view a big chunk of Canadian exports as strategic for the US. On energy, why would Trump slap 25% tariffs and run the risk of seeing higher prices at the pump? This would go against his promise to contain inflation. Could Trump be using the 25% tariff threat as a bargaining chip? We believe cool heads will prevail and expect a more moderate ~10% tariff on Canadian and other non-Chinese imports (i.e., scenario 1).
Impact of Trump 2.0 tariffs on the Loonie. US export markets cannot be overlooked from a Canadian perspective. Over the past year, 77% of Canadian exports landed south of the border (Figure 2). Just as important, Canadian exports account for 33% of GDP. Assuming the CAD$ plays its role as a macro stabilizer with 50% absorption, for the 10%/60% tariff mix (scenario 1), this would imply CAD$ depreciation of ~5%. In the 25%/70% mix (scenario 2), it would be ~13% depreciation. Since the CAD$ is already down ~4 cents (or 5%) from its 2024 peak of ~75 cents, we see CAD$ supports at ~71 cents for scenario 1 and 66 cents for scenario 2, which we consider less probable.
Impact of Trump 2.0 tariffs on US inflation. The first round of tariffs in 2018 had little impact on US inflation (Figure 3) because the USMCA tariffs did not increase materially from NAFTA and China bore the brunt of US protectionism. This time around, a blanket tariff of 10% for all countries (except China at 60%) should lead to a more important rise in inflation.
For the record, US total imports (goods + services) account for 14.2% of US nominal GDP (Figure 4), of which imports from China amount to ~1.5% of GDP. In the first scenario, we estimate that tariffs would increase US imports as a percentage of GDP by ~2.1% overnight. In the second scenario, we foresee a jump of ~3.8%. This is obviously overly simplistic.
First, we believe exchange rates would help absorb a non-negligeable portion of the tariff burden from a US consumer perspective (~50%). As for China, one should expect authorities to deliver measures to support the economy. Second, we anticipate producers/retailers absorb a portion of the tariffs, if only to mitigate their impact on sales/market share (Figure 5). We believe the proportion could reach 50% in the first scenario, but only 30% in the second. Third, we believe substitution effects (both supply and demand) and demand destruction dynamics would further reduce the impact on retail tag prices. Last, new tariffs imply a one-off jump on the general price level. This means that tariff-induced inflation should wear off rapidly. Adjusting for these factors, we estimate the impact of Trump’s tariffs on inflation in the first scenario at ~0.5% in 2025 and ~0.25% in 2026. In the second scenario, these percentages rise to ~1% and ~0.5%, respectively.
We have gone through several articles and reports over the past 48 hours. While an important cohort of geopolitical experts have warned about Trump’s seriousness with the 25% tariffs on Canada and Mexico, we beg to differ. The math just does not support this scenario since it would potentially trigger an inflation shock that neither Trump nor Republicans want to be responsible for. That said, the 10% levy is a >50% probability, in our view, though we believe it is manageable inflation-wise.
Martin Roberge
-Research Managing Director at Canaccord Genuity-
