U.S. tariffs on Canada, Mexico and China: A renewed trade war?

The proposed tariffs announced by the U.S. signals a significant shift in global trade dynamics, with 25% tariffs on Canada and Mexico to be imposed beginning in March and an additional 10% on China. 

While officially justified as a measure to curb fentanyl trafficking, in our view, since U.S. seizures of the drug on the Canadian border amounted to a trivial 43 pounds in the whole of last year (1), we believe this is just a pretext for Trump to employ the International Emergency Economic Powers Act (IEEPA) for the first time to levy tariffs. These tariffs appear to be part of a broader economic strategy. Imports from the European Union (EU) will likely be hit within the next month or two. Also, a universal tariff is expected in April.



Since exports to the U.S. account for around 20% of Canada and Mexico’s gross domestic product (GDP), if the proposed tariffs are implemented, they could push both the Canadian and Mexican economies into recession later this year. The resulting surge in U.S. inflation from these tariffs and other future measures is going to come even faster and may be larger than we initially incorporated into our macro views. The key questions now are how affected countries may respond and what this means for North American and global markets. 

Macroeconomic implications: inflation, growth, and policy response

U.S. economy: Higher inflation, tighter monetary policy

In our view, if implemented, the most immediate consequence of these tariffs will be higher inflationary pressures in the U.S., as importers pass on increased costs to consumers. Historically, tariffs have proven to be a tax on domestic buyers rather than foreign producers, and this round would be expected to push inflation in the U.S. back above 3% by the second half of the year.



This complicates the Federal Reserve’s (Fed) outlook. While we believe the Fed is unlikely to raise interest rates in response, since tariffs create a one-off price shock rather than persistent inflation, this move effectively narrows the already slim window for rate cuts in 2025. A scenario where inflation stays elevated while growth slows could put the Fed in a difficult position, limiting its flexibility to support the U.S. economy.

Canada and Mexico: Recession risks rise

For Canada and Mexico, the impact could be far more severe. Their economies are highly integrated with the U.S., and the imposition of such significant tariffs would disrupt supply chains that have functioned seamlessly for decades. Canada has already signaled its intent to retaliate with tariffs on up to $155 billion worth of U.S. imports, escalating trade tensions further.



Economic forecasts now suggest that both Canada and Mexico could face back-to-back quarters of negative growth, effectively pushing them into recession. The energy sector in particular is a critical area to watch. While some Canadian energy exports may receive exemptions, the uncertainty surrounding trade policy could weigh heavily on investment decisions in the sector.

Market reaction and investor considerations

Currency and equity market volatility

In response to heightened trade uncertainty, the U.S. dollar has grown stronger and our expectation is it will continue to strengthen, driven by demand for safe-haven assets. A stronger dollar could weigh on emerging markets and U.S. multinationals, particularly those with significant exposure to Canada, Mexico and China.



Equity markets are also likely to experience heightened volatility. Sectors with deep exposure to North American trade, such as manufacturing, industrials, and consumer goods, will face margin pressures from increased input costs. Meanwhile, companies with domestic supply chains may be viewed as relative beneficiaries, though broad-based market sentiment is likely to turn more risk averse.

Fixed income and credit spreads

The bond market reaction will be equally important. If the outlook for U.S. growth deteriorates, U.S. Treasury yields could trend lower as investors seek safety. However, if inflation concerns dominate, the yield curve could steepen, reflecting expectations that the Fed will be constrained in its ability to cut rates. Credit spreads may widen, particularly for corporate bonds in industries exposed to trade disruptions.

Global trade war risks: Lessons from history

The parallels to the 1930s Smoot-Hawley tariffs are hard to ignore, but historical context is key. While trade protectionism contributed to the economic collapse of that era, it was not the primary cause. The Great Depression’s demand shock played a much larger role. However, the risk today lies in the response. If tariffs are ultimately implemented and major economies retaliate in ways that escalate tensions further, we could see a chain reaction that slows global trade growth significantly.



While China's initial tariff hit was lower than what may be imposed on Canada and Mexico (10% versus 25%), the broader expectation is that U.S.-China trade tensions will continue to escalate, potentially reaching a 60% tariff level on all Chinese imports. The geopolitical dimension adds another layer of complexity. This trade war is not just about economics but about broader strategic competition between the U.S. and China.

Investment strategy: Positioning for uncertainty

Given the macroeconomic and market implications, a disciplined approach to portfolio construction is critical.

• Diversification remains key: Exposure to uncorrelated assets, such as private credit and alternative strategies, can help hedge against market volatility.

• Focus on high-quality assets: Companies with strong balance sheets and pricing power will be better positioned to weather cost pressures from tariffs.

• Selective fixed income exposure: While U.S. Treasury bonds may serve as a safe haven, credit spreads could widen, making credit selection crucial.



• Opportunistic equity positioning: U.S. companies with strong domestic revenue streams may be relative beneficiaries, while multinational firms exposed to North American supply chains may face headwinds.

Final thoughts

Although tariffs on Canada and Mexico were paused for the next 30 days, the coming weeks will be pivotal. If tariffs are imposed in March and retaliation is measured, the economic damage may be contained. But if this escalates into a full-scale trade war, the implications for global growth and financial markets could be severe. All else equal, we believe tariffs are bad for U.S. equities, but in general worse for equities elsewhere. Longer term, Trump's latest tariff actions against Canada and Mexico, and his recent threats against the European Union and Taiwan, show that he is willing to damage those alliances over minor economic disputes. If he maintains this approach, it risks undermining global confidence in U.S. leadership and diplomacy. And while it is unlikely that Western countries like Canada or Denmark would switch sides and align with the Communist Party of China leadership in Beijing, some countries in the Global South may be inclined to lean more toward China after seeing how the U.S. treats its closest allies.

Over the short and medium-term, investors should prepare for increased volatility, balancing risk management with strategic positioning to navigate a more uncertain trade environment.

Sincerely,

Vice President, Asset Allocation & Chief Investment Officer

Canada Life Investment Management

Source: [1] U.S. Customs and Border Protection. (2025). Drug Seizure Statistics. Retrieved from https://www.cbp.gov/newsroom/stats/drug-seizure-statistics

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