MacroMemo - April 8 – 29, 2025

Big tariffs

The much-feared tariff storm crashed ashore last week, with large and wide-ranging reciprocal tariffs announced by the White House against nearly the entirety of its trading partners on April 2. This announcement was followed by 25% auto sector tariffs that were implemented on April 3.

The effect of these actions when combined with earlier tariff initiatives is potentially quite large. The effective U.S. tariff rate on goods has now increased from approximately 2.5% at the start of President Trump’s second term to a whopping 22% today. That’s the highest rate since the early twentieth century. It exceeds even the infamous Smoot-Hawley tariffs that intensified and extended the Great Depression in 1930. Compounding the danger, international trade is three times more important to the U.S. economy today than it was in 1930.

These actions offer further confirmation, if any were needed, that the global economic order is indeed changing, and more quickly and severely than nearly anyone had imagined six months ago. U.S.-led globalization is dead. That still leaves the remaining four-fifths of the global economy in a position to continue interacting with one another and perhaps even drawing more tightly together in response to this trauma. But there is a large scar in the middle that had once been the beating heart of the enterprise.

Reciprocal tariffs redux

It was apparent that there was no real plan for the long-awaited reciprocal tariffs as recently as a few days before the April 2 announcement. It is perhaps not a surprise, then, that what was announced was not a sophisticated counter to foreign tariffs, foreign exchange-rate undervaluation, foreign value-added taxes and the other perceived injustices long cited. Instead, the announced tariffs were set according to a simple formula based exclusively on the magnitude of a country’s trade surplus with the U.S. (with a minimum floor of 10% for those countries without a sizeable trade surplus).

Representing a continuation of the trend, the reciprocal tariffs were, on the net, larger than expected. Whereas we and many had braced for an effective American tariff rate that would rise to perhaps 15%, instead the rate has risen to 22%.

Curiously, Canada and Mexico avoided any reciprocal tariffs – more on that later – but most other countries were hit quite hard (see next chart). The tariff hike was 20% against the European Union, 24% against Japan, 25% against South Korea, 26% against India, 31% against Switzerland, 36% against Taiwan and a further 34% (now totaling a 54% total tariff jump in the past two months) against China. Asian economies were particularly affected given their famously large trade surpluses with the U.S.

Exports to U.S. are significant for some countries

Reciprocal tariffs announced by the Trump administration on April 2, 2025. Sources: International Monetary Fund, The White House, Macrobond, RBC GAM

Ultimately, the greatest economic damage will occur in the countries that a) trade extensively with the U.S. and b) are subject to large tariffs (see next chart, which multiplies the first variable by the second to determine greatest theoretical impact). Vietnam easily tops the list, followed by Thailand, Taiwan and Malaysia, with South Korea trailing. On the other hand, we continue to flag that most countries have sufficiently limited trade with the U.S. that their economies should handle the tariffs reasonably well.

Reciprocal tariffs hit Asian countries hardest

Reciprocal tariffs announced by the Trump administration on April 2, 2025. Calculated as reciprocal tariffs times exports to U.S. in 2023 as a % of National GDP. Sources: International Monetary Fund, The White House, Macrobond, RBC GAM

And, of course, the U.S. is set to be hit hard by virtue of being counterparty to every one of these countries.  In addition, there’s the prospect of retaliatory tariffs set to increase the damage.

The reciprocal tariffs are structured with an initial 10% “baseline” tariff as of April 5. The remaining tariff rate is to be applied on April 9. There has been some indication that even if countries manage to negotiate away the bulk of their tariff, the baseline portion could remain.

The 25% of U.S. international trade that occurs via the delivery of services received nary a mention and so appears to be exempt from reciprocal tariffs. Presumably this is in part because services are inherently hard to tariff (given that they don’t physically transit border crossings) and in part because the U.S. runs significant service trade surpluses with most countries. Thus, the overall U.S. tariff rate on goods plus services is somewhat lower than 22%. Instead, the rate is in the realm of 17%.

Also exempt from the new reciprocal tariffs are energy products (oil, natural gas, etc.), precious metals including gold, semiconductors, some critical minerals and some lumber products. In several cases, this is merely because the White House plans to instead apply sector level tariffs later. In the case of energy, it is probably for the more pragmatic reason that households don’t want to pay more for energy.

Auto tariffs rev up

A 25% auto tariff was activated at midnight on April 3.

With the exception of Canada and Mexico, an additional 25% tariff will be applied on all automobiles and large auto components such as engines, transmissions, powertrain parts and electrical components. This comes on top of a longstanding 2.5% auto tariff that applies to countries without a U.S. trade deal. As such, the new rate is effectively 27.5%. The most affected countries include Japan, South Korea, Germany and the United Kingdom.

Canada and Mexico are also affected, but in a more complicated way. Motor vehicle trade that is not compliant with the USMCA trade deal is subjected to the full 25% tariff. The USMCA rules are strict, requiring a minimum 75% North American content, among other criteria. As a result, and because the prior punishment was a mere 2.5% tariff, a large fraction of the North American auto trade has traditionally not been officially USMCA-compliant. As such, there is likely significant auto trade that is subjected to this element of the new tariff regime.

The second element of the auto tariffs on Canada and Mexico is that any non-American added value shipped into the U.S. is also subject to the 25% tariff, even if USMCA compliant. So, effectively, all auto trade with the U.S. is subject to the full 25% tariff except for the bits and pieces that are being reimported back into the U.S.

Auto parts are presently exempted but are expected to be subjected to a similar treatment in May, once a system is set up to properly track the origin of different components.

As such, Canada and Mexico are deeply affected by the auto tariffs as well. Real-world damage is already becoming evident. Production has temporarily halted at assembly plants in Windsor, Canada and Toluca, Mexico.

S&P Global estimates that one-third of North American light vehicle production could shut down within a week of 25% tariffs being implemented, with the number then rising sharply in subsequent weeks. Some carmakers are capitulating to the U.S. goal of onshoring auto production, with Hyundai promising a US$21 billion new investment into the U.S.

A large fraction of U.S. vehicles will become significantly more expensive with these changes, on the order of a 10-12% jump in the average car price. There may be some lag in these prices reaching the consumer as dealers have reportedly stockpiled several months’ worth of new vehicles, though this will not necessarily prevent price increases during that period if they detect a shortage coming.

Fully repatriating U.S. production would require enormous investments, take years of effort, and ultimately result in higher vehicle prices and reduced vehicle quality and selection within the U.S. Demand for American vehicles would presumably increase within the U.S. as foreign brands are crowded out. However, demand for American vehicles would simultaneously decline elsewhere.

De minimis exemptions gone

A Chinese backdoor into the U.S. consumer market will also be closed on May 2 after a false-start a few months ago.

The de minimis duty-free exemption previously allowed goods valued at under US$800 to be shipped directly to American consumers without facing the usual applicable tariff or customs scrutiny. The idea behind the exemption, established in the 1930s, was to ease the burden on customs by expediting the processing of low-value goods. The exemption was quadrupled from US$200 in 2016.

The Federal Reserve Bank of New York has estimated that Chinese goods entering the U.S. via this channel could represent upwards of US$100 billion in value per year. An incredible 1.36 billion shipments alighted on U.S. shores from all countries via the exemption in fiscal year 2024, of which between 67—75% are estimated to come from China. Around 83% of all U.S. e-commerce imports rely on the de minimis exemption.

The de minimis exemption remains in place for other nations. In the short run, one might imagine a surge of such exports from other nations such as Vietnam and Thailand. This could serve as a work-around to the new Chinese restriction, and also to circumvent these countries’ own new large tariffs.

But the U.S. talks of removing the de minimis exemption for all once it can find a way to efficiently handle the logistical burden that will accompany that change. Customs officials say that such unexamined packages also enable the unencumbered flow of illegal narcotics and contraband into the U.S.

For context, other countries often have their own de minimis exemptions, but these tend to be at a much lower value point. The UK limit is £135, whereas it is just C$20 in Canada and the equivalent of just US$7 for China. The European Union (EU) recently removed its exemption. Australia and New Zealand are more comparable to the U.S., with relatively high A$1,000 and NZ$1,000 thresholds.

What about Canada (and Mexico)?

Beyond their sheer scale, the other major surprise in the reciprocal tariff announcement was that Canada and Mexico were not targeted.

While welcome, this decision ran distinctly counter to the White House statement made on March 6. At that time, USMCA-compliant goods were temporarily exempted from a blanket 25% tariff until April 2. The exemption had been articulated as being specifically intended to allow the auto sector time to adjust. Ironically, auto sector tariffs now apply (with the implication that the adjustment time for the sector is over), but the exemption that was motivated by the auto sector somehow remains in place.

Avoiding reciprocal tariffs altogether wasn’t even on the bingo card – the default expectation had been for substantial new blanket tariffs against Canada and Mexico, with some hope that they might land at a lower level than the 25% rate temporarily put in place on March 4. For what it is worth, the White House’s reciprocal tariff formula would have yielded an additional 8% tariff on Canada (presumably rounded up to 10% like all the others), and a 17% tariff on Mexico.

Instead, no new tariff was applied and the cumulative tariff rate levied by the U.S. on Canada is “merely” in the 5-10% range once one has factored in the impact of 25% tariffs on a wide range of Canadian exports, including:

• steel and aluminum

• the Canadian value-added portion of vehicles

• any non-USMCA compliant goods

• a 10% tariff on any non-USMCA compliant energy and potash.

That motley combination still does economic and inflation damage (and intense damage to the directly targeted sectors), but rather less than feared.

Why have Canada and Mexico avoided reciprocal tariffs?

There are several theories for why Canada and Mexico have avoided reciprocal tariffs.

One argument is that it would have been illegal to levy reciprocal tariffs on the two countries given the USMCA trade agreement. But this doesn’t hold much water as the U.S. has already hit the two countries with a range of tariffs. Further, the White House is using the same national emergency / national security arguments for the reciprocal tariffs that it did for the prior levies.

Finally, other countries were hit with reciprocal tariffs despite having free trade agreements of their own with the U.S.  These include Australia, Singapore, South Korea and a significant swath of the Caribbean, Central America and South America.

Another argument is that President Trump may have been persuaded to favour Canada and Mexico after private conversations with the two countries’ leaders. He appears to like Mexican President Claudia Sheinbaum, and Trump described his first conversation with newly appointed Canadian Prime Minister Mark Carney as “extremely productive” and that Canada and the U.S. “agree on many things.” This is plausible.

It is conceivable, though not especially likely, that Canada received a temporary reprieve so that the country can conduct its national election on April 28. Negotiations before then might be fruitless if the control of Canadian Parliament were to pass to another party. This theory is likely too charitable, and also fails to account for why Mexico also avoided the new tariffs.

It could be that the White House recognized that the U.S. economy would suffer too much damage if it levied large tariffs against the entire world all at once, and so it exempted two of its three large trading partners – Mexico and Canada. This could be true, though you wouldn’t have picked Mexico and Canada to be the beneficiaries of this light touch based on the rhetoric in recent months.

The White House may have belatedly come to the recognition that, despite all of its fiery comments directed against the two countries in recent months, Canada and Mexico have minimal U.S.-facing goods trade barriers relative to the international norm.

Finally, and perhaps most compellingly, Canadian and Mexican tariffs may just be on pause until the USMCA trade deal can be properly renegotiated. At this point, any such negotiation is more likely to build up trade barriers via new restrictions than it is to tear them down. Such negotiations are officially scheduled for on or after July 1, 2026 – six years after the trade pact was implemented – but the actual renegotiations will likely occur sooner.

Canada is not off the hook

Focusing on Canada for a moment, the country can hardly be said to be off the hook. It faces a new average U.S. tariff rate of about 5-10%. This is problematic for an economy that generates 20% of its gross domestic product (GDP) via exports to the U.S.

 In addition, the steel and aluminum tariffs affect Canada more than any other country. These tariffs apply much more broadly than the equivalent tariffs implemented in 2018 (and lifted in 2019).

Canada is among the most affected by the auto tariffs as well. Further, it came as a startling revelation that upwards of 60% of Canadian exports to the U.S. were originally not compliant under USMCA rules, with the implication that a large fraction of Canadian exports would be subjected to the full 25% tariff. It appears that much of this has since been rectified with most products now up to date on their paperwork and so USMCA compliant. However, the impact of the 25% tariff on non-USMCA compliant products is presumably not zero.

Looking ahead, Canada will be disproportionately impacted by planned sector tariffs on copper and forestry products, with some impact if pharmaceutical tariffs are also implemented.

Just as importantly, there is obvious scope for a deterioration in trading relations ahead:

• The tariff surprises and related flip-flopping have been nearly constant, and so it would be exceptionally naïve to imagine that the present arrangement represents the final form of tariffs.

• It is hard to fathom that Canada and Mexico have truly gone from being adversaries number one and two to friends number one and two in the span of a few days.

• The obvious moment to implement further tariffs against Canada and Mexico is just before USMCA renegotiations begin, so as to secure maximum leverage.

• President Trump’s speech announcing the reciprocal tariffs specifically levelled a complaint against the Canadian dairy sector.

• More broadly, the U.S. still has many stated grievances against Canada. These include not just supply management sectors such as dairy, but also border security, military spending, the country’s digital services tax, Canada’s trade surplus vis-a-vis the U.S., possibly Canada’s value-added sales tax, potentially the low value of the Canadian dollar, auto production content rules, access to the financial services sector, and so on (see next table, with likelihood of Canada complying).

As of 03/27/2025. Source: RBC GAM

Thus, we continue to expect some increase in trade barriers against Canada and Mexico, even if the countries have dodged the latest mighty blow.

Tariff retaliation

Countries continue to pursue a variety of response strategies, with some pursuing a variation of the tit-for-tat response, and others taking a more cautious approach that focuses first on negotiations.

China has responded with an additional 34% levy on U.S. products, precisely matching the U.S. action against it. The U.S. is now threatening additional tariffs of its own in response, risking a vicious circle.

Canada has applied a tariff on the U.S. value-added component of its automotive imports, in line with the U.S. treatment of Canada.

After applying retaliatory tariffs in response to prior rounds of U.S. actions, the European Union is now instead proposing a “zero-for-zero” approach that involves de-escalating the situation by reducing industrial tariffs on both sides. This is a strategy that many countries are likely contemplating as the U.S. tariffs now so greatly exceed their own that any agreement to eliminate all such tariffs would involve a sharp decline in U.S. tariffs versus only a small decline in U.S.-facing tariffs. And, most importantly, if successful, global trade would be enhanced relative to pre-2025 levels rather than impeded.

Many other countries are criticizing the new U.S. tariffs but seem more inclined to try their hand with negotiations rather than confrontation to start. This list includes Vietnam, Japan, Indonesia and Australia.

Tariff economic impact

Stagflationary

Tariffs are famously stagflationary in the sense that they cause economic growth to weaken and inflation to accelerate. This is, of course, undesirable, and especially at a time when inflation is already too high and the risk of de-anchoring expectations is higher than normal after the recent inflation shock.

Stagflation also happens to be quite unpleasant for financial markets: weak growth hurts the stock market, while high inflation hurts the bond market.

A persistent negative economic shock

Most negative economic shocks are only temporary. This is to say, the economy weakens during such events as a pandemic lockdown, financial crisis or business-cycle downturn, but it can be expected to rebound later, and there usually isn’t any reason why the economy needs to be on a permanently worse trajectory over the long run. What goes down comes back up later. The economy even gets to grow faster than normal for a period of time as it catches up to the normal trajectory.

In theory, tariffs are different. If greater trade barriers and the accompanying reduction in international trade is permanent, the productivity and income of the affected countries is permanently lower than it would have been. The economy can still return to growth once the initial adjustment has occurred, but there is no reason to expect a period of unusually fast catch-up growth later.

From an investment standpoint, then, there is still the usual debate as to whether financial markets have overreacted to the initial shock. Further, there needs to be an active debate about whether these tariffs will prove to be permanent – see our discussion later on this subject. But, if permanent, there is no reason to think that markets should immediately snap back. Indeed, you would expect corporate earnings to be on a permanently diminished upward trajectory.

For policymakers, the reaction to a tariff shock is also potentially different. To be sure, additional monetary stimulus and fiscal stimulus are both arguably warranted. But the response should theoretically be skewed more toward fiscal support than monetary support, for two reasons.

1.       Monetary policy is somewhat conflicted given that weaker growth and higher inflation send opposite signals. On the net, the enduring damage to output is arguably the more relevant development than a one-time price jump, but this still tempers the magnitude of the central bank’s response.

2.       Tariffs have a highly uneven effect on the economy. The impact varies substantially by sector. Service-sector companies are less affected than goods ones. Some sectors are hit much harder than others depending on their trade intensity and the nature of the tariffs applied. Some companies even win as their foreign competition is crowded out. From a GDP add-up perspective, for every 1ppt decline in consumption, one might expect roughly unchanged government spending, a three-fold hit (on a percent change basis) to capital expenditures, a seven-fold hit to exports and perhaps even a ten-fold hit to imports. The point is that monetary policy is a blunt instrument and is unable to delicately support one industry without overheating another. Fiscal policy is much better suited to the task.

3.       A final point is that the scale of policy stimulus of any kind should probably be somewhat smaller than usual for the very reason cited at the top of this section: because the damage to the economy is permanent, there is only limited scope for reviving the economy unless one is committed to delivering additional stimulus indefinitely.

Tariff economic damage

There is considerable uncertainty around the economic implications of these new higher tariff rates. This is for quite a number of reasons: the extent and duration of tariffs is still not entirely clear, the direct impact of tariffs on the economy is subject to some debate, there may be ancillary effects, and the policy response is also not certain.

Is it possible that the U.S. economy descends into a recession as a result of large, enduring tariffs? Absolutely – the risk of recession has risen. It is notable that these Trump tariffs constitute the largest U.S. tax hike since 1968, representing a large 2% to 2.5% of GDP. However, we still put the recession risk at somewhat below 50% – perhaps at a 40% chance. For context, Polymarket assigns a U.S. recession probability for 2025 of 62% as of April 7.

Surveying the literature and reviewing our own various tariff models, the central tendency is that a 22% U.S. effective tariff rate (up by around 20 percentage points from the prior 2.5% level) should make the U.S. economy grow by a cumulative 1.0% to 2.0% less quickly over the next few years. That’s quite significant, but not enough to completely hobble an economy that might otherwise have grown by around 2.5% per year. We tentatively target something like 1.0% U.S. economic growth across 2025.

If that economic damage sounds implausibly small, keep in mind that imports are just 14% of U.S. GDP, and exports are an even smaller 11% of GDP (see next chart). That means that 86-89% of U.S. economic activity is not directly impacted by tariffs. Furthermore, every business and household is incented to adapt to the tariffs in a way that is as minimally disruptive as possible, whether that means pivoting where production occurs or what products are purchased.

U.S. trade as share of GDP has been on a downtrend

As of 2024. Sources: U.S. Census Bureau, U.S. Bureau of Economic Analysis (BEA), Macrobond, RBC GAM

The central upside risk to this base-case impact is that the tariffs could be reduced, completely altering the calculus. A secondary one is that the tariff damage from Trump’s first term proved to be relatively slight (though the tariffs were much less pervasive than this round), and no worse than economic models had predicted.

The downside risk is that these estimates may overlook other forces that could prove more negative than usual:

• Non-linearities: Most economic models have been trained and calibrated using the relatively small tariff adjustments that have transpired over the past several decades. It is possible that a large tariff has a greater than linearly scaled effect on economic activity relative to a small one. For instance, there may be threshold effects such that household budgets and business income statements might be able to absorb a small tariff without substantially changing behaviour, whereas a large tariff might force a structural upheaval in behaviour and thereby the economy.

• Confidence effect: Related to the above non-linearity idea, small tariffs don’t impact confidence much, whereas these large ones are showing up in materially reduced consumer and business confidence. That may impact spending, hiring and investment decisions. This could create a negative feedback loop.

• Wealth effect: Similarly, the sharp recoil in risk assets such as equities may persuade otherwise unaffected economic actors to pull back their spending via a negative wealth effect. The stock market might overlook small tariff adjustments but cannot overlook the large reciprocal tariffs. This could also create a negative feedback loop.

• Boycotts: The residents of other countries are beginning to boycott some U.S. products. This serves as something like an additional tariff and could reduce U.S. growth by around 0.3ppt, all else equal. Refer to the next chart for the recent decline in trips to the U.S. from Canada.

• History of tariffs: The economic outcome was quite unpleasant on several past occasions when the U.S. substantially raised tariffs, including in 1890, 1922 and 1930. That said, other rounds of tariffs, including in 1816, 1824, 1828, 1860 and 1971, seemingly did less aggregate economic damage.

• Public policy: Given the unfortunate circumstance of elevated inflation even before the tariffs were implemented, U.S. monetary policy is in a worse position than usual to deliver economic support. It is somewhat similar on the fiscal side, with an enormous fiscal deficit theoretically limiting the scale of any economy support, and with money already tentatively allocated toward a tax cut that isn’t especially growth-optimizing.

• Retaliatory spiral: If other countries respond to the U.S., and if the U.S. responds to them, the tariffs could rise quickly and induce even more economic damage.

Number of people entering the U.S. from Canada fell recently

As of February 2025. Passengers entering the U.S. from Canada at land border crossing stations include bus, train and personal vehicle passengers. Sources: Bureau of Transportation Statistics, RBC GAM

Tariff inflation damage

There is similar uncertainty around the price effect of higher tariffs, and for a similar set of reasons – see above.

In a small way, there is yin and yang between the tariff impact on output versus inflation. Consumers must choose between buying less (tilting the impact to the economy) versus holding their nose and paying more (tilting the impact toward inflation). In practice, they will do some of both.

That said, the distinction between the output and inflation impacts is arguably overblown because much of the economic damage is actually in the form of reduced purchasing power – because everything costs more, real incomes are effectively lower and so people are poorer and can afford fewer things.

However, a 25% tariff doesn’t mean the price of a product necessarily goes up by 25%. Some of the additional cost will be shared by the foreign producer, the exchange rate, the importer, the wholesaler and the retailer. In practice, quite a lot ultimately accrues to the consumer, but not all.

Additionally, using a grocery store as an example, if the input cost of imported food rises by 25% but the cost of labour, rent and other expenses remain constant, that might “only” result in a 15% increase in the price on imported food that consumers face. Furthermore, to the extent that only 15-20% of a grocery store’s products are imported, the average price of all food in the grocery store would “only” rise by 2-3%. That’s not great, but it isn’t 25%. The math for other sectors varies enormously but is generally more favourable than this. Many, particularly those providing services, would see very little direct impact.

Of course, some products could experience a significantly larger price boost. It has become a popular sport to estimate how much more expensive a ubiquitous iPhone could become given that most of these products are assembled in China, which is now subject to a 54% tariff. The price could rise by between 30% and as 44% – to as much as US$2,300 from US$1,599 for a top-of-the-line model.

Overall, most economic modelling points to between a 0.75% and 1.75% increase in U.S. prices in response to a 22% average effective tariff rate. We flag the risk it could be more, as this feels quite small. In particular, if the U.S. dollar were to continue declining, this could boost the inflationary aspect of tariffs. But sticking with the model estimates for the moment, U.S. Consumer Price Index (CPI) might rise by around 4% over the next year – double the country’s target.

Short-term sequencing

Let us appreciate that the impact of tariffs is neither steady nor gradual. One can imagine that economic activity leading up to the tariffs was somewhat weaker than normal as the negatives of high uncertainty outweighed the positives of stockpiling.

Once the tariffs were announced, but before they were implemented, there should be a brief spurt of demand to acquire products before the tariffs are applied.

Then demand should weaken fairly abruptly as the tariffs take effect. A large part of the economic damage will likely accrue over the first few quarters that they are in place.

Rest of world impact

Re-estimating the economic implications for every nation is still a work in progress. Suffice it to say that while the growth outlook is surely diminished for the bulk of the affected countries, it should not be anything resembling a recession for the great majority of them given their relatively limited trade exposure to the U.S. as a percent of GDP. Individual industries could be problematically exposed, of course.

In contrast to the rest, the direction of forecast revisions for Canada and Mexico should be up rather than down given the light touch the countries received. In particular, it is no longer obvious that Canada must descend into a recession, though a period of weakness is still likely given the pain from sector tariffs and from what could be a weaker U.S. economy. But should larger tariffs reassert themselves in Canada and Mexico, it would be back to a recession call.

How long will tariffs last?

No less important than the size of tariffs (large) and how broadly they are applied (widely), is the question of how long these tariffs will last (see next graphic). This is, at present, unclear.

Looking at tariffs in three dimensions

As of 04/03/2025. Source: RBC GAM

Arguments that the tariffs could persist for a long time include:

• President Trump has advocated for tariffs for decades and believes this is a case of short-term pain for long-term gain.

• Even if there proves to be no net long-term gain as we suspect, Trump may simply prioritize U.S. economic security and U.S. manufacturing over maximizing the economy’s size.

• Trump needs tariff revenue to help fund his proposed tax cuts.

• President Trump recently said, “My policies will never change” and that he would need a “phenomenal” deal to justify easing tariffs.

• The White House has a large number of grievances with foreign countries, many of which are unlikely to be fully resolved (such as the use of value-added taxes and currency valuations). In particular, it will be difficult for the U.S. trade deficit to vanish – a source of U.S. aggravation – so long as Americans prove unwilling to save more and so long as the fiscal deficit remains so large.

Conversely, arguments that tariffs will prove temporary include:

• There were recent rumours that the White House is considering a 90-day tariff pause. While this was since denied, where there is smoke there is often fire. The current Administration has already delayed tariffs on several occasions and lifted several tariffs during the first Trump term.

• While President Trump has proven more indulgent of financial market weakness and prospective economic weakness than anyone had imagined, his tolerance likely still has limits.

• President Trump has indicated a willingness to negotiate with some countries including Vietnam. That suggests a theoretical willingness to negotiate with all.

• Congress could muster sufficient will to introduce legislation clarifying that tariffs are the domain of Congress rather than the President. But this particular argument is a weak one: President Trump has threatened to veto such legislation and so it would require an unrealistic two-thirds majority to overcome that blockage.

Our base-case view is that there is scope for some reduction in tariffs on the basis that targeted countries can make some concessions and the American tolerance for economic weakness will wear thin. We budget for this happening within about six months, though it could be much faster or slower. Tariffs are unlikely to go away altogether.

With regard to concerns that it is exceedingly hard to lift tariffs once they have been applied, we disagree. That is more of a concern if tariffs are in place for years such that industries are built up as a consequence of the protective shielding provided. It should not be a problem to lighten tariffs after a handful of quarters.

Other tariff musings

More tariffs ahead?

Copper, lumber, pharmaceutical and semiconductor tariffs have all been threatened. Several are likely to be implemented. Most of these products were exempted from reciprocal tariffs, so in a strange way this would just bring them back into approximate line with other products.

We continue to flag the risk that Canadian and Mexican tariffs rise.

The White House also recently threatened a new kind of tariff – a “secondary tariff.” This was proposed in the context of Venezuelan oil. The U.S. says that it will impose a 25% tariff on any country that buys oil or gas from Venezuela. In practice, China, India and Spain would be among the most affected parties. The tariff, of course, is not imposed on the actual flow of oil from Venezuela to these countries, but instead on these countries’ trade with the U.S.

Let us see if it actually happens – it would be a worrying development if it did.

Government revenue boost

These tariffs are likely to generate additional tariff revenue, even on a net basis.

The Treasury Department has estimated the tariffs will deliver up to US$600 billion annually in additional revenue. While we would guess that the number arrives lower than this due to a reduction in trade, the idea that it will be in the many hundreds of billions is correct.

Importers will directly pay for this, but then pass a significant fraction of the tax onto others, with the largest share paid by American consumers.

Pitted against this revenue gain is the diminishment of government revenue from a weaker economy. However, this would only cost about US$45 billion in lost revenue, leaving as much as US$550 billion in net additional government revenue.

Reverse brain drain?

Between tighter immigration rules, reduced university funding, a changing political climate and a weaker economy, it is not unreasonable to speculate as to whether approximate substitutes such as the UK, Canada, Australia and EU member states might be in a position to lose fewer of their own best minds, to attract some portion of the emerging-economy human capital that would normally have opted for the U.S., and perhaps even to convince some top U.S. talents to emigrate.

There have been anecdotes in the news pointing to a trickle of such outcomes. Providing historical context, Canada received significant numbers of American draft dodgers during the Vietnam War, many of whom were highly educated and benefited the country.

Cross-border shopping?

From a Canadian standpoint, large U.S. tariffs will likely encourage more cross-border shopping by Americans into Canada. The weak Canadian dollar may also provide an additional motivation, though less so for goods originating in third-party countries such as China.

If everything from groceries to iPhones really suddenly become palpably cheaper in Canada, a trip into the country could become easily justifiable with hundreds of dollars of potential savings on the line. Historically, the cross-border shopping flow has tended to run in the reverse direction – Canadians venturing into the United States. Duty-Free limits of just US$200 over the first 48 hours may limit such enthusiasm, but compliance has always been imperfect.

Plunging financial markets

Financial markets have expressed their extreme displeasure at the newly announced tariffs, with the S&P 500 stock market down a large 18% from its peak (see next chart).

Stock market tumbled over tariff concerns

As of 04/04/2025. Sources: S&P Global, Macrobond, RBC GAM

Bonds are rallying in response to risk aversion, though the rising term premium speaks to some small amount of discontent with U.S. bonds as well (see next chart), whether due to the large deficit, large public debt, the prospect of economically damaging tariffs or the all-around political instability.

Term premium has been rising

As of 04/02/2025. Sources: Federal Reserve Bank of New York, Macrobond, RBC GAM

The U.S. dollar has also fallen (see next chart). That may sound like the logical response to trouble in the U.S., but it is actually quite uncharacteristic. In theory, a country applying tariffs should see its exchange rate rise as a way of partially offsetting the effect of the tariffs. And, as the world’s reserve currency, the U.S. dollar normally rises during times of market turmoil like this.

U.S. dollar tumbles on Trump tariff turmoil

As of 04/04/2025. Shaded area represents U.S. recession. Sources: ICE, Bloomberg, RBC GAM

While still tentative, the fact that the currency is weakening argues that something more profound may be going on – that the attitude toward the U.S. economy and market could be fundamentally changing.

For years now, few would argue with the assertion that the U.S. dollar is overvalued, that the U.S. has a concerning fiscal position, and that the U.S. stock market is expensive relative to its peers. But it may have taken an exclamation mark in the form of these tariffs and the related policy chaos to get investors acting on those facts and pivoting toward other markets. It is also undeniable that the economic outlook has soured in the U.S. at the same time that Europe is looking somewhat better (see next chart).

Economic expectations for euro area reviving while outlook for U.S. takes a dive

As of March 2025. Sources: ZEW (Centre for European Economic Research), Macrobond, RBC GAM

Whether this is merely a cyclical pivot away from the U.S. or an enduring structural change remains to be seen. However, one can certainly posit that there are structural elements given that U.S. exceptionalism does genuinely appear to be in retreat as the country withdraws from global affairs.

All the same, investors are unlikely to abandon U.S. markets altogether given the remarkable regularity with which American companies manage to out-innovate the rest of the world.

Economic developments

With tariffs threatening the economic outlook, we must now keep a close eye on what the data is saying. Survey-based metrics such as the Institute for Supply Management (ISM) Manufacturing and Services indices have dipped (see next chart) and sentiment-oriented metrics – from CEOs to consumers to newspapers – have fallen quite far.

U.S. manufacturing is back in contraction, services sector continues to expand but slowing

As of March 2025. Shaded area represents recession. Sources: Institute for Supply Management (ISM), Macrobond, RBC GAM

The question is the extent to which that that somber sentiment will map onto actual hard economic activity. On this front, slower-moving economic data, such as U.S. payrolls for March, seem mostly fine, with an above-consensus 228,000 new workers in the month, albeit pitted against -48,000 net revisions to earlier months. The unemployment rate edged higher from 4.1% to a still good 4.2%.

Arguably of greater value, real-time metrics claim that despite some damage from high uncertainty, there has not been a sharp decline in economic activity just yet. Weekly jobless claims continue to look fine (see next chart). The Dallas Fed Weekly Economic Index has only decelerated slightly (see subsequent chart).

U.S. jobless claims still look fine

As of the week ending 03/29/2025. Sources: U.S. Department of Labor, Macrobond, RBC GAM

Dallas Fed Weekly Economic Index has decelerated only slightly

As of the week ended 03/29/2025. The Weekly Economic Index is an index of 10 indicators of real economic activity, scaled to align with the four-quarter GDP growth rate. Sources: Federal Reserve Bank of Dallas, Macrobond, RBC GAM

Real-time consumer spending in the U.S. also looks fairly normal for the moment.

Similarly, real-time measures of U.S. inflation do not yet show a leap higher in prices (see next chart). It could take some time for higher prices to fully appear as retailers and others along the supply chain may first exhaust their inventories of cheaper goods.

U.S. Daily PriceStats Inflation Index remains steady

PriceStats Inflation Index as of 04/04/2025. CPI as of Feb 2025. Sources: State Street Global Market Research, RBC GAM

Canadian corner

Canadian economic developments

Canada has been whipsawed in the opposite direction of most countries. The nation had been bracing for a devastating tariff blow, to the point that small business expectations have collapsed to the lowest level in over a decade (see next chart). Real-time business conditions are starting to fade (see subsequent chart).

Canadian small business confidence on future conditions is at record low

As of March 2025. Sources: Canadian Federation of Independent Business (CFIB) Business Barometer, Macrobond, RBC GAM

Business conditions in Canada are at levels last seen in late 2023

As of the week of 03/10/2025. Equal-weighted average of Business Conditions Index of Calgary, Edmonton, Montreal, Ottawa-Gatineau, Toronto, Vancouver and Winnipeg. Sources: Statistics Canada, Macrobond, RBC GAM

Canadian jobless claims also appear to be rising, albeit choppily (see next chart).

Employment Insurance claims appear to be rising

As of Week 12 2025. Year-over-year % change of 4-week moving average. Sources: Government of Canada, Employment & Social Development Canada, Macrobond, RBC GAM

Canadian employment has also been weak, with a February that yielded just 1,000 new jobs followed by a March in which 32,600 were shed. Even with the usual notorious volatility of the Canadian numbers, this is bad.

The big question for Canada is what happens next. Tariffs appear set to be smaller than expected, which is helpful. Some fiscal support is now coming in, at both the federal and provincial level.

But there are still significant sector tariffs that have come into effect over the past month, and there is still material uncertainty around what additional tariffs might arrive later.

As such, and on the back of the evident weakness in the latest economic data, we should brace for further softness, though not of the apocalyptic variety. A recession can probably be avoided. The near-term outlook for the auto, aluminum and steel sectors is obviously quite poor, however.

Canadian election approaches

Canada’s April 28 election is now immediately ahead. The polls continue to show the NDP and to a lesser extent the Conservatives bleeding votes to the Liberal Party, which now has a significant lead in the polls (see next chart). Reflecting this, Polymarket now assigns a 73% likelihood that the Liberals and Mark Carney form the next Canadian government, versus just a 27% chance that it is the Conservatives and prior favourite Pierre Poilievre. Of course, 27% chances manifest all the time, so the race isn’t quite over yet.

The Liberals surge past the Conservatives

As of 04/03/2025. Trendlines are 10-poll equal-weighted averages. Sources: Wikipedia contributors, “Opinion polling for the 2025 Canadian federal election,” Wikipedia, The Free Encyclopedia, https://en.wikipedia.org/wiki/Opinion_polling_for_the_2025_Canadian_federal_election, RBC GAM

From a public policy perspective, the main message remains that both candidates espouse economic policies that are consistent with faster productivity and economic growth. Indeed, many of the headline policy ideas are quite similar.

Both parties have submitted new policy ideas of economic relevance in just the past few weeks, prompting us to update our policy scorecard. The Conservatives have added two new tax cuts for households who invest more within Canada. They have also proposed to implement the energy industry’s wish list of policies to encourage more investment by the sector.

For their part, the Liberals now propose a sharp increase in the construction of affordable housing through a variety of mechanisms. These include a new government agency that would actually do some of the construction.

Overall, one might posit that the Conservative platform is slightly more growth-friendly than the Liberal one, if with a fair amount of variation by category, and with the recognition that much will come down to the calibre of the execution (see next chart).

As of 04/07/2025. Not an endorsement or assessment of good/bad, but instead simply whether GDP growth might proceed more quickly over the medium term under various policies. Source: RBC GAM

-With contributions from Vivien Lee, Aaron Ma and Ana Ardila