Unpacking the potential impact of tariffs

What you need to know:

• On March 4, President Donald Trump proceeded with implementing tariffs on Canada and Mexico, driving market volatility. We expect trade policy to remain in headlines in the near term, potentially stoking bouts of volatility in markets.
• The U.S. is less dependent on trade compared with its largest trading partners, potentially insulating the U.S. economy from the impacts of a trade war.
• While tariffs could create a one-time increase in the prices, we don't expect the impact to be large enough to drive the Federal Reserve to raise interest rates.
• We continue to favor U.S. stocks over international, as we believe the U.S. is best-positioned to handle the potential impacts of tariffs. Well-diversified portfolios can help spread risk, as certain asset classes may respond differently to tariff headlines.  

What is a tariff? A tariff is a tax on goods imported from another country and, all else equal, increases the cost of imports, making foreign goods less competitive in the marketplace. 

On March 4, U.S. President Donald Trump proceeded with implementing tariffs on Canada and Mexico under the International Emergency Powers Act. Imported goods from Canada and Mexico will be subject to a 25% tariff, while Canadian energy imports will be subject to a 10% tariff. U.S. imports from China will be subject to an additional 10% tariff, adding to the 10% levies last month. Canada announced retaliatory tariffs on roughly $107 billion of U.S. goods, while China announced retaliatory tariffs of 15% on select U.S. goods. Mexico stated it would announce retaliatory measures by March 9.

The impact of tariffs will vary based on the degree and the duration of the tariffs implemented, and it remains uncertain as to how long these measures will remain in place. For this reason, we recommend investors adhere to their long-term investment strategies and resist the urge to overreact to headlines.

Despite the uncertainty, we offer a framework to assess how tariffs could impact global economic growth, inflation, central-bank policy, and financial markets. We also provide key financial insights for individuals and business owners.

Impact on the economy

From an economic standpoint, the U.S. is less dependent on trade compared with many of its largest trading partners. Total trade (the sum of imports and exports) represented roughly 25% of U.S. GDP in 2023 compared with 73% of GDP for the U.S.’s largest trading partner, Mexico, and 67% for Canada. For this reason, we believe the U.S. economy is more insulated from the impact of tariffs, providing leverage in trade negotiations with other countries.

However, the potential for higher prices and uncertainty caused by trade could weigh on household and business spending, providing a modest and likely manageable headwind to economic growth. We've seen this uncertainty play out in softer consumer-spending data and falling consumer-confidence readings to start the year. However, the impact of tariffs should be considered within a broader policy mix, where tax cuts and deregulation – which may come to the forefront later this year – could offset some economic weakness and boost domestic growth.

Tariffs could have a more meaningful negative impact on economic growth in regions such as Mexico and Canada given their economies are more dependent on trade. Additionally, economic growth in these regions has lagged the U.S. over the past several years, placing them at a more vulnerable starting point relative to the U.S. where economic growth has been robust.

Impact on inflation

Prolonged tariffs would likely put upward pressure on U.S. inflation, as domestic importers will likely pass part of the increased cost from tariffs on to the consumer. Additionally, retaliatory tariffs, such as those levied by Canada, could have a meaningful price impact on industries such as autos, which have highly integrated supply chains across North America, with parts crossing the border multiple times before final assembly. However, there are potentially mitigating factors.

• A stronger U.S. dollar can make foreign goods cheaper in U.S. dollar terms and could partially offset the impact on prices.
• Foreign manufacturers and U.S. importers or retailers could choose to absorb part of the cost instead of passing higher prices on to the consumer. However, for certain products where profit margins are slim, like gasoline and perishable food, any additional costs are more likely to be fully passed on to the consumer.
• U.S. importers may find substitutes for products when available, and over time supply chains may be altered or brought on-shore, although the latter will require investment and more time.

During the 2018-2019 trade war, prices of laundry equipment spiked in the months following the implementation of tariffs. However, prices subsided shortly after and the overall impact to headline inflation was muted. While the tariffs implemented this time around are much broader in scope, we expect the impact will be a one-time increase in prices as opposed to an ongoing source of inflation.

Impact on central-bank policy

In our view, sustained tariffs would likely lead the Federal Reserve (Fed) to maintain its policy rate and delay further rate cuts. However, we believe the bar is high for the Fed to hike rates. Policymakers are likely to view tariffs as a one-off increase in prices as opposed to an ongoing source of inflation that would de-anchor inflation expectations, though they will closely monitor the latter. Additionally, tariffs would most directly impact goods inflation, which carries a smaller weight in the consumer price index (CPI) basket compared with services inflation. However, U.S. economic momentum has slowed in the first few months of 2025. Signs of further softening in U.S. economic data could prompt the Fed to continue cutting rates to support the economy and labor market.

Impact on the markets

Well-diversified portfolios are designed to spread risk, while certain asset classes that comprise them may respond differently to upcoming policy shifts. While we wouldn't characterize tariffs as a positive for U.S. equity markets, we believe that U.S. markets are best positioned to deal with tariffs relative to international equities. Additionally, a stronger U.S. dollar has historically been associated with periods of U.S. outperformance versus international stocks.

Within the U.S., certain industries, like U.S. autos, could be challenged, given that the U.S. is a major importer of car parts. But the broader equity market is likely to hold up better than trade-sensitive sectors. Cyclical asset classes, such as U.S. small-cap and U.S. mid-cap stocks, derive less than 30% of their revenue abroad and could be relative beneficiaries of lower tax rates. Within fixed income, investment-grade bonds could offer diversification benefits during periods of volatility. This was on display in early February, as longer-term bond yields declined initially following the U.S. announcement of tariffs, and more recently as U.S. economic data has pointed to signs of slowing growth.

Tariff and trade tensions were a source of volatility for equities throughout the 2018 trade spat with China. On the flip side, a trade truce helped stocks rally in 2019. We expect a similar sensitivity to trade headlines, but we recommend investors avoid the temptation to abandon long-term strategies in hopes of avoiding short-term dips. The fundamental backdrop remains supportive, in our view, with corporate profits rising and the U.S. economy on strong footing, despite a potential soft patch in the first quarter, while potential pro-growth policies are also likely on the way.

Financial considerations

What can I do to prepare for tariffs?

It's important to keep in mind there are many unknowns, including which countries and goods will ultimately be impacted and for how long. That said, if you're concerned about price increases, options include revisiting your budget, refreshing your emergency fund, and considering accelerating large purchases likely to be impacted.

Revisit your budget

If you're concerned that higher prices will impact your ability to spend within your means, it's a good time to tune up your budget. If you need to make adjustments, options include:

• Substituting expenses: look for items that could easily be swapped for cheaper alternatives like generics for brand names, or going on a picnic instead of to a fancy restaurant for a date night
• Reducing expenses: see if you can cut any expenses that aren’t being used or are unnecessary
• Creating more income: explore whether there are ways to make additional income like working toward a promotion, looking for a higher-paying position, or taking on a side job

For more information about budgeting, ask your financial advisor for the "Budgeting: Take control of your spending and saving" report.

Refresh your emergency fund

An emergency fund can help with unexpected expenses, and you want to be prepared in case the cost of those expenses (like car parts) increases. We recommend having three to six months’ worth of living expenses in cash or cash equivalents for emergency needs. If you're really concerned about the uncertainty in the environment, holding the higher end of that range may be worthwhile. For more information about emergency funds, ask your financial advisor for the "Building an emergency fund" report.

Consider accelerating large purchases likely to be impacted

If you're already planning on making a large purchase that's likely to be impacted, you can accelerate the purchase if you can afford it. Examples could include automobiles or electronics like phones or computers.

Additional Considerations for Business Owners

• Take a measured approach to the tariffs. While it's important to plan and take steps to prepare, we recommend taking a measured approach to account for the rapidly changing landscape.
• Understand and diversify your supply chain. If you rely on imports, look for opportunities to diversify your supplier base or to substitute inputs. This can give you more flexibility, reduce the probability of disruptions, and potentially reduce the impact of rising costs. You may also consider increasing inventories of durable goods prior to price increases taking effect.
• Know your pricing flexibility. If the goods you rely on become subject to tariffs, you may be able to negotiate lower prices from your suppliers. Alternatively, you might be able to pass along some of the increased costs to your customers. Their willingness to accept price increases are determined by several factors that may include things like the availability of substitute products, whether the product is a necessity or luxury, and how much of their income is allocated to the product, among other factors.
• Look for other areas to cut costs. Having a process for forecasting, budgeting, and tracking expenses can help you assess where expenses are going and potential ways to reduce them.