Tariff scenarios

President Trump's 1 February Executive Order implementing US tariffs on Canada and Mexico took effect on Tuesday, 4 March after a 30-day pause. As a result, the administration will levy additional 25% tariffs on imports from Canada and Mexico, except for a lower additional 10% tariff carve-out on Canadian energy. President Trump also amended the original Executive Order on 3 March to double the additional tariffs on China to 20% from the initial 10% that took effect on 4 February. The de minimis exemption for parcels from Mexico and Canada valued at less than USD 800 remains in effect until such a time when Customs and Border Protection can process the tariffs.

China and Canada immediately responded with a wide slate of reciprocal retaliatory measures, while Mexico will announce its response on Sunday. China's initial calibrated retaliation in early February was meant to send a signal but not endanger the Chinese economy. The measures included 10-15% tariffs on a range of energy products, agricultural machinery, and heavy-duty trucks; an antitrust investigation into Google; export controls on critical elements; and a complaint filed with the WTO's dispute resolution. China responded to the latest tariff increase with additional tariffs as high as 15% on US agricultural exports and added 10 more companies to its unreliable entities list.

Canada's reciprocal retaliation comes in two stages. In a first round effective immediately, Canada imposed 25% tariffs on roughly CAD 30 billion (USD 20.6 billion) worth of US goods imports, including food, beverages, household items, and clothing. A second round of retaliatory tariffs are slated to take effect 21 days later at the same rate on an additional CAD 125 billion of products that could include big-ticket items like cars, trucks, steel, and aluminum.

The combined effect of the tariff moves since Inauguration Day has lifted the effective US tariff rate by roughly 7 percentage points to nearly 10% from just over 2% (see Figure 1). By comparison, the US effective tariff rate rose from 1.4% to just 2.4% during the first Trump administration and the Biden administration.

Figure 1: Latest escalation lifts effective US tariffs to levels not seen since the 1940s

Duties collected as a share of total imports, in %

The rise in Chinese tariffs to an effective rate of 30% from 10% is well within our base case scenario. However, the additional 25% tariffs on Mexico and Canada fall under our highly aggressive tariff downside scenario. Although we think these tariffs will not be sustained, we have opted to increase the probability of the highly aggressive trade downside scenario to 35% from 25%, while simultaneously reducing the combined upside scenario probability from 25% to 15% (see table above). In our view, the risk that these tariffs remain in place long enough to weigh on economic activity has increased. Moreover, the willingness to impose tariffs against allies and adversaries alike illustrates how far the US administration is willing to go to achieve a range of economic and noneconomic policy goals, thus lowering the odds of ending up in a limited or benign tariff environment.

An important reason for retaining a 50% probability for our base case is the assumption that tariffs on Canada and Mexico will be reversed before they inflict too much damage. If tariffs remain in effect for several months, both countries would likely fall into recession, prompting leaders to offer substantive concessions to arrest the flow of drugs and undocumented immigrants across the borders. Mexico offered to deploy 10,000 national guard troops to tighten the border, release drug cartel operatives into US custody to face prosecution, and establish a bilateral working group to deal with trade, security, and migration. Canada proposed boosting border and drug enforcement and appointing a fentanyl czar.

The Trump administration may be looking for additional concessions before allowing a sizable relaxation of tariffs. Canada, for example, could propose accelerating its commitment to raise defense spending to its 2% NATO commitment faster than the current 2032-33 timeline. Both countries could offer to raise tariffs on China or offer solutions to limit the transshipment of Chinese goods and ringfence China's surplus production of metals and other products. These steps could give President Trump a list of achievements to justify lowering the tariffs ahead of the scheduled 2026 USMCA review.

Our base case scenario still envisions a limited impact of US tariffs on the global economy and markets beyond temporary bouts of volatility. We expect equities, bonds, commodities, and gold to perform positively this year. Uncertainty in currency markets is likely to remain high, with large swings driven by individual policy announcements. For example, the Canadian dollar lost nearly 3% against the US dollar in initial trading after 25% tariffs on Canada and Mexico were first announced on 1 February, before fully recovering later the same day after the tariffs were postponed.

Our downside scenario of highly aggressive US tariffs, to which we now assign a 35% probability, would create a less favorable backdrop for risky assets. Most equity and bond markets would likely suffer losses, while the US dollar and gold would see further strength, in our view. In the upside scenario for global trade, to which we now assign a 15%chance, equities would likely rally with bonds remaining largely flat and the US dollar and gold weakening.

For a full list of our investment ideas, please consult the latest UBS House View.

12 March: All US steel and aluminum imports inclusive of derivative products face 25% tariffs on national security grounds under Section 232. These tariffs were originally established on 8 March 2018 during the first Trump administration. Quota agreements with Argentina, Australia, Canada, Mexico, EU countries, and the UK will end. The administration’s strategy is to use the tariff threat to force allies and trade partners to pressure China (and other non-market producers) to either curtail metal production or block its export to global markets. All recent efforts for a coordinated multinational solution have failed to unlock a consensus on how to tackle the problem. Retaliation against US products is likely if there is no workable solution and these metal tariffs are imposed (e.g., 2018 EU response).

14 March: Government funding deadline could prompt a US government shutdown without the passage of a continuing resolution or the 2025 appropriations bills. Republicans need Democratic support to fund the government, and the two sides are miles apart.

1 April: Economic agencies of the US government are due to report their trade policy reviews to President Trump as instructed in the 20 January America First Trade Policy Executive Order.

2 April: Reciprocal tariffs could go into effect based on the US president's comments in an address to a joint session of Congress. The administration aims to lower global tariffs on US exports to US tariff levels, remove non-tariff barriers (e.g., export bans), and implement digital service taxes.