While Trump’s executive order on trade didn’t include immediate tariffs, President Trump stated that he may impose 25% tariffs on Mexico and Canada starting February 1^st(1). If fully implemented, these tariffs could severely impact Mexico and Canada, as exports to the U.S. make up 32% and 21% of their GDP, respectively.

As we await further news, distinguishing between noise and actual implementation is key. It is increasingly evident that the current administration views tariffs as a strategic tool to address broader issues, especially:

1. Immigration: U.S.-Mexico border encounters and pending cases hit a record 2.5M and 2.1M in 2023, respectively, sparking concerns over immigration rates and Mexico’s border security efforts. On Day 1, President Trump reinstated the Migrant Protection Protocols, requiring asylum seekers to wait in Mexico for hearings, and declared a border emergency.
2.  Drug trafficking: Fentanyl-related deaths, making up 70% of U.S. overdoses, have surged. The U.S. seeks more cooperation to curb the cross-border flow of illicit substances.
3. Trade deficits/disputes: In 2023, the U.S. faced trade deficits of $152B with Mexico and $64B with Canada, its largest trade partners. Despite replacing NAFTA in 2020, issues like the automotive plant offshoring and energy policies persist. The U.S. is also concerned with Mexico’s GM corn import restrictions and access to Canadian dairy markets. The upcoming 2026 USMCA review is crucial for clarifying the block's future⁽²⁾. 
4. China’s influence: China's investments in Mexico over the past five years are estimated to exceed official reports by US$7B ⁽³⁾,  raising concerns about China's growing influence in Mexico and Canada, particularly in sectors like autos and mining.

Mexico and Canada have anticipated these escalations and may respond in various ways, including with retaliatory tariffs. So far, they have chosen to signal their willingness to align more closely to the U.S.’s priorities. Mexico recently imposed 19% tariffs on imports on several countries like China and launched "Plan Mexico" to promote investment and nearshoring, while Canada pledged $1B to hire more border agents.

Tariffs would be costly for all parties, given the deep economic ties between the three nations. Mexico and Canada account for 52% of U.S. auto part imports, while Canada alone makes up 60% of U.S. crude oil imports. The PIIE estimates that 25% tariffs would reduce Mexico’s and Canada’s GDP by 1.7% and 1.2%, respectively, over five years, with inflation rising by up to 2.3% and 1.7% ⁽⁴⁾. While U.S. GDP is expected to suffer less, tariffs would impact key industries such as autos, agriculture and energy, affecting equities and credit of companies facing higher import prices. Tariffs may also boost the dollar while weakening other currencies, as demonstrated by Monday's market reaction when the peso and Canadian dollar each fell by 1.5%.

The road ahead may be bumpy, with tariffs used as negotiation tools potentially causing short-term market volatility until deals are struck. However, the significant consequences of a USMCA breakdown would likely prevent drastic actions.

(1)     The trade executive order that President Trump signed on Day 1 asked agencies to undertake a review to identify unfair trade practices by China and others.

(2)     The US is required to initiate public consultations for the 2026 USMCA Review (due July 1, 2026) at least 270 days prior, around October 2025. According to some reports, the US has requested an earlier start date for USMCA reviews talks between the three nations.

(3)     According to the Dussel Peters Institute.

(4)     Trump's threatened tariffs projected to damage economies of US, Canada, Mexico, and China by Warwick J. McKibbin and Marcus Noland

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