US Tariffs on Mexico: USMCA Hangs in the Balance, Central Banks Plot their Next Moves

With the governments of the United States, Mexico and Canada all signing onto the new USMCA (United States-Mexico-Canada) Trade Agreement, it seemed as though President Trump's longstanding promise to redo NAFTA was assured. However, in an unexpected move, Trump once again flared up political tensions between his country and Mexico by threatening to impose a 5% tariff on Mexican imports—with a gradual increase to 25%—if the Mexican government doesn't adequately stop illegal immigration over the US border. Understandably, this surprise announcement has sent destabilizing shockwaves throughout the market. Trump has framed these new tariffs as a border security issue, although they undoubtedly have the potential to negatively impact the economies of all three partner nations in the USMCA.

This recent spat between the US and Mexico has called into question whether or not the USMCA can survive should these new tariffs be imposed. The Canadian government has reaffirmed its commitment to move forward with ratification, as has, for now, Mexico. It is unclear how long this new trade dispute might delay the USMCA from coming into effect, although what is clear is the economic damages that could arise. The Mexican Peso dropped by approximately 3% against the US Dollar following the tariff announcement and has hardly recovered. Economic forecasts suggest that just a 5% tariff could lower Mexican export growth by nearly 3%. In the US, Trump's ongoing trade disputes with major partners, and now Mexico, is raising concern about the growing risk of a recession. In response, Federal Reserve Chairman Jerome Powell indicated that the bank is prepared to protect the US economy, if necessary, by cutting interest rates. This would be a stark contrast to Powell's direction in 2018, where the bank hiked rates four times. Though it is likely the bank will keep rates steady, the market has begun anticipating a prospective rate cut later this year. Even Canada, which views the new tariffs solely as a US-Mexico issue, is at risk. Bank of Canada Governor Stephen Poloz is increasingly being expected to follow alongside any US rate cut, as excessive delays to the implementation of the USMCA could herald the return of trade uncertainties between Canada and its largest trading partner. A gloomier outlook for global trade would also likely prompt Poloz to take a more cautionary approach.

As the US and Mexico now engage in negotiations over their most recent squabble, the state of North American free trade will find itself, once again, in a precarious situation.

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