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Podcast:听Jump Start: Will aggressive tariffs derail US economic growth?听(4:22)

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Video:听CIO鈥檚 Sundeep Gantori: DeepSeek and its impact on the AI value chain听(1:46)

Video:听CIO Alert 鈥� Navigating Trump's tariffs with CIO's Jon Gordon听(7:38)

What happened?

The Trump administration has signed executive orders to impose an additional 25% tariff on most imports from Canada and Mexico, as well as an additional 10% duty on all imports from China, citing a national emergency over 鈥渢he extraordinary threat posed by illegal aliens and drugs.鈥� Duties levied on Canadian 鈥渆nergy resources鈥� will face a lower 10% tariff, although Mexican energy imports will face the full 25%. President Donald Trump also reiterated he will 鈥渄efinitely鈥� hike tariffs on European Union goods 鈥渧ery soon,鈥� citing the 鈥渢remendous deficit鈥� with the EU. He added that he would 鈥渆ventually鈥� put tariffs on semiconductors, steel, copper, aluminum, and pharmaceuticals.

In response, Canada's government has announced a 25% tariff on some US imports, starting with CAD 30bn worth of US goods on 4 February, to be followed by another CAD 125bn added in 21 days鈥� time. Canada is also said to be considering several additional measures, including restrictions on critical mineral and energy exports. Mexico鈥檚 President Claudia Sheinbaum has ordered retaliatory measures, and China's foreign minister has vowed to take 鈥渘ecessary countermeasures,鈥� though neither provided additional details. Trump later said he would hold separate calls with the leaders of Canada and Mexico on Monday.

The US dollar rallied while Asian and European equity markets declined on Monday. S&P 500 futures are down 1.5% at the time of writing, Japan's TOPIX fell 2.5%, and European markets stood 1-2% lower. Traders also reduced their positions in a range of cryptos amid weakening risk sentiment, with Ethereum falling as much as 26.5%.

What do we think?

In our Monthly Letter: Prepare for Trump 2.0, we said that 鈥渁ggressive鈥� tariffs by the US, including 30% effective tariffs on Chinese imports and selective tariffs against EU imports, were within our base case scenario. We also said that such tariffs would be insufficient to derail US economic growth. However, we also said that tariffs against Canada and Mexico, if sustained, have the potential to inflict a 鈥渢ariff shock鈥� to US growth and risk higher US inflation, as Mexico and Canada together account for about 30% of the US鈥檚 total trade.

In our base case, we do not expect the 25% tariffs on Canada and Mexico to be sustained for a prolonged period. The Trump administration would not want to jeopardize US economic growth or risk higher inflation by leaving the tariffs in place for a sustained period, and significant stock market volatility could lead to a change in approach. We would expect industry groups representing companies on the northern and southern borders to file court challenges and lobby for their removal. It is also possible that the tariffs against Canada and Mexico are merely a tactic to accelerate a renegotiation of the United States-Mexico-Canada Agreement (USMCA), which is a free trade pact between the countries. The significant potential economic effect of the tariffs on Mexico and Canada may ultimately lead to concessions, even if their initial response has been to announce retaliation.

At the same time, Trump's comments on Friday, which suggested that the tariffs were 鈥減urely economic,鈥� linking them to the US鈥檚 bilateral trade deficits, are more concerning, in our view. Deficits cannot easily be "negotiated" in the same way as non-trade issues like migration and drug control. Meanwhile, we continue to believe that the US effective tariff rate in China will eventually rise to 30% (from the current 11%), even if Trump鈥檚 recent more diplomatic tone with China suggests the White House may believe it has something to gain from the more gradual approach.

In the weeks ahead, tariffs are likely to represent an overhang on markets and contribute to volatility, at least until investors gain greater clarity on the path and destination of US trade policy.

In the very near term, the period between now and implementation on Tuesday could provide a brief window for negotiation or compromise. Thereafter, we believe the US Customs and Border Protection may need some weeks to implement the tariffs (based on the experience of tariffs imposed in 2018 and 2019), providing a potential further window for negotiation. Another key date is 1 April, the deadline for federal agencies to report back their findings on persistent trade deficits and 鈥渦nfair鈥� trade policies鈥攁 report that could be a catalyst for additional tariffs. Earlier last week, the Financial Times reported that US Treasury Secretary Scott Bessent is proposing a gradualist approach on universal tariffs, starting at 2.5%, with a monthly step-up of 2.5 percentage points until they reach as high as 20%, while Trump had singled out tariffs on computer chips, medicine, and metal imports.

How to invest?

Navigate political risks. More volatile markets require an increased focus on portfolio diversification and hedging approaches. In equities, capital preservation strategies can potentially help limit portfolio losses. As volatility and skew are low relative to current levels of uncertainty, mean-reversion strategies can also be an effective way to harness higher volatility. We like high grade and investment grade bonds, as they offer some insulation against uncertainty and can help diversify portfolios. Separately, we believe being long USDCNY could be an effective hedge against trade risks, while CAD and MXN long exposure should be hedged or avoided in the near term. Gold also remains an effective hedge against geopolitical and inflation risks, in our view. For investors willing and able to manage risks inherent in alternatives, we also think certain hedge fund strategies are well-positioned to offer attractive risk-adjusted returns and portfolio resilience during market volatility.

More to go in equities. Although we will continue to monitor trade policy closely, our base case remains for the S&P 500 to rise to 6,600 by year-end. Tariffs on Canada and Mexico are unlikely to be sustained, resilient US economic growth should support stocks, and we continue to believe that AI presents a powerful structural tailwind for earnings and equity markets. We believe that the recent development of DeepSeek, a lower-cost AI model, will ultimately lead to even broader proliferation of AI, enhancing growth and productivity. We also like quality bonds. Aside from the attractive yield, this asset class has the potential to act as a diversifier in periods of equity volatility.

Harvest currency volatility. Changes to trade policy are likely to be keenly felt in currency markets, providing investors an opportunity to use volatility spikes to boost portfolio income. Over the next one to three months, and while trade uncertainty remains particularly elevated, we like picking up yield by selling the risks of a rally in EURUSD and of a fall in USDCHF. Over the next six months, we like selling the risks of gains in the CHFJPY, the EURGBP, and the EURAUD exchange rates, and selling the risk of declines in the GBPUSD, the GBPCHF, and the AUDUSD crosses. While the US dollar has room to strengthen in the near term, we expect it to give up its gains over the balance of 2025.