The Fed Can’t Seem to Catch a Break

Tariff policy and uncertainty moved back into the spotlight this week as the President announced a major new round of tariffs: 50% tariffs on US$20 billion, or 5% of Canadian goods imports under a never-yet-used Section 338 provision of the 1930 Tariff Act, and 10%-to-12.5% tariffs on most of its major trading partners (80 countries), alleging forced labor in their supply chains. The forced labor tariffs were recommended by the USTR under Section 301 of the Trade Act of 1974.

The forced labor tariffs are already in effect with some exemptions for imports of fuel, foods and fertilizers, and products tariffed under separate industry-specific tariffs. These duties will largely replace the temporary 10% global tariff (under Section 122 of the Trade Act of 1974) that expired Friday and were put in place in February, following the Supreme Court decision to strike down many of the Administration’s earlier tariffs. So for now, the move is not expected to materially increase the U.S. average effective tariff rate (AETR), but it will keep it from falling further. Thankfully, the 50% Canadian tariffs won’t take effect until August 19 and whether they actually get implemented could depend on how USMCA negotiations go.

The inflation impact has been somewhat lower than initially thought, but recent research from the NY Fed shows companies are not done passing along tariff cost increases to customers. Its latest regional surveys reveal nearly half of firms that have paid tariffs still plan additional price increases to offset these costs. In short, these new measures, with more in the pipeline, threaten to sustain the tariff-driven inflation pressures and supply-chain uncertainty that kicked off last year. This is unfortunate, since a measure of U.S. trade policy uncertainty that we track finally fell in June to its lowest level in the second Trump Administration. Many businesses were looking beyond the trade shocks of 2025 (Chart 1).

The fear is that the U.S. may be embarking on another damaging trade policy uncertainty cycle. One of the worst parts of these tariffs is the fact they aren’t achieving what they set out to do: rebalance the overall U.S. trade deficit. The goods trade deficit continues to deteriorate (Chart 2). We estimate the real trade shortfall widened again in Q2, capping three quarters of deterioration. In fact, the real Q2 trade deficit is expected to be larger than in 2024Q4, or before tariffs even started.

If the new tariff announcements weren’t enough to send fixed income investors scrambling for cover, the intensification of the Middle East conflict over the last two weeks has sent Brent and WTI crude oil futures soaring and retail gasoline prices back on the rise. On Friday, WTI futures were up 30% from July 6 lows. Brent futures looked even worse, up 40.7% from their July 1 low (Chart 3). With the Strait of Hormuz closed once again, and the Houthis now attempting the same with Saudi oil in the Red Sea, shipping through these vital waterways has once again ground to a halt. Average retail gasoline prices jumped to $4.11 per gallon on Thursday, their highest level since June 10, according to AAA. This is another shot across the bow for the Fed that is actively on inflation watch and nervous about inflation expectations becoming unanchored as energy prices vault higher.

This sets Chair Warsh and the FOMC up for a contentious debate on the inflation outlook and the proper level of policy rates to combat the problem. While we don’t expect a rate hike at next week’s meeting, we do expect a hawkish tone to resonate across the statement and post-meeting press conference. Markets will likely react more to Warsh’s press conference than to the statement itself, listening for any hints that September remains a ‘live’ meeting for a possible hike. As of Friday, fed funds future markets are pricing in a 34% chance of a hike next week and making a quarter-point hike a near-certainty at the September meeting.

Fed Preview: A Step Closer, but not a Step Up

We expect the FOMC to keep policy rates unchanged on July 29, with the fed funds target range at 3.50%-to-3.75% for the fifth consecutive confab. But the decision will not be unanimous; we expect to see at least one member dissenting in favor of a rate hike. Currently, the market is pricing in around 35% odds of a rate rise.

Recall from last month’s Summary of Economic Projections and its (days-are-numbered) dot plot, that nine of the 18 participants providing a forecast (Chair Warsh did not) penciled in at least one rate hike by the end of the year. In participants’ minds, if ‘hold vs. hike’ was a close call as of last meeting, the subsequent data flow might have tipped it more to the hold side, at least for now. The core CPI was unchanged in June (unrounded, it dipped 0.02%), which was the smallest move in more than nine years apart from the pandemic’s triple-play (March-May 2020). And after three months of solid gains (averaging 164k), June payrolls expanded by only 57k. However, the job growth and core inflation readings are still just one month’s worth, something Chair Warsh mentioned recently in discussing the CPI. So, any tipping of the balance will probably be by just a bit.

June’s benign CPI and PPI reports point to a restrained result for the PCE price index for the month (due July 30… the consensus call is +0.1% for the core). This will still leave core PCE inflation running in the low-3% y/y range and far from the 2% target for the total—and still outpacing the core CPI (2.6% y/y) which is abnormal and alarming (although looming methodology changes to the PCE should close the gap a bit). One month’s benign reading is not going to alter much of the narrative on the ground… that core PCE inflation, the Fed’s current operational guide, is still too sticky, and too stubborn for comfort. Not only has the yearly change been drifting up recently (from under 3% to 3.4%) but the latest three- and six-month trends are running even faster (3.5% and 4.1% respectively). More months of data are needed to change the narrative. The question is: How many voting members are prepared to wait?

Meanwhile, we reckon the bar to act, be it a rate hike or a rate cut, has been lifted a little by the potential for changes to the conduct of monetary policy (notice the underlined word in the paragraph above). There is a (small) risk that a rate decision determined to be appropriate today (indeed, even to hold!) might look less appropriate in light of the results and recommendations of the five task forces delving into the Fed’s current conduct, should the FOMC adopt some of them early next year. When it’s a black or white decision based on unequivocal evidence, this shouldn’t be an issue. But when the data are decidedly mixed and the decision cast in gray, this could add just a bit to Fed caution. We reckon ‘caution’ is going to be the Fed’s catchword for a while.

The 411 on 338s and 301s

We review recent moves on the Section 338 and 301 tariff fronts.

After the Supreme Court struck down tariffs justified by the International Emergency Economic Powers Act (IEEPA) in February, President Trump forcefully recited the three statutes and their combined five sections that authorized him to impose tariffs. He said, “those statutes include, for example, the Trade Expansion Act of 1962, Section 232… all of these things I know so well… the Trade Act of 1974, Sections 122, 201, 301, and the Tariff Act of 1930, Section 338.” (See Table 1). It turned out that this was not a civics lesson, but a game plan.

The President also announced at that time the first-ever Section 122 tariffs, a 10% duty to address the purported “fundamental international payments problems”. Given that the U.S. has no problem attracting sufficient foreign investment to cover its moderate (~3% of GDP) current account deficit (and the President often touts the trillions of foreign investment dollars he has attracted), the action was controversial. It was also unlawful, according to a lower court on May 7. The latter, along with the fact that affordability is a hot-button issue in the midterm elections, ensured that Congress would not extend Section 122 tariffs after 150 days, and they expired as of July 24. In the end, the 122s were probably more about biding time until tariffs with sturdier legal footings but longer investigations could be introduced. Indeed, at the same time, the President said: “we’re also initiating several Section 301 and other investigations to protect our country from unfair trading practices of other countries and companies.” Little did we know that Section 338 tariffs were likely also brewing.

Below, we take a closer look at Section 301 and 338 tariffs. We published a report on the remaining ‘200 series’ duties, “The 411 on 232s”, last year [1]. Since then, the number of 232 investigations and tariffs in place have expanded from 11 to 15 (see Table 4 for an updated list). Section 201 duties were first introduced in the first Trump Administration (February 2018) to protect the washing machine and solar panel industries. The former’s original three-year run was extended for two years until 2023. The latter’s original four-year run was extended for another four years (by the Biden Administration), expiring this February. Finally, with the introduction of Section 338 tariffs this week, President Trump has now used all five available tariff authorities.

More on 301s

Section 301 of the Trade Act of 1974 gives authority to impose tariffs once it is determined that the acts, policies or practices of a foreign government are “unjustifiable, unreasonable or discriminatory” and “burden or restrict” U.S. commerce. The U.S. Trade Representative (USTR) is tasked with initiating the investigations, making the determinations, and setting tariff rates (or quotas, or other trade restrictions). The process includes consultations with the targeted foreign government and domestic stakeholders and can take 12 to 18 months to complete, although it can be expedited (as we saw with the ‘forced labor’ duties).

In the first Trump Administration, the Section 301 investigation into China’s treatment of technology transfer, intellectual property, and innovation led to a 25% broad-based tariff that was extended (301s are reviewed every four years) and expanded by the Biden Administration (e.g., from 25% to 100% on EVs). Since January 2025, the White House has initiated six Section 301 investigations (Table 2). The first began in July 2025 concerning a collection of Brazilian trade practices and resulted in a positive determination last month. After further consultations, a 25% tariff was applied on certain goods effective July 22 (the full process took around 13 months) [2].

Two multi-country investigations were initiated after the Supreme Court’s IEEPA ruling. Beginning March 11, 16 countries were probed for maintaining structural excess capacity in manufacturing. Starting March 12, 60 economies were investigated for failing to sufficiently restrict imports made with forced labor. The latter was clearly expedited, as a potential replacement for expiring Section 122 tariffs (the 60 economies represent almost all goods imports).

On July 24, Section 301 tariffs to address economies’ forced labor practices came into effect, following consultations after the proposed duties were announced on June 2 (it took less than five months to get these done). As in last month’s announcement, none of the 60 economies investigated were found to have both adequate prohibitions against forced labor in supply chains and adequate enforcement of their prohibitions (adequate defined as being up to U.S. standards). However, the list of economies with at least adequate prohibitions on the books, and thus given a 10% tariff, was expanded from 6 to 19. The new list is (with the original six underlined): Argentina, Bangladesh, Cambodia, Canada, Ecuador, El Salvador, the European Union, Guatemala, Honduras, India, Indonesia, Jordan, Malaysia, Mexico, Pakistan, Sri Lanka, Taiwan, the United Kingdom, and Trinidad and Tobago. All other countries (41) are in the 12.5% group.

The Administration appears to have made a path to get from 12.5% to 10%, but it’s unclear how long a proven adequate enforcement period must last before the move from 10% to zero (Section 301 actions are typically reviewed every four years). The list of exemptions was modified, but USMCA-compliant goods are still exempt. So too are goods subject to 232 tariffs along with certain raw materials and industrial inputs among other items.

More on 338s

This week, completing the tariff policy pentagon, the Administration announced Section 338 tariffs for the first time in 96 years, invoking the Tariff Act of 1930. Also known as the Smoot-Hawley Tariff Act, it triggered, at the time, a global tit-for-tat tariff war causing international trade to collapse and exacerbating the Great Depression. This never-used-before section gives authority to impose tariffs of up to 50% due to discrimination against U.S. goods—and, unlike Section 301, no major investigation or consultations are required. On July 20, a 50% tariff was announced on $20 billion worth of Canadian goods.

Implications for Canada

The announcements cited discrimination against the U.S. on three fronts: alcohol, vehicles, and dairy products (particularly cheese). The new tariffs are to take effect August 19 on a wide swath of Canadian goods. As Table 3 shows, the largest impacts are in the following sectors: chemicals, plastics, electronics and related equipment; consumer goods and forestry and wood products; and other manufacturing, machinery and industrial equipment, agricultural and food products. And there are exemptions, such as goods already saddled with Section 232 tariffs.

But in a radical departure from previous U.S. tariff actions, USMCA-compliant goods are not exempt. This raises more questions on the usefulness of the trade deal, especially as formal bilateral negotiations appear to have stalled (conversely, the U.S. and Mexico held its third round of talks this week).

It is argued that this latest tariff action is designed to pressure Canada to make trade concessions, both generally and amid USMCA negotiations. As such, these duties could be postponed or pulled. But if they do take effect, they would raise Canada’s average effective tariff rate on exports to the U.S. from about 5% (and nearly 0% pre-trade war) to roughly 7.5%. We dig deeper into these tariffs and their economic consequences below.

Dairy products: Canada’s dairy supply management system has been a longstanding trade irritant, and the current USMCA conceded limited access to the Canadian market. U.S. authorities cite discrimination because the arrangement negotiated in the USMCA is ‘worse’ than the one negotiated by the EU in its trade deal with Canada. While this latest action is the most explicit form of U.S. disapproval, it is unlikely that it will result in major overhaul of this longstanding regime—especially since Canada exports very few dairy products to the U.S. so the actual impact of these tariffs will be limited.

Alcoholic beverages: The White House is responding to early-2025 measures by most provincial governments (two of which have since pulled back) to remove U.S. alcohol from provincially owned liquor stores as a retaliatory action against U.S. tariffs. U.S. officials have highlighted ongoing restrictions by the two largest provinces, Quebec and Ontario, as particularly harmful.

For now, it seems unlikely that these measures will be fully lifted given their broad public support. Indeed, Chart 1 highlights that Canadians have redirected their imports away from the U.S. in a shift that has largely persisted since March 2025. (Note this is all imports, not just restricted alcohol.) If the provinces were to allow American alcohol back on to their shelves, it is unlikely that consumer demand would snap back to pre-2025 levels, at least as long as broader U.S. trade tensions persist.

Automobiles: The U.S. tariffs are in response to Canada’s countermeasure of 25% on non-USMCA vehicles, or 25% on the portion of USMCA-compliant vehicles that do not originate from Canada or Mexico and are imported from the United States. It is this proclamation that provides the most opportunity for negotiations, since it is tied to the widest range of U.S. tariff threats.

Ultimately, the impact on Canada’s economy will rest on the extent (and duration) of these tariff threats; the silver lining is there is at least some room for negotiations—and relief—ahead of the August 19 start date. Even so, our initial estimate is for these tariffs to carve out roughly half a percentage point from Canadian growth if implemented in full. Regionally, we expect the biggest impacts will be felt in B.C., Quebec, and Ontario—the three provinces that are already feeling the largest strain from existing duties, particularly on steel, aluminum, and lumber.

This comes just as growth looked to be finding its footing more than a year into the trade war and months into the Iran war-driven energy price shock. Although businesses had been showing signs of looking past tariff headlines, this would be the toughest action since the spring of 2025, adding yet more headwinds for a struggling loonie. The uncertainty will likely endure as long as the tariffs persist: on one hand, businesses could again recognize the need to move past the tariff news; on the other, questions about the effectiveness of the USMCA could hit already-damaged business investment over the longer term.

On net, the elevated uncertainty underlines the Bank of Canada’s inclination to remain on hold. Over the medium term, however, a weaker growth backdrop tilts the risks to a slightly more dovish skew, as the BoC specifically noted worsening tariffs as a potential reason to lower rates further. For the record, we are still calling for the overnight rate to remain at 2.25% through the rest of this year. But with inflation remaining well behaved through the energy price shock (so far) and the risks to growth taking a big step up this week, the dovish argument just got a little stronger.

With files from Robert Kavcic and Erik Johnson

[1] https://bmoficc.bluematrix.com/docs/pdf/67e8f6e1-6236-48ca-90f4-f7056967a9d8.pdf [^]

[2] The USTR also completed an investigation started by the Biden Administration into Nicaragua’s “abuses of labor rights, abuses of human rights and fundamental freedoms, and dismantling of the rule of law”. In December, it announced a ‘stackable’ escalating tariff that hits 15% on January 1, 2028 (after 0% effective 2026 and 10% effective 2027). Goods compliant with the Dominican Republic-Central America-United States Free Trade Agreement (CAFTA-DR) are exempted. [^]