Talking Points
March 28, 2025 | 13:10
’Til Tariffs Take the T-Bird Away
Economics
Economics
A recent estimate finds that 8% of U.S. households do not own a car. That portion may soon see a big increase, as vehicle prices are poised to rise, and potentially meaningfully so, in the wake of aggressive and broad-based U.S. tariffs on all imported vehicles. While the details are still being ironed out on vehicles assembled in Canada and Mexico, the whopping 25% headline rate is like a hammer blow to the industry globally. From Japan, to Korea, to the EU, the reaction was intense, and only somewhat more muted in Mexico and Canada on the prospect/hope of a slightly lighter touch. We are assuming the average tariff on Canadian assembled vehicles will be 12.5%. Even so, Prime Minister Carney intoned that this was a direct attack on Canadian workers, and who can disagree? Breaking with decades of free trade in the auto industry in North America, any tariff on vehicles is a massive step-up in the trade war, let alone a levy as high as 25%. |
We dig much more deeply into the specifics of the auto tariffs and the implications in the Focus Feature, but we can’t precisely gauge the economic impact until the full details are revealed, as well as Ottawa’s response. However, we do know that vehicle prices are going higher, especially in the U.S., and production is likely to be stunted, especially in Mexico and Canada (depending on the details). We also know that over the past year the U.S. assembled 10.75 million vehicles and bought 16.07 million. Looking beyond the fact that the U.S. exported about 1.5 million vehicles in that time, that leaves a gap of more than 5 million cars and trucks that needs to be filled from somewhere. In theory, some of the supply gap can be met by increased domestic production, a point the Administration is making—the U.S. auto industry is operating below normal capacity and has some room to boost output. In February, the Capacity Utilization (CAPU) in the auto sector was 68.4% versus a long-run median of 74%; just reaching the average could mean a boost in output of nearly 1 mm vehicles. Meeting the highest quarterly CAPU of the past 25 years (84%) could see a boost of 2.5 mm vehicles. But that takes time, manpower, parts, and yet still leaves a big shortfall. It also ignores the small detail that many models and some makes are not currently produced stateside, and would require some serious retooling and investment to bring those models onshore. So, even with a tariff wall, the U.S. will be importing a lot of vehicles, saddled with heavy-duty tariffs. The conclusion has got to be that the marginal price for autos is about to rise, and rise markedly. The President has warned automakers not to raise prices, which, along with a build-up of inventories ahead of the tariffs, may initially keep things in check. But it’s tough to fight the laws of economics, and rational actors will quickly realize that there is a limited supply of tariff-free vehicles, driving demand for those units, as well as for used vehicles. While the pandemic spike in auto prices—used cars soared 26% in 2021, and then new car prices jumped 10% in 2022—isn’t likely to play out in precisely the same fashion, it does serve as a template and a warning. The two account for a heavy 6.7% weight of CPI, and can thus make serious waves in overall and core price trends. We are expecting overall vehicle prices to rise roughly 10%, cutting sales by about 5% from where they would have been before tariffs (or to 15 million this year). Awkwardly, this week’s major U.S. economic release saw the core PCE deflator already post its largest increase in more than a year at +0.37% in February, lifting the annual rate a tick to 2.8%. That’s not a breakout from recent trends, as this metric averaged 2.8% last year as well, but it reinforces the point that core inflation seems a bit stuck at just under 3%. Not helping, the University of Michigan reported that consumer expectations of inflation for five years out jumped to 4.1% in March, up from 3.5% the prior month and 3.0% at the end of last year, the highest rate in 32 years. Even so, the market still expects the Fed to cut by up to three times this year (we’re at two, both in the second half). A key reason the market continues to gamely price in meaningful Fed easing is on growing concerns about the trade war’s toll on growth. After staging a brief counter rally, equities are also expressing some similar concerns again—the auto tariffs cut short a budding recovery, sending the S&P 500 down about 1% for the week and nearly 9% below its mid-February apex. Bond yields have also see-sawed on the many ebbs and flows of trade news, further bewildered by the conflicting forces of weaker growth and higher inflation pressures. On net, yields nudged up this week, with 10-years ending near 4.3%, after testing 4.4% at one stage. Currency markets are also torn between conflicting forces. In the preliminary stages of the trade war, the U.S. dollar was ascendant—and that seemed to be the logical response, as a stronger greenback would neutralize modest U.S. tariff increases. However, the broad and aggressive nature of the U.S. trade threats and actions has triggered a more aggressive response by others and has darkened the U.S. economic outlook more significantly. Accordingly, this week’s step-up made little net impact on currencies. Even the Mexican peso softened only slightly this week, despite the fact that the nation is the single biggest exporter of autos to the U.S., and even with another 50 bp interest rate cut by its central bank this week (to 9%, down a cumulative 225 bps since the cutting began a year ago, which just so happens to precisely match cumulative BoC cuts). The trade news is so overwhelmingly immersive that we only now get around to noting that the Canadian federal election campaign got officially underway this past week. And yet, like other currencies, the Canadian dollar was mostly becalmed, even with the tough news on autos. The loonie toggled around the 70 cent line (or just below $1.43/US$) for most of the week, before ending stronger on an “extremely productive” call between President Trump and Prime Minister Carney on Friday morning (the President’s words, per a post). Expectations are running high that Canada, and perhaps Mexico, will be treated a bit less harshly on the auto front, recognizing the heavy weight of U.S. parts in production, as well as the deeply integrated nature of the North American market. The flip side is that the President has been very clear about the long-run goal of moving production stateside, so there are no illusions on this front. |
The never-ending trade saga and the election start completely overshadowed economic news, but there were some notable developments there. First, the Bank of Canada essentially let us all into their private group chat, as the Summary of Deliberations revealed that the only reason it cut rates earlier this month was due to trade uncertainties. And increasing the chances the Bank moves to the sidelines soon was a sturdy GDP report, showing a 0.4% pop in January on top of a 0.3% advance in December. But, that release also suggested that the trade battle is chilling activity, with the early read calling for no growth in February. And, almost all sentiment surveys are flashing massive warning lights in March, with historic declines for both consumers and businesses (Chart 1). |
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Bottom Line: The planned 25% tariff on autos is a major step up in the trade war. However, for Canada at least, the reportedly civil call between leaders and the potential for slightly less unfavourable treatment for local production leaves some sliver of light. Of course, the grand reveal on so-called reciprocal tariffs now awaits in the coming week. |