Global Headwinds From U.S. Tariffs

In a new Global Economic Outlook & Strategy report from Citi Research, a team of analysts and economists led by Chief Economist Nathan Sheets looks at the challenging headwinds for the global economy created by U.S. tariff rates’ rise to historically high levels. In the face of these headwinds, we see global growth softening to 2.1% this year, down from just under 3% in 2024. This forecast is 0.5 percentage point weaker than what we expected in March, with lower growth projections for a broad set of countries. We see 2026 global growth rebounding to just 2.3%, down 0.3 percentage point from our forecast in March. And the risks to our forecast are strongly skewed to the downside.

Since President Trump took office, the U.S. effective tariff rate has surged from 2.5% to just under 25%, the highest level in more than a century. These tariffs come after decades of intense global integration and are likely to require a significant and potentially disruptive reprofiling of the global goods sectors, including broad patterns of sourcing and production. This gives us few precedents to draw on in judging the likely effects of these policies.

Another complication is that the composition of the tariffs continues to evolve, with recent action from the White House including pausing reciprocal tariffs for 90 days, significantly hiking duties on China, exempting broad swathes of electronics and then clarifying that this exemption is only temporary. And the jury is still out on the White House’s willingness to negotiate down tariffs, or potential retaliation from U.S. trading partners.

This has left markets to handicap two distinctly different types of uncertainty. The first is how a given configuration of tariffs will affect global trade and economic performance. The second is even more fundamental: What will the U.S. tariff policies ultimately look like? Stated bluntly, heightened policy uncertainties are greatly exacerbating the underlying economic uncertainties. 

This has left financial markets facing amplified pressures, with market moves arguably signaling reduced foreign appetite for U.S. assets. As the U.S. strikes a more aggressive economic posture vis-à-vis the rest of the world, it would be naïve to think this will have no effect on how attractively U.S. assets are perceived and how willing foreign investors are to hold these assets. The accompanying uncertainty about U.S. economic policies further amplifies these pressures. We think it’s too soon to conclude that foreign investors are poised to leave the U.S. in an appreciable and sustained way, but it’s an issue we’re watching closely. 

Some have argued that President Trump’s administration has already done permanent structural damage to the U.S. and global economic performance through its realignment of U.S. economic policies. We think it’s too early to reach such a judgment with any confidence, while noting that it’s clearly a risk. President Trump has only been in office for three months; for now, it behooves us to wait and see how his administration’s initiatives play through. 

Implications for global growth

The global economy is increasingly feeling the effects of the tariff shock and its associated uncertainties. We see global growth as likely to slow, with the stepdown in developed markets especially pronounced and lower projections for countries including the U.S., euro area, Canada, Japan, China, Mexico, India and South Korea. We emphasize that our forecast is necessarily fluid as we respond to evolving news about the tariffs, but risks are clearly skewed to the downside.

The U.S. has seen economic-sentiment measures continuing to retreat; though the “hard” data have held up comparatively well, we think the broader economy is likely to feel the pinch soon. That said, the ultimate slowdown in spending may still be a few months down the road. Consumers and firms are likely to bring their spending forward during the next few months to front-run the tariffs, but the second half of the year looks likely to be weak. As this softness becomes apparent, the White House may seek to accelerate its tax cuts and deregulatory efforts.

For the euro area, a more positive narrative that had taken hold during the first quarter has been largely squelched. These downward pressures were strikingly captured by the sharp drop in April’s expectations component of the German ZEW, a key sentiment gauge. We see euro-area growth over the next four quarters running just slightly above zero, down from a 1% projected pace in our March forecast.

China is now embroiled in a full-blown trade war with the U.S., and its sizable exports to the U.S. are likely to contract sharply. With triple-digit tariff rates, only Chinese goods that are essential and can’t be sourced elsewhere will be competitive in U.S. markets. We’ve cut our forecast for Chinese growth this year to 4.2% from 4.7% and for next year to 4.4% from 4.8%. We do expect the Chinese authorities to dial up stimulus efforts, forestalling an even steeper decline in growth.

How central banks respond is an important part of this story, with the U.S. Federal Reserve facing a fundamentally different policy challenge than other central banks. For more, we direct you to our early April note.

How tariff effects might vary for trade partners

With the recent shifts in the contours of U.S. tariffs, it’s helpful to think about U.S. trade policies across three distinct global corridors:

• U.S. trade with China (about 13% of goods imports), now in the throes of a full-blown trade war;
• U.S. trade with Mexico and Canada (about 28% of U.S. imports); and
• U.S. trade with the rest of the world, including Europe, Japan and emerging Asia.

We consider these corridors one by one:

U.S.–China Trade: The escalation in tariff rates between the U.S. and China has been breathtaking. Broad swathes of U.S. imports from China currently face a tariff of 145%, with the current carve-out for electronic goods promised to be swept up in forthcoming sectorial tariffs, which are likely to run at 25%. 

In response, China has raised its tariff rate on the U.S. to 125% and announced a global suspension of exports of rare-earth minerals to the auto, aerospace and defense manufacturing sectors, a move that looks particularly directed at the U.S.

We note that with U.S. imports from China roughly three times as large as its exports ($440 billion vs. $140 billion), the U.S. market is clearly the principal theater for this confrontation. Tariffs of this magnitude are likely to be prohibitive, with China’s price competitiveness in U.S. markets greatly diminished or reversed. And we remain especially concerned about the implications of the tariffs for global production chains. Since the pandemic, many firms have diversified their supply chains away from China, but China remains a key source of inputs.

We’re also struck by the rapid and apparently unpremeditated escalation in tariff rates. We don’t think either side anticipated or desired this outcome as recently as a month ago. This raises questions about the commitment to these policies; while we aren’t anticipating a near-term rapprochement, the table could be set for meaningful negotiations within the next year or so.

U.S. Trade With Mexico and Canada: Imports compliant with the 2020 U.S.–Mexico–Canada Agreement (USMCA) remain entirely duty free, with most trade that isn’t USMCA-compliant facing 25% tariffs. To be USMCA-compliant, goods must meet “rules of origin” standards regarding their North American content. Clearly, a goal of the White House is to vigorously screen out re-exports from other countries, especially China.

The share of U.S. imports that is and isn’t USMCA-compliant is an open issue; we envision that 85% to 90% of U.S. imports from Mexico and Canada will ultimately prove compliant, with the clear implication that broad swathes of trade within the USMCA corridor should continue to enjoy privileged access to the U.S. market.

Could these tariffs rise further? We see reasons for cautious optimism, as there looks to be sufficient U.S. political support for USMCA that the White House will seek to renegotiate it rather than scrap it. But we see few concrete signals of what such a renegotiation process might look like.

Given the full-blown trade war with China, Mexican firms appear to have a unique opportunity to expand their footprint as suppliers to the U.S. market. Relative to China, they offer attractive geographic proximity and cost competitiveness, as well as a more stable geopolitical setting, with Mexico’s President Sheinbaum proving effective in her interactions with President Trump. We see the stage as set for an upsurge in nearshoring activity.

The Rest of the World: Many of the remaining U.S. trade partners are benefiting from the 90-day pause capping reciprocal tariffs at 10%, as well as the temporary exemption on electronics. As such, these countries are scrambling to strike deals with the U.S. to avoid a snapback in reciprocal tariffs. The White House has signaled increased openness to negotiations, but it’s unclear what concessions will be demanded and how quickly these negotiations could be completed.

As a baseline, we expect some countries to strike deals over the next 90 days, potentially including Japan, South Korea and India. But we expect these agreements will hew to a minimum reciprocal tariff of 10%, and won’t offer exemptions to the sectoral tariffs. Over time, we expect other countries to reach similar deals. We also judge that most U.S. trading partners will be hesitant to pursue meaningful retaliation against the U.S., given the importance of U.S. markets and President Trump’s vigorous response to China’s retaliatory tariffs. Moreover, with the U.S. running a large goods deficit with many countries, the White House simply has more imports to tariff.

That said, the U.S. trading partner we’re most concerned about is the European Union (EU). The EU broadly sees itself as a counterpart to the U.S. in terms of global size and stature, and European countries’ patience appears increasingly frayed. EU leaders may conclude that a muscular response is a better approach than meeting U.S. demands, and domestic politics may make it more difficult for the EU to make concessions.