Thoughts on the Market: Special Encore – Will US Tariffs Drive Mexico Closer to China?

Hosted by Morgan Stanley | Release Date: December 31, 2024

Morgan Stanley’s podcast, Thoughts on the Market, presents a comprehensive analysis of the evolving trade dynamics between the United States, Mexico, and China in their special encore episode titled “Will US Tariffs Drive Mexico Closer to China?” Hosted by Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist, and Nick Lippmann, Morgan Stanley's Chief Latin American Equity Strategist, the episode delves deep into the repercussions of the 2024 U.S. election on Mexico’s economy, its trade relationships, and the broader geopolitical landscape.

1. US Election Outcomes and Immediate Market Reactions

The episode opens with Ariana Salvatore setting the stage by highlighting the significance of the 2024 U.S. election and its potential impact on Mexico:

“The U.S. election has generated a lot of debate around global trade and now that Trump has won, all eyes are on tariffs.”
— Ariana Salvatore [00:50]

Nick Lippmann responds by discussing the mixed sentiments among investors regarding Trump's re-election:

“International and US Investors are generally rather apprehensive about getting in front of the Trump risk in Mexico.”
— Nick Lippmann [01:14]

Despite investor apprehension, it’s noted that many Mexico-based and Latin American investors view Trump’s victory positively, even more so than alternatives like Biden or Harris. This sentiment is reflected in the Mexican peso’s performance, which has depreciated by 25% against the dollar year-to-date, a significant shift from its previous stability.

2. Trump’s Trade Policy and Potential Tariff Implications

Ariana explores the possible trajectories of Trump’s trade policies with Mexico, emphasizing the ambiguity and range of potential outcomes:

“We think a wide range of outcomes is possible here, especially because the President can do so much without congressional approval.”
— Ariana Salvatore [01:54]

She references past instances where Trump leveraged tariffs for policy concessions, such as the 2019 threat to impose a 5% tariff contingent on Mexico addressing border immigration issues. The discussion underscores the delicate balance required, given that the U.S. remains Mexico’s primary trading partner, making any policy shifts highly impactful.

Nick adds depth by analyzing the integration of North American manufacturing ecosystems and the challenges in disentangling U.S.-Mexico economic ties from China:

“The North American model is really very integrated. US Companies are by a mile the biggest investor in Mexico.”
— Nick Lippmann [02:52]

He emphasizes that Mexico’s transition from a mere assembly hub to a value-added manufacturing ecosystem is crucial for maintaining competitiveness, regardless of U.S. tariff policies.

3. Mexico’s Trade Relations with China: Current Dynamics and Future Prospects

The conversation shifts to Mexico’s trade policies with China, revealing a complex interplay between political rhetoric and actual implementation:

“There is growing evidence that China is trying to use Mexico as a China bridge.”
— Nick Lippmann [04:01]

A critical analysis is provided on Mexico’s imposition of 25% and subsequently 35% tariffs on Chinese imports. Despite these high tariffs, imports from China have not significantly declined, partly due to multiple discounts and exemptions resulting in effective tariffs of only 2.5% to 3%. This discrepancy suggests a superficial alignment between Mexico's policy stance and its actual trade practices.

Ariana summarizes the gap between rhetoric and reality:

“There is a political or rhetorical, at least alignment between the US And Mexico when it comes to China, but the reality is that the policy implementation is not yet there.”
— Ariana Salvatore [05:23]

4. The Future of the USMCA Agreement Under Trump’s Administration

Looking ahead, Ariana discusses the pivotal role of the upcoming USMCA (United States-Mexico-Canada Agreement) review in 2026:

“The USMCA review that's coming up in 2026 is going to be a really critical litmus test of the US Mexico relationship.”
— Ariana Salvatore [05:50]

She outlines the structure of the agreement, noting its longevity until at least 2036 but highlighting the 2026 review as an opportunity for significant evaluations and potential amendments. Key areas of focus include digital trade, AI, labor protections, Mexico’s energy sector, auto and EV disputes, and notably, Chinese investment in Mexico.

Nick elaborates on the potential outcomes of this review, suggesting that the Trump administration may confront specific trade disputes and integrate immigration policy considerations:

“Trump's approach likely will involve confronting the auto EV disputes and could possibly introduce an element of immigration policy within the revision.”
— Nick Lippmann [07:04]

5. Impact of Nearshoring and Future Manufacturing Ecosystems

The discussion transitions to the nearshoring trend, which has benefited Mexico by attracting manufacturing investments closer to the U.S.:

“Mexico has been a beneficiary of the nearshoring trend. Do you think this is going to change as we look ahead?”
— Ariana Salvatore [08:34]

Nick acknowledges Mexico's current underweight status but remains optimistic about its future:

“We're still underweight in Mexico, but I think risks are ultimately biased to the upside over time with regards to trade.”
— Nick Lippmann [08:34]

He distinguishes between the initial wave of nearshoring, focused on brownfield projects with existing infrastructure, and the next phase, which may involve greenfield projects in sectors like IT hardware and EV batteries. This evolution will hinge on policymaker incentives and strategic investments.

6. Conclusion and Forward Look

In wrapping up, Ariana anticipates further insights as the Trump administration makes key personnel appointments, which could influence Mexico’s trade policies and its relationship with China. The hosts express gratitude to listeners, encouraging them to share the podcast and look forward to future episodes.

Key Takeaways

• Investor Sentiment: Mixed reactions to Trump’s re-election, with apprehension among international investors contrasted by optimism among Mexico-based investors.

• Trade Policy Uncertainty: Trump’s potential to influence Mexico’s trade policies significantly, especially regarding tariffs and immigration, without needing congressional approval.

• China-Mexico Trade Dynamics: Despite high nominal tariffs, effective rates remain low due to exemptions, indicating challenges in shifting Mexico’s trade orientation away from China.

• USMCA Review Importance: The 2026 review stands as a critical juncture for redefining US-Mexico trade relations, with potential impacts on various sectors including digital trade and energy.

• Nearshoring Evolution: Mexico’s role as a nearshoring beneficiary is poised to evolve, potentially expanding into new manufacturing sectors contingent on strategic policy and investment decisions.

This episode of Thoughts on the Market offers a nuanced exploration of the intricate trade relationships shaping North American economies, providing listeners with valuable insights into the potential shifts in Mexico’s economic landscape amidst changing U.S. policies and global geopolitical tensions.