2026 Trade Outlook: A Herculean Effort
Tariffs are not in the rearview mirror.
February 3, 2026
The myth of the Hydra is an apt metaphor for the trade and supply chain disruptions we have seen emerge over the last decade. Slaying the Hydra, a labor of Hercules in mythology, was much easier said than done. As one head was cut off, more grew in its place. The trade landscape has faced a similar struggle, with everything from extreme weather to economic and geopolitical tensions prompting firms to adjust, sometimes on a daily basis.
When one disruption to trade flows recedes, another rises in its place, each adding additional complexity. The uneven reopening of the global economy post-pandemic laid bare the vulnerabilities to trade shocks. Many firms sought more resilient supply chains, reversing a decades long shift to just-in-time inventory systems.
In 2025, the heads of the hydra rose faster than firms could tackle them. That added greater volatility and uncertainty. The latter causes hesitation and paralysis on large investment decisions including hiring.
This annual report takes a closer look at the 2026 trade outlook. Global trade flows remained remarkably resilient in 2025, despite the first tariff tantrums in April 2025. Less than a year later, trade policy is still evolving with an eye toward securing and building critical industries.
Special attention is paid here to how we weathered the trade storm in 2025 and the shifts we anticipate in 2026. This report focuses on four key areas which form challenges for global firms: the “heads of the hydra.” They include: 1) The trade and tariff outlook for the US; 2) Likely shifts in trade policy; the threshold for retaliation by our trading partners is lower than it was in 2025; 3) Changes in global trading alliances, and; 4) Why the push for resilience over timeliness is likely to persist.
As of the writing of this report, we were still waiting for a ruling from the Supreme Court on the legality of emergency powers the administration has used to levy about half of current tariffs. Should the court rule against the administration, the White House has levers to pull to reinstate tariffs; what they are replaced with could be more difficult to overturn, while preserving much of the ability to levy tariffs at will.
A 2025 trade reset
Trade developments throughout 2025 were driven largely by policy shifts originating in the US. Most countries bided their time waiting for the dust to settle, resisting the desire to retaliate. That paid off. The tariffs announced on April 2 were scaled back, while the lack of retaliation enabled many central banks to cut rates. The latter blunted the blow to demand due to tariffs for many of our trading partners.
Global trade remained remarkably resilient in 2025, despite the rise in tariffs. The year did not represent a substantial slowdown in trade or globalization, but a reorientation.
US imports soared more than 50% in the first quarter of 2025 as firms scrambled to get goods into the country and “on the water.” (There were tariff exemptions for goods in transit.) The deficit widened at its fastest pace on record only to shrivel in the second and third quarters. Trade started to show signs of stabilizing late in the year.
Chart 1 shows how the composition of imports shifted in 2025. Imports of goods with lower tariffs and those that fell under exemptions rose, while those with higher tariffs fell.
The international arms race in AI fueled a surge in semiconductor and electronic machinery imports, which the administration accorded waivers and carve-outs to facilitate. They are seen as national security issues, which require imports because we currently lack the critical infrastructure to build our own products. The goal is to eventually shift production to the US, something both domestic political parties have embraced: one with the carrot of subsidies, the other with the stick of tariffs.
Imports and tariffs added up fastest for consumer goods, automotives and industrial supplies (excluding oil and gold). Those imports plummeted.
Gold accentuated those swings but does not count in GDP. Most gold transactions – buying gold bars, coins, resale jewelry and Exchange Traded Investment Funds (ETFs) – are simply asset exchanges. They involve existing gold changing hands, not a new good or service produced.
The largest drop in US imports last year emanated from China. Those shifts did not stop the flow of exports out of China. Much of the excess factory capacity was diverted to other countries instead of the US.
China also shifted its sourcing of agricultural products from the US to other countries. Brazil was the largest single winner on that front. American soybean farmers suffered the most. A global bumper crop added insult to injury as it lowered prices which were already falling due to the loss in demand from China.
Many US firms opted to reshuffle supply chains to lower tariffed counties in southeast Asia and North America, instead of onshoring. Factories take time to build, while tariffs have increased the cost of new construction. The skilled labor needed to run more automated plants is another hurdle; manufacturers have complained for years that we do not have enough workers with those skills.
The only offset is the full expensing of new equipment and plants passed in the tax package in July 2025. The bulk of the benefits of those tax credits have accrued to tech companies, which are writing off their investments in data centers.
Chart 1: AI fuels capital goods imports while consumer goods and autos fall
Year-over-year percentage point contribution, %, goods imports, 3-mo. moving average
Initial effect larger on employment than inflation
Tariffs hit employment more than prices in 2025, although both were affected. Nearly 85% of employment gains for the entire year occurred between January and April, before the worst of the tariffs were implemented from April 2.
Measures of economic policy uncertainty soared. That prompted firms to shelve major investment decisions, notably employment. The margin compression and overstaffing that we saw emerging from the pandemic exacerbated those factors. Unemployment edged up as the labor market seemed to freeze. Workers who had jobs clung tight and quit rates plummeted, while those without jobs were left wanting.
The inflationary impact of tariffs was small, but it is not yet over. Inflation, which had been cooling, reversed course and accelerated. The effect of tariffs alone added an estimated 0.5 percentage points to the annual core measure of the personal consumption expenditures index, which the Federal Reserve targets.
Those gains came at what was hoped to be the tail end of the pandemic inflation. Much like stock returns, inflation compounds, which leaves price levels out of reach of most Americans.
Unemployment and inflation rose in tandem for the first time since the 1970s. Consumer attitudes cratered. The result left many feeling left behind, even if they still had jobs.
Much of the inflation associated with tariffs lies ahead of us. The inventories that firms stockpiled ahead of tariffs have been liquidated. That and recent shifts in the producer price index, which shows pipeline inflation, suggest we will see additional inflation in early 2026. New goods coming into the country are now more expensive due to tariffs and a weakening dollar.
Firms tend to reset their prices at the start of the year. Those who hoped to get relief from tariffs have hit a tipping point. Fiscal stimulus passed last year will show up as lower withholdings and higher tax refunds in early 2026. Consumers tend to treat tax refunds as windfall gains. A good portion of that fiscal stimulus will be spent, which could further buoy price hikes. We saw a similar shift emerging from the pandemic.
2026 trade and tariff outlook
Chart 2 shows our forecast for the US effective tariff rate. We expect it to hit a peak at around 13% in early 2026. That is half of the tariff levels announced on April 2, reflecting deals, exemptions and mitigation. It is still more than four times the level at the start of 2025.
Little is known about how much tariff mitigation is reducing the overall tariff rate. Publicly available data on foreign trade zones (FTZs) suggest they are shaving more than a full percentage point from the overall tariff rate. Tariff mitigation can include, but is not limited to:
- FTZs: Designated secure areas inside the US treated as outside customs territory. That means companies that import directly into FTZs can avoid payment of duties and taxes until they pull their products from those warehouses. Storage is commonly used to optimize cash flow. Manufacturing can be done in FTZs to reduce overall tariff payments but that is expensive and can be limited by new rules.
- Duty drawback: Exporters can receive up to a 99% refund on the components of their product that were imported.
- First sale for export: Importers can utilize this program to reduce their overall tariff bill if there are multiple stages in their supply chain. If their original manufacturer sells to a middleman who then sells to the US importer, the importer can use the lower price from manufacturer to middleman as the basis for tariff payments. The declaration at Customs on which tariffs are paid would be lower than the total import price.
Another challenge is what is known as “cascading protectionism.” That happens when the least protected firms lobby for tariffs of their own to reduce competition and raise their own prices. That means tariffs are likely here to stay.
The administration threatened additional tariffs as the year wore on. Tariffs on countries that do business with Iran, those that sent troops to Greenland, Canada and more recently, Korea have all shown up in the president’s social media account. Those on Iran, Europe and Canada were averted. In Korea, the National Assembly has yet to approve the trade deal negotiated with the US.
One of the latest executive orders declared fentanyl a “weapon of mass destruction” in November 2025; that opens the door to sanctions.
Wall Street is betting that the Supreme Court will rule against the emergency powers the administration used to levy about half of the tariffs. Many who paid tariffs may be eligible for refunds, but the ruling is not a slam dunk.
To bridge the gap, section 122 tariffs would likely be leveraged to reinstate tariffs of up to 15% on any country for 150 days. That would buy time for investigations into more consequential and more permanent tariffs.
The administration has already started investigations and levied tariffs under sections 232 and 301 of trade law. They have more staying power than tariffs levied via executive order and cover tariffs under a broad umbrella from national security to unfair trade practices.
Section 338 tariffs would pack a larger punch. They harken back to the 1930s trade wars and could be levied on any country seen as discriminating against US commerce. That is a large blanket. They include tariffs of up to 50% and embargoes on goods deemed a threat.
Sections 122 and 338 have never been utilized; they could be challenged in the courts as well, but not until they are deployed.
Retaliation has been limited, but recent developments between the US and Europe suggest it could still be on the table. Greenland represented a line in the sand for Europe, as it challenged EU and NATO member sovereignty. Agreements between the US/EU removed immediate risks of escalation, but the threshold for retaliation is lower than it was in 2025.
The trade framework between the US and China calmed the waters but that could be temporary. Any provocation could put the agreement at risk, while the clock is ticking on existing agreements.
The US agreed to extend tariff exclusions to November 2026. China agreed to extend its loosening of export controls to December. Those agreements will need to be renewed before the deadlines for détente to continue.
Expect continued oversight and enforcement of barriers for US economic ties to China. The administration has already tightened rules of origin. Outbound and inbound investment are likely to face greater scrutiny.
Chart 2: Effective tariff rate peaks lower
Federal effective customs duties rate, %
USMCA talks
Another flashpoint could occur over the US-Mexico-Canada (USMCA) free trade agreement. That is scheduled to be renegotiated in 2026. It has enabled about 90% of goods crossing the borders of the three countries to do so tariff free.
If the US, Canada and Mexico are unable to renegotiate and ratify the treaty, USMCA would be in limbo for ten years, subject to annual reviews. The worst case scenario would be if those negotiations failed and one or more of the countries pulled out of the agreement. If that happened, the USMCA tariff exemptions would be eliminated.
Forecast
We expect AI-related trade to continue to expand. There is a large backlog in data centers to serve AI. Trade negotiations have centered around the rare earth minerals behind advanced technologies. The US is trying to challenge China’s stronghold on rare earths production; it currently accounts for over 90% of global refined rare earths capacity.
Chart 3 shows the contribution to GDP growth from exports and imports. Trade is forecast to play a smaller role in the economy in 2026 and 2027 than it did in 2025.
The slowdown in imports due to tariffs is likely to be offset by the near insatiable demand for data centers. Hurdles exist on the supply side: computer chips are growing scarce. That is pushing up chip prices and could increase costs for other products.
We saw a similar phenomenon when chip shortages erupted in the wake of the pandemic. The capacity to build the advanced chips needed for data centers and to run AI models is constrained.
Exports are expected to be limited due to higher costs. A weaker dollar usually increases demand for US goods by making them cheaper for foreign buyers. However, those same exporters are experiencing higher input costs from the tariffs themselves. In response, export prices rose instead of getting cheaper.
Global growth is forecast to slow in 2026-27 which could dampen demand for exports, along with boycotts of US-made goods. Tariff threats at the start of the year lowered the threshold for retaliation in 2026.
Chart 3: Trade deficit unlikely to shrink much more
Contribution to GDP growth
Shifts in trade policy
Changes in trade policy were sweeping in 2025, some with unintended consequences. The desire for deglobalization and tariff revenues butted up against national security issues. There is a lack of alternatives for key parts in the US.
The arms race in AI provides a case in point. The majority of AI data center inputs, like chips, are produced outside of the US. Those could increase revenues significantly if they were to be tariffed. However, that could stall the AI buildout.
The administration (and those before it) view AI as one of the best potential drivers of future economic growth and more importantly of military development. If others were to surpass the US in AI, they could surpass the US in those areas.
Notably, a main national security concern is that supply chains for critical technologies in future commercial and defense applications will be in other countries. Those countries could use their positions to influence strategic decisions of other governments and firms.
Usually, to protect a US-based industry, tariffs would be placed on imports of that product. However, “Buy American” is difficult in an industry like AI where the US produces relatively little of the natural resources and intermediate goods needed for the buildout. Thus, carve-outs have been established for high-tech goods needed to service soaring demand for data centers and AI.
The US relies heavily upon countries like Taiwan for fabrication. Deals with Australia, Brazil and others, as well as domestic investment announcements, have centered on critical materials and scaling production. Capacity will take years to build. In the interim, producers in Taiwan, China, Southeast Asia, Japan and Mexico will benefit.
Spillover effects
Trade wars often lead to capital account wars. The desire to protect industry spreads to financial flows. That can show up as capital controls, which limit capital from leaving the country or a loss of faith or retaliation by foreign investors against making big investments in the country that levies tariffs.
Some worrisome trends emerged in 2025 and early 2026. Investors fled the usual safety of the US Treasury bond market for gold; bond yields rose and the dollar depreciated.
The EU threatened the use of its Anti-Coercion Instrument, developed in 2023. That would put financial flows and US services exports at risk. Tensions have since cooled but the potential for expanded retaliation has risen.
Reordering global trade alliances
The post-WWII trading system was designed to establish trust between close allies. Those who are fighting globalization see it as a threat, or a challenge, to a country’s economic supremacy and sovereignty.
An erosion of trust is the largest threat to global economic activity that could come from trade wars. That risks far reaching consequences, including the reserve currency status of the dollar. There is no easy replacement for the dollar, but some worrisome trends are emerging.
Deteriorating relationships between the US and its closest allies have been the most notable consequences of a loss of trust. Most of the talk about a reordering of global trade has focused on economic fragmentation. The rest of the world is not fragmenting; it is forging ahead on trade agreements, with or without the US.
The EU has signed trade agreements with India and tentatively joined the South American Mercosur trading bloc, (Canada has also expressed interest.) while Asia is solidifying regional trade ties. Mexico has positioned itself as a manufacturing destination by building trade relationships globally; it has free trade agreements with over fifty countries. Overarching geopolitical tensions could seep into trade via larger boycotts of US goods or severed financial ties.
The question is how long that can last. The US is the world’s largest buyer and represents a significant share of GDP for many of its trading partners. That means there is still hope for diplomacy. Reorganizing supply chains is not quick or easy. Supplier relationships are built over the course of years, if not decades.
The focus on the trade relationship between the US and China will not disappear. Since the start of the US-China trade war in 2017, Chinese firms have set up production hubs in other countries to establish a broader manufacturing footprint. At the same time, US supply chains lengthened, adding more nodes for disruption.
Recent developments may be short-lived given the longer-term trend of pushback against China’s increasing advantage in industrial manufacturing. Mexico has levied tariffs aimed at China. The EU, Brazil and Turkey have all erected or are considering their own barriers.
A push for resilience
Supply chains have been shown to be much more prone to disruption post-pandemic. That is not just from tariffs. Everything from hot wars to extreme weather events has wreaked havoc on supply chains.
Outside of recent tariffs and the pandemic, disruptions have included the Russia-Ukraine war, the Red Sea shipping crisis and more frequent extreme weather events like the 2021 winter storms in the US South or Hurricanes Ian, Helene and Milton in 2022 and 2024. Labor strikes in the maritime and air logistics industry add another node of disruption.
Longer, more complex supply chains add pressure points: while many attribute the lengthening of supply chains to “transshipments,” which can be a reason, it is also due to the complexity of what we are importing.
Tariffs are forcing firms to think harder about where and with whom they do business; uncertainty over where tariffs will land is delaying those decisions. The administration would clearly prefer suppliers to move back onshore. That takes time and is not economically feasible for much of what is produced.
The winners are likely to be those who produce in lower-tariffed countries that have strong institutional quality. The question will become where the supplies and components of production come from; broader integration of supply chains and country of origin will be emphasized.
Strategies for supply chains are not consistent across industries or firms but include a common theme: resilience as a buffer against continued and persistent shocks. In other words: making supply chains less fragile, and more like the mythical Hydra. Strategies include diversification of supplier sources, nearshoring, inventory buffers and utilization of new technologies. The goal is to thrive amidst stress.
The paradoxical goal for organizations is to evolve their supply chains to be more like the mythical hydra: resilient, adaptive and able to withstand repeated shocks.
Meagan Schoenberger
KPMG Senior Economist
Bottom Line
This year will continue to be one of volatility and uncertainty in global trade and supply chains. Tariffs are here to stay as policy increasingly focuses on balancing national security and revenue priorities.
The winners will be more protected industries in high-tech manufacturing and artificial intelligence. The worst case scenario is that financial markets could become more skittish, whether from tariffs, a loss of trust or both.
Shifting geopolitical alliances and supply chain disruptions will make strategic sourcing decisions more urgent for firms. The paradoxical goal for organizations is to evolve their supply chains to be more like the mythical Hydra: resilient, adaptive and able to withstand repeated shocks; otherwise, stabilizing systems could become a Herculean task.
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