2025–2026 Quarterly Outlook: Damocles
Genevieve Signoret & Delia Paredes
(Hay una versión en español de este artículo aquí.)
Executive Summary
We project the global and Mexican economies under two U.S. tariff scenarios. In our base case, Damocles, we assume that, regardless of whether any tariff agreements are reached with Mexico, Canada, or any other country, throughout the two-year forecast period, U.S. President Donald Trump will hold a “sword of Damocles” over its trading partners by continuing to threaten to punish them for perceived sins by slapping higher tariffs on them without warning.
In Damocles, this sword keeps uncertainty high enough that businesses postpone investment projects, and consumers postpone durable goods purchases, leading the U.S. economy to slow down and Mexico’s recession to be worse than we had earlier projected.
Inflation in this scenario, however, remains stubborn, thus short-term U.S. interest rates don’t come down farther till the second half of this year. U.S. long-term rates fall more sharply than do short-term rates—the yield curve flattens. For well diversified investors, this fall in long-term rates (rise in their prices) offsets somewhat market corrections.
The euro and Japanese yen strengthen against the dollar in Damocles. But not the peso. Banxico cuts rates more sharply than the Fed, opening up the rate spread and leading the peso to weaken to 21 pesos per dollar.
We also visualize a downside risk scenario we call Hades in which no new agreements are reached this April: all Mexican and Canadian exports to the United States not covered by free trade agreement USMCA are subject to a 25% tariff.
In this case, the United States goes into recession and Mexico goes into a deeper and more prolonged recession than the one foreseen in Damocles. In Hades, the U.S. yield curve inverts and we experience a bear market in stocks. The Fed and, especially, Banxico, cut rates sharply. The euro and yen strengthen against the dollar, while the peso weakens to 22.25 pesos per dollar.
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