This report does not constitute a rating action.

The stop-start nature of the U.S. administration's policies on tariffs suggests that import duties could still be reconsidered (at least in scope and scale). The uncertainty surrounding the unfolding trade conflict is complicating strategic responses from auto original equipment manufacturers (OEMs) and their suppliers.

Relocating production to the U.S. to avoid exposure to tariffs is theoretically possible for the auto industry. Yet it represents a material deviation from prior capital allocation strategies, which mainly aimed to reduce costs, counter Chinese manufacturers' expansion through product innovation, and manage the transition to clean mobility. Those issues remain pressing, and auto industry management has been left pondering the merits of a relatively costly mid- to long-term rebalancing of strategic investment to meet a tariff crisis that may have significantly diminished in importance by the time assets have been relocated.

While moving assets to avoid tariffs should be possible, it will not be simple. The main challenge of relocating the production of a vehicle model is the reorganization of the related supply chains. That task is made harder by the uncertainties surrounding the conditions under which companies will operate. Further revisions to the scope and level of tariffs seem likely given the U.S. administration's claims of progress on negotiating new trade deals. Supply chain redesigns will also have to reckon with a relatively tight U.S. labor market, higher labor costs (with U.S. hourly pay at about 10x the Mexican average), and last, but not least, local suppliers' reliance on imports from China (in particular, for electronic parts, batteries, and rare earths). That said, we see some possibility for selective relocation of vehicle assembly based on existing unused capacity in U.S. plants, especially for models on platforms that are already in U.S. production.

Retaliation Raises Complexity

China's response to the U.S. tariffs, including countertariffs, adds to the already challenging environment for auto and parts makers. Beijing's actions represent a risk not only for issuers producing in the U.S. and exporting to China but are a source of potential disruption for global supply chains.

For example, China's decision, announced on April 4, to halt exports of some heavy rare earth metals, highlights its role at the center of raw material supply chains that are crucial to the global auto sector. Officially, the restriction precedes the establishment of a licensing system, which could take up to six months to finalize. The export suspension includes rare earths (neodymium, dysprosium, terbium, and praseodymium) that are used in electric motors, sensors, and fuel efficiency systems.

Based on preliminary conversations regarding the suspension, we understand there is generally no overstocking of rare earths in end markets, meaning that the halt on exports could quickly lead to shortages and disrupt production of electric motors. Rare earths are not the only materials critical to the auto sector in which China has a significant role in mining or refining (see chart 1).

Chart 1

China's control of the mining and refining of critical minerals provides significant leverage in negotiations with its trade partners, which may feel they have little choice but to remain engaged with a key supplier. If the U.S. administration seeks to barter the lowering of tariffs against demands that commercial partners isolate China, then we consider the likelihood of a wider de-escalation of trade tensions to be low.

Global Light Vehicle Production And Sales Will Decline

We are reassessing our view of global light vehicle sales and production for 2025 and 2026. The trade dispute, the organization of a strategic response by industry participants, and supply-side disruption risks will all weigh on light vehicle production, which we now forecast will dip for the second year in a row (after a 1.1% decline in 2024). It seems inevitable that OEMs and suppliers will pass the cost of tariffs through to consumers, at least partially, through higher prices, even if this may not be evident in the first months. We expect that will dampen demand and result in a rapid downward adjustment in production (see table 1).

Table 1

U.S.

In the U.S. our downward revision of forecast production is premised on expected weaker demand due to rising prices; the potential discontinuation of low-margin, highly price-elastic models that tariffs would make uneconomical to produce; and vendors' reliance on available inventories of vehicles not affected by tariffs. We now expect U.S. light vehicle sales will be about 15 million in 2026, down almost 1 million from our previous 2026 forecast of about 16 million. Further downside to our revised forecast could stem from supply chain disruptions caused by interruptions to the import of parts and materials from China (which were subject to a 125% tariff at the time of writing) and due to bottlenecks at the U.S. border.

Europe

The prospect of a downturn in the U.S. market will weigh on light vehicle production in Europe, where OEMs (for the second consecutive year) and suppliers will try to quickly adjust capacity to match weaker economic conditions and their diminished pricing power. Over the medium term, we do not exclude some selective relocation of the production of models to the U.S. That would further impair production levels in Europe, and repeat a pattern already observed post-COVID-19, when OEMs shifted some operations to China and North America, which came to be considered strategic export hubs. We understand that Audi, which has historically been located in Europe, is considering building U.S. production capacity (in addition to a Mexican plant where its Q5 model is produced), while Volvo could also consider relocating one volume plug-in hybrid electric vehicle (PHEV) to the U.S. from Europe. Many other OEMS could follow the same path.

At the same time, pressure to reduce idle capacity in Europe will likely grow in the event of further relocation to other regions. That will be driven by efforts to reduce fixed costs and create room to at least partly absorb the new tariffs, but also by the need to ready operations to face direct competition from Chinese OEMs that will start production in Europe from the end of this year.

China

We revised slightly higher our 2025 sales forecast for China, where government stimulus aimed at boosting domestic consumption should partly offset ongoing weak consumer sentiment and more unfavorable trade conditions. We are, however, doubtful that current support for the auto market (an extended scrappage system and tax incentives) can durably sustain demand for passenger cars and thus expect a decline in 2026.

It is not certain that European automakers and suppliers will benefit from China's positive momentum. The erosion of European carmakers' share of the Chinese market, which emerged post-pandemic, seems to have continued into 2025, when sales in the first three months fell by a record amount. We increasingly consider that the deteriorating appeal of international brands in China might not be solely linked to the weak economy. Chinese consumers seem to be undergoing a paradigm shift, switching out of expensive international brands that were seen as superior quality in favor of domestic brands capable of offering luxury and cutting-edge technology at competitive prices.

Significant Credit Quality Effects

Because pricing power remains weak globally, we believe automakers and suppliers will need to absorb at least a share of extra costs arising from the new tariffs. We expect pricing will not be able to completely offset weaker sales volumes, resulting in a trend toward declining revenues over the next two years.

Profit margins will also come under pressure, as will cash flow generation, which will have to absorb increased capital expenditure (capex) needed to adjust issuers' footprint to the new trade landscape. Headroom built in our auto ratings will be significantly diminished across all issuers should prevailing tariffs prove permanent, which looks increasingly likely.

We also acknowledge that the scenarios which currently underpin our assessment could still change. Exemptions remain possible for selected OEMs, while the tariffs applied to different parts and components may change in scope and scale. While we expect auto suppliers will seek to recover the vast majority of direct tariff-related costs from OEMs, we believe the main risk for auto suppliers is related to lower volumes. Given that many suppliers’ rating headroom is already tighter than those of OEMs, we maintain our view that suppliers might be more vulnerable than OEMS in this environment.

CHART 2

Our revised electrification scenario (see table 2) reflects weaker consumer sentiment with regard to electric vehicles (EVs) over 2025-2027 outside China. That is mainly due to the persistent price differential between electric and traditional propulsion, consumers' expectations that more affordable electric models will be delivered by virtually all OEMs (emerging and legacy) over the next two years, and hybrids' (both full and mild) growing appeal as an acceptable technology and price compromise for consumers in Europe and the U.S. Despite near-term sluggishness, we continue to expect EV penetration will accelerate towards the end of the decade. We also see a risk that EV growth will prove slower than anticipated, mainly due to the potential for supply chain disruption linked to geopolitical events that affect sourcing from China.

Europe

Strong Q1 2025 EV sales in Europe, led by Germany and the Netherlands, were driven by the region's strict emission regulations, which were relaxed in early March (see "Auto Brief: Automakers Breathe Easier As CO2 Sanctions Ease," March 4, 2025). We note that the change to the regulations doesn't substantively ease CO2 reduction targets, but it gives automakers until 2027 to comply without incurring fines. That represents a relief, particularly for legacy automakers with weaker electrification strategies, though the resulting benefits are unlikely to be sufficient to offset exposure to trade tariffs for automakers like VW, Stellantis, and Mercedes.

Recent trends in European EV competition have resulted in market share gains for VW and Chinese manufacturers (in particular BYD, SAIC-MG, and Leapmotor) to the detriment of Tesla. We expect automakers to carefully manage the shift in powertrain mix from traditional propulsion systems, while taking advantage of full and mild hybrids over the next two years. The aim will be to balance the margin-dilutive impact of EV sales against the cost of penalties and pooling, while OEMs roll out EV-dedicated platforms with lower cost structures that can narrow the gap between EVs and traditional engines. We believe increased model availability and competitive pricing in Europe will drive EV's market share from about 25% over the year to the end of February 2025 to between 27%-30% by 2027 (see table 2).

Table 2

China

In China, the EV momentum remained upbeat in Q1 2025 with a 39% increase in sales in the year to the end of February. China stands out, compared to Europe and the U.S., as plug-in hybrid electric vehicles are driving EV market share gains, with an increase of 74% in sales over the twelve months to February.

Tesla's Model Y was the best-selling SUV over the year to February despite the company experiencing a challenging start to 2025. Geely's Xingue L gasoline-powered SUV was the No.2 seller followed by BYD's Song Plus. We expect China’s EV market to continue growing, fueled by strong domestic demand, proven TCO (total cost of ownership) benefits, government support, and advancements in EV technology.

U.S.

Our downward revision of EV growth and market penetration in the U.S. reflects the Trump administration's seemingly less supportive policy stance on the transition to clean mobility. Our revision comes despite mid-single-digit EV sales growth (for the year to the end of March 2025) that outpaced sales growth in Europe. We have low visibility on the likely continuation of Inflation Reduction Act tax credits for EV purchases following open criticism of the scheme by the current administration.

Related Research

• China Consumer Outlook: A Pressing Policy Initiative Takes Shape, April 15, 2025
• Tariffs Take The Wheel: Higher Prices, Lower Sales, Greater Risks For The North American Auto Sector, April 14, 2025
• Global Credit Conditions Special Update: Ongoing Reshuffling, April 11, 2025
• Automakers Breathe Easier As CO2 Sanctions Ease, March 4, 2025

Primary Contact:	Vittoria Ferraris, Milan 390272111207; vittoria.ferraris@spglobal.com
Additional Contacts:	Claire Yuan, Hong Kong 852-2533-3542; Claire.Yuan@spglobal.com
	Lukas Paul, Frankfurt 49-693-399-9132; lukas.paul@spglobal.com
	Nishit K Madlani, New York 1-212-438-4070; nishit.madlani@spglobal.com