Global equity markets have been grappling with the threat of U.S. tariffs in recent days. Markets have digested the news reasonably well as the selloff has been unremarkable. That may be partly attributable to uncertainty as to the timing of when tariffs will take effect given recent postponements as well as the persistent belief that broad-based indiscriminate tariffs may ultimately not be a lasting feature of North American trade relationships. The Canadian equity market has not fared any worse than other major developed markets, and the Canadian dollar has rebounded following some initial weakness, though it remains depressed in the grand scheme of things. Meanwhile, Canadian government bond yields are lower (prices higher) and the difference relative to U.S. government bond yields has modestly widened. This situation remains unpredictable and very fluid, but we offer some high-level perspectives below.
The U.S. was expected to apply a 25% tariff to all Canadian imports with the exception of energy-related imports, which will face a 10% tariff. The Canadian government had unveiled retaliatory tariffs on a range of products in response, some of which were expected to take effect whenever U.S. tariffs were implemented, and others phased in at a later date.
The team at RBC Economics produced an update in recent days that is worth reading. In it, they discuss their framework for assessing how U.S. tariffs would flow through Canada’s economy. They mention the difficulty in trying to pinpoint the exact economic impact given a number of variables that are hard to predict, including retaliatory measures, the Bank of Canada response, and fiscal support provided by government to businesses and households, among other things. They acknowledge that tariffs of this magnitude, should they be sustained, pose recessionary risks for Canada. While goods-producing industries like the automotive sector are most directly exposed, there could be ripple effects that affect other industries as well. Meanwhile, U.S. inflation and growth will also be impacted via retaliatory tariffs and the disruption of integrated North American supply chains. Nevertheless, the U.S. economy is starting from a place of relative strength and is less dependent on trade, and the impact to growth should therefore be less pronounced than in Canada.
There is much uncertainty as to whether tariffs get implemented or not, and whether they are broad in nature or more specific and targeted. The other question that will determine how impactful this will be, is the duration of the tariffs. Should they extend for a period of three months or more, the risk of a recession in Canada becomes more significant. Moreover, the longer the duration, the higher the potential for more permanent damage to the economy due to lower business investment and a reduction in longer-term economic potential.
The Canadian dollar may remain vulnerable though we acknowledge it is already sitting near a five-year low. Should the tariff situation prove to be short-lived, there is potential for the Canadian dollar to recover somewhat. Meanwhile, the Canadian equity market is also vulnerable despite the fact it has behaved reasonably well in the face of the tariff threat. As explained in this recent piece produced by our firm’s investment team, it may weather some challenges better than some investors may expect.
While it is hard to know precisely what the future has in store, we believe maintaining a disciplined investment strategy focused on the long-term while avoiding knee-jerk reactions to near-term headlines is the most prudent approach. Our portfolios remain diversified in order to navigate a range of economic scenarios. Fortunately, global markets have delivered some sizeable returns over the past few years and our portfolios have benefitted as a result. This has left our clients’ financial plans better able to weather any challenges that come their way.
Should you have any questions, please feel free to reach out.
