Global equity markets are grappling with an executive order signed by U.S. President Trump on February 1st authorizing tariffs to be placed on all Canadian imports beginning Tuesday, February 4th – with a deal then being reached today between President Trump and Prime Minister Trudeau delaying those tariffs for 30 days. Canada has announced it will appoint a ‘Fentanyl Czar’ and bolster border security as part of the agreement.

Markets have digested the news reasonably well as the selloff has been unremarkable. This may be partly attributable to uncertainty regarding the timing of when tariffs will take effect 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, although it remains depressed. Canadian government bond yields have drifted lower (prices higher) and the difference between 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. is expected to apply a 25% tariff to all Canadian imports except for energy-related imports, which will face a 10% tariff. The Canadian government has unveiled retaliatory tariffs on a range of products in response, some of which are expected to take effect when U.S. tariffs are implemented, and others phased in over the following few weeks.

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 several 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 on other industries.

U.S. inflation and growth will also be impacted by 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.

The duration of any tariffs will be a key factor. Should they extend for a period of three months or more, the risk of a recession in Canada will become more significant. 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, although it is already valued near a five-year low against the USD. If tariffs prove to be short-lived, there is potential for the Canadian dollar to recover somewhat. The Canadian equity market is also vulnerable despite having behaved reasonably well in the face of the tariff threat. As explained in this recent piece produced by our firm’s investment team, the Canadian market may weather challenges better than some investors expect.

While it is difficult to know precisely what the future has in store, we believe that 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 across asset and sub-asset classes 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.

If you have any questions, please do not hesitate to contact us.

 

Drew M. Pallett, LL.B.

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities

Email: drew.pallett@rbc.com