The Tariff Situation

 

 

Global equity markets are grappling with an executive order signed by U.S. President Trump over the weekend authorizing tariffs be placed on all Canadian imports beginning Tuesday, February 4^th. 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 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 between U.S. government bond yields has modestly widened. This situation remains unpredictable and very fluid, but here are some high-level perspectives below.

 

The U.S. is 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 has unveiled retaliatory tariffs on a range of products in response, some of which are expected to take effect whenever U.S. tariffs are implemented, and others phased in over the next 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 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.

 

The 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 I 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. 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, I 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. We’ve already learned earlier today that the proposed tariffs on Canada will be delayed by 30 days. The situation is fluid.

 

Our portfolios remain diversified across asset and sub-asset classes in order to navigate a range of economic scenarios. Fortunately, global markets have delivered some sizable returns over the past few years and our portfolios have benefitted as a result.

 

Should you have any questions, please feel free to reach out.

 

Tim