Canada seen as ‘low-hanging fruit’ for Trump tariff tactic

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

Éric Morin, director of global macro and strategy at CIBC Asset Management 

Trump has signaled that he will be implementing tariffs in February or in April, and that is a risk for the Canadian economy. 

Unfortunately, Canada is a perfect target for tariff threats. The Canadian government, with Trudeau departing, is weak politically. And Canada is a small economy that is highly dependent on the U.S., unlike the Eurozone, for example, or China. 

So Trump can expect to secure quick political gains with Canada on issues such as secure borders and military spending. Canada is really a low-hanging fruit option for the U.S., because an agreement is highly likely because of aligned incentives. And for Trump, it would be a quick win that would set the precedent for upcoming negotiations with other trading partners. 

But, in the near term, the balance of risk is skewed to the downside because, simply, Canada is at risk of being imposed a tariff in the short term. So this is, of course, a negative risk for the currency, and also the Canadian economy. 

But it’s important to point out that we don’t expect tariffs to be implemented across the board and we expect them, if any, to be short lived. So what could happen if Trump decides to implement tariffs on the Canadian economy? Well, we think that he will have no choice but to target [the] tariffs. He will have to exclude oil first, because tariffs on Canadian oil would hurt U.S. consumers and U.S. refiners, and this could come with a big political cost for Trump in the 2026 mid-term election. So this is a sector where we don’t expect Trump to implement tariffs.  

On cars and transportation, this is another area where we expect no tariffs because that would predominantly hurt U.S. car manufacturers, and this would come also with a big political cost for Trump in the 2026 midterm election. 

Tariffs on Canadian machinery are also unlikely because several swing states are importers of Canadian machinery, and tariffs could hurt their profitability and represent a political cost for Trump. 

So when we look at the sectoral exports of Canada to the U.S., we believe that tariffs on about 60% of goods are perhaps unlikely. And, so, if the U.S. were to implement, let’s say, 25% tariffs on Canadian exports, that would likely apply on about 40% of Canadian exports. So that would result in an aggregate increase of tariffs equivalent to 10%. So, if Trump announced 25% tariffs on targeted goods, well, that would likely imply a 10% tariff effective across the board.  

But we do expect them to be short lived because of the cost first, but also because of the fact that Canada and the U.S. both have strong incentives to reach a deal on political issues such as border controls. And, also, it’s important to reiterate that both countries are key winners at free trade. Both countries have deeply integrated supply chains, and tariffs on Canada would hurt U.S. manufacturers and U.S. consumers at the end of the day. 

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Tariff risks will likely provide better entry points for Canadian assets, including Canadian equity, [on] which we are upbeat. So we expect a recovery of the Canadian economy in the second-half of the year. We expect a Bank of Canada that will be more and more dovish. And that is positive for Canadian equities. And so the fact that we expect tariff risks to be short lived, combined with our macro outlook, is something positive for Canadian assets. So really after the rain comes the sunshine. 

In the near term, however, the currency risk could bring more downside to the currency. The tariff threat is really a source of downside pressure for the Canadian dollar. And for us it’s too early to consider hedging the Canadian dollar at this juncture. 

So, some historical context about trade restriction and tariffs. Well, for the U.S., once they impose tariffs on imports from abroad, it’s typically a stagflationary shock. So, it means that the impact on growth is negative, while the impact on inflation is positive. And there is a cost for the U.S. to do tariffs. There is an economic cost, but also a political cost. And that should limit the magnitude of tariffs that the Trump administration will be able and willing to implement this year. 

One key risk that we see that the inflationary impact of tariffs may be bigger this time than it was during the first trade war. So, the first trade war was in 2018-2019. We saw some modest upside pressure on inflation. But what’s different now is the fact that the economy is much stronger than it was back then. And the pass-through of tariffs to the consumer may be bigger this time, due to the fact that the economy is stronger. And so, as a result, we think that there is a greater inflationary risk this time. This is likely what economic advisors will tell Trump. So don’t expect a blanket tariff across the board. 

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So, what are the impacts for portfolios of the Trump tariff threats? First, the tariff threats themselves should bring more volatility in the portfolio and asset classes. So this leads me to the second take away. It will be increasingly important for investors to have a balanced portfolio and a disciplined approach, and not try to speculate on the short-term policy action by the Trump administration, but instead to focus and stick to fundamentals. Despite the Trump tariff threats, the fundamentals are positive. The economic backdrop for 2025 is constructive for markets. That is also true for Canada, where we expect the equity market to outperform other equity markets in 2025 as a whole. So this is a constructive outlook, and the Trump threats on tariffs are not enough to derail that story. The last thing is that some tilts in portfolios are possible, meaning that slightly higher exposure to defensive assets is something that could be needed if Trump were to be more aggressive on his tariff threat. 

And also in terms of tilts, we recommend having lower exposure [to] assets that are highly influenced by the Chinese economy, and also have a more positive tilt on Canadian equities, despite the short-term tariff threat coming from the Trump administration. 

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For 2025, the main opportunity for investors in commodities is perhaps in gold. We continue to see a compelling case for owning gold in balanced portfolios. And we see three reasons for that. 

First is that gold is a key diversifier of tail risks, including political risks. And what we saw during the 2018-2019 trade war is that gold was trending up. So gold should provide diversification against tail risks coming from politics. 

The second point is that central banks across emerging markets should continue to have strong demand for gold. The reason is that they want to diversify their reserves, derisking from an excessive reliance on U.S. assets. So they are desired by many central banks to increase their holdings of gold. And that should create inelastic demand for gold that should support gold prices. 

Third point is that gold should continue to provide protection against sticky inflation in 2025. Unfortunately, inflation in the U.S. and in many countries will remain above the target of the central banks. That is also true for core inflation in most cases. Inflation will remain an issue, and gold historically has been able to provide protection against sticky and elevated inflation. 

So, when we look at a total portfolio approach or standpoint, what we see is that gold is a useful diversifier, and gold prices should continue to go up in 2025 and also over the medium term.

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