Signs suggest Canada will avoid deep recession

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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. 

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Leslie Alba, head of portfolio solutions, Total Investment Solutions, CIBC Asset Management 

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With the Liberals winning the Canadian elections at the end of April, we expect their pro-growth fiscal policies to support Canadian equities over U.S. equities, and the Canadian dollar over the U.S. dollar. But we do have a relatively negative bias on the Canadian 10-year government bonds. 

In the context of political tensions and long-term uncertainty with the United States, the election outcome reinforces our view that Canada is entering a multi-year pro-growth fiscal policy regime. And specifically, a regime that 1) targets housing financing of about 1% of GDP for innovative, prefabricated and low-cost homes; 2) infrastructure to boost chronically weak Canadian productivity; and 3) trade diversification to help Canadian businesses diversify their markets and reduce dependency on the United States. 

That said, an important order of business, which might even be of greater importance than anything else on the Liberal platform is the trade relationship with the United States. And it’s important because we view tariff uncertainty as the main driver of recent volatility in global markets. We believe that the market is really wrestling with the frequent sway of tariffs and related announcements, which is creating a series of under and over reactions. 

But volatility doesn’t imply markets only go down; it means up and down, and often pretty sharply in a pattern that keeps repeating. 

It’s worth noting too that short-term volatility tends to be a recurring feature of markets. When we looked at data from January 1980 to the end of December 2024, we experienced an average intra-year maximum drawdown of 15% on the TSX index. That said, despite that average drawdown of 15%, the annualized total return on the TSX index was 7.7%. So our long-term observation is that markets do tend to find ways to climb over the wall of worry. 

Nevertheless, we believe the primary macroeconomic driver of the performance of Canadian assets will continue to be the trade relationship with the U.S. At a micro level, though, volatility can actually create opportunities through some of the price dislocations that result from the over and under reactions. 

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While the Bank of Canada decided to hold its policy rate in April, we do expect rate cuts over the remainder of 2025. The decision to hold the policy rate at 275 basis points in April was largely due to the unprecedented magnitude in and shift in U.S. trade policy, and the unpredictability of tariffs, which made it unusually challenging to project GDP growth and inflation in Canada, but also globally. 

Taking a step back, heading into this year, Canada was actually well-positioned for an economic recovery, thanks to aggressive policy easing by the Bank of Canada, robust real incomes and signs of improvement in residential construction. Also, inflation was easing towards the central bank’s target. However, tariffs and the uncertainty around it really have weakened the economic outlook for Canada. 

But in our view, a protracted trade war between the U.S. and Canada would actually have large implications for the U.S. economy, and would likely push the U.S. economy into a recession, given other tariffs that the U.S. has put in place. So that incentivizes U.S. policymakers to reach a revised trade agreement with Canada sooner than later. And for this reason, our baseline outlook is for a U.S.-Canada trade deal within the coming months. 

So overall, our view on policy rates is that they will more likely go down than up. And while there’s a risk that tariffs stay on longer than we expected, in that scenario, our view is that the Bank of Canada might step in to provide some relief to the economy through lower policy rates, despite potential inflationary impacts, which we expect to be transitory anyways, but coming from tariffs. 

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Our team is cautiously optimistic that the Canadian economy will avoid a deep recession over the next 12 months. 

We expect fiscal stimulus, monetary policy accommodation, and lower oil prices due to rising supply of OPEC and slowing global growth to really mitigate the negative impact of tariffs on GDP growth. 

That said, there may be a short period of meaningful economic slowdown, or even negative growth. But ultimately, we expect growth to average 1% over the next four quarters. 

Of course, there are some risks to that view. From a political perspective, there are risks to the efficacy of the Liberal government, including the absence of a majority government, which could hinder some important items on the Liberal agenda, and could also weaken Mark Carney’s political leverage in some of the U.S. negotiations. 

And then there’s also — albeit a smaller risk — there’s the risk that the federal government may under deliver on some of its promises due to red tape and potential lack of expertise. 

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Our advice is to position portfolios for the long term. 

The current policy environment continues to be highly uncertain and is far less predictable than usual, and we do expect heightened tariff risk to remain. And with global trade making up about 6% of global GDP, we expect market volatility also to remain elevated for at least the foreseeable future. 

That said, we believe the responsible thing to do for investor portfolios is to take a step back and remain calm, really, despite potential short-term swings, like the ones we’ve seen recently, volatility does tend to smooth out over the long term. 

Diversification in portfolios is key. In the midst of market volatility so far this year, with the largest swings in volatility really occurring at the beginning of April, diversification within and across key capital markets did help offset pockets of weakness in others. 

In 2025 through to the end of April 11, bonds were a dependable offset during the larger equity drawdown days. The Bloomberg U.S. Treasury bond index in U.S. dollars delivered a positive return on 75% of the days that the S&P 500 index lost more than 175 basis points, also in U.S. dollars. 

So looking forward, we expect the diversification benefits from bonds to persist. We remain optimistic on the potential for bonds to provide useful diversification in investors’ portfolios. 

Unlike 2022, all-in bond yields today remain relatively attractive. And this is an important prerequisite for bonds to offset negative equity performance because higher coupon rates create return reliability and stability, which should create some buffer for portfolio returns amid equity market weakness. Also in times of economic weakness, bonds are counter-cyclical to monetary policy. You know, we see bond prices rise when central banks cut rates to stimulate the economy. So investors should be able to find some comfort in diversification and in the yield coming from bonds. 

Corporate bonds can also be expected to do well, relative to equities, when the economy suffers. Along with benefiting from the negative correlation to interest rates, corporate bond holders are higher priority in the capital stack than shareholders, meaning that they will get paid before equity holders in the event of default. 

So with the degree of continued policy uncertainty, we believe true diversification — and that means investing in a range of assets with different drivers of financial productivity, or with different risk exposures — is particularly useful. While it can be tempting to sell out of markets when faced with uncertainty, such as, you know, the ones we currently face with trade policies, sticking to a strategic asset allocation is a sound way to navigate near-term volatility, and to be able to continue to pursue long-term investment objectives. 

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