Recession unlikely despite significant downside risks

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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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Michael Sager, MD and CIO of the multi-asset and currency management team at CIBC Asset Management 

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Where does the Canadian economy stand as we move through the first half of 2025? Well, I think it’s very clear that the outlook for the Canadian economy, Canadian growth is weaker than we had expected it to be earlier in the year. This is due to a combination of U.S. tariffs on Canadian exports to the U.S. and — related to that — extreme policy uncertainty.  

That said, at the time of recording on April the 14th, we continue to think that the Canadian economy can continue to deliver positive growth across the next year as a whole. This positive growth outlook is driven by tailwinds from previous Bank of Canada policy rate cuts, additional rate cuts by the Bank of Canada that we think we’re likely to see in the coming 12 months, targeted fiscal policy stimulus from the federal government, the fact that consumer balance sheets are currently relatively healthy and, therefore, supportive of continued consumer spending growth, and we have an expectation that we will see a revised trade deal between Canada and the U.S. in the next six months or so, which will help also to moderate some of the high current uncertainty that we see.  

So if you put all of those pieces together, weaker growth, but still positive growth. And to be clear, again, at the time of recording, we don’t see a recession for Canada as the most likely outcome. However, downside risks are clearly significant at the moment. 

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So, what actions do we think need to be taken to ensure that the Bank of Canada’s inflation target is met, and that growth does continue over the coming year? Well, definitely one element will be additional Bank of Canada policy rate cuts. We expect the Bank to deliver another three quarter-point cuts in the coming 12 months. 

That said, the Bank is likely to be on the sidelines for the next couple of months, as it assesses the relative strength and persistence of the likely increase in inflation due to tariffs, versus the expected weakening in growth that tariffs are expected to trigger. 

Our view is that the negative growth impact of tariffs is ultimately more significant than the temporary boost to inflation that higher tariffs imply. Hence, ultimately, the Bank of Canada will focus on supporting growth via additional rate cuts. But it might take its time for the next couple of months while it assesses the situation before it implements its next easing. 

And then another action that we definitely think is needed, and likely to mitigate the negative impacts on growth of higher tariffs and elevated uncertainty is federal government stimulus — targeted stimulus — to help support growth in the worst affected segments of the Canadian economy. 

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What key factors will continue to impact markets through the remainder of 2025? I think there are a few. 

First of all, if we are correct that growth will be weaker than we previously expected but nonetheless still positive, we need to monitor the labour market. Clearly there will be a further rise in unemployment. But the size of that — the magnitude of that increase in unemployment — matters. We think it will be relatively contained, and so we need to monitor that as a key determinant of whether we’re correct in our less-positive but still constructive, relatively constructive outlook for growth.  

We are making an assumption that there will be a revised trade agreement between Canada and the U.S. Economic and political self-interest on both sides of the border suggest that that is likely to happen, but that’s a key element of our outlook for growth. 

And then U.S. trade policy, more generally, has injected an extreme amount of uncertainty into the economy and markets. Until U.S. policy objectives broadly become much clearer and much more predictable, volatility will likely remain elevated, whether that’s volatility in the real economy or volatility in financial markets. So those are some of the key factors. 

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What can investors expect from fixed income and equities through year-end? 

Well, let’s start with equities. Heightened volatility, both in the economy and in markets, suggest that equities will continue to be challenged in coming months. That said, in relative terms, we do favour Canada and Europe over the U.S. 

Unfavourable U.S. valuations are likely to remain an important headwind in the current uncertain environment. The U.S. is the most expensive market in our investment universe. And so, while stocks elsewhere will be hit by tariffs imposed by the U.S. government, these other markets tend to be less expensive and have more support from underlying improvements in organic growth fundamentals and fiscal stimulus. So we prefer Canada and Europe over the U.S. 

So Canadian equities, again, will likely benefit from an expected trade deal between Canada and the U.S. That’s a positive. And then, supported tailwinds from the Bank of Canada cutting, and from targeted federal fiscal policy will also be constructive. They will have headwinds from slower sales and earnings growth. But net-net in relative terms, we think the positives outweigh the negatives, and prefer Canada to the U.S. 

If we turn to Europe, the recent transition in U.S. economic and security policies has prompted a response from Europe in terms of fiscal spending that was pretty unthinkable just a couple of months ago. You know, in particular, Germany is committed to a significant fiscal spending increase that will support defence and infrastructure spending, and will, again, help mitigate the negative impact of U.S. tariffs on domestic German and European growth. 

And so, again, in relative terms, that’s helpful for European equities, particularly again, when we take into account very stretched U.S. valuations. So, volatility in markets and a challenging environment for equities overall, but a favour of Canada and Europe over the U.S.  

So then turning to fixed income, we think fixed-income markets are likely to continue to experience a push-pull between weaker growth, higher inflation — both due to tariffs — and then elevated policy uncertainty. If we can get to a less-uncertain policy environment, then markets will likely begin to focus primarily again on weaker growth prospects, more than a temporary increase in inflation. 

That means for us that from mid-April onwards, on balance over the next year, higher-quality fixed income can outperform from current levels. But given the weaker growth outlook, it probably means a continued challenging environment for riskier fixed-income segments. For instance, high yield, where spreads could continue to widen. 

So a challenging market environment. We probably lean towards bonds over equities for the time being. But because the environment is so uncertain, conviction on any particular positioning, in terms of tactical asset allocation, our conviction around positioning is very low right now. So we’re staying close to benchmarks.

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