Trade uncertainties create two potential paths for economy

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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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Avery Shenfeld, managing director and chief economist at CIBC 

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The Canadian economy looked pretty good in the second half of 2024, and as we entered this year. And that would have had the Bank of Canada deciding to take a pause on interest rate cuts to see whether they had done enough to stimulate growth. 

All of that went out the window with the tariff threat from the U.S. That has clearly soured business sentiment, and although that’s not likely to really show up in first quarter numbers, we’re expecting to see some weakness in economic activity, likely an outright decline in GDP in the second quarter of the year.  

So the Bank of Canada, attempting to provide maybe only a band aid for the economy, but lend some support to economic health, opted to cut interest rates a quarter point. That’s certainly not a cure-all for what the economy would look like if a trade war does, in fact, materialize.  

But it will be a little bit of support to domestic spending at a time when exports might be under siege and businesses might be holding back on capital spending, awaiting greater clarity. 

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A 30-day pause on most tariffs from the U.S. was certainly welcome news in the sense that it gives Canada a bit more time to send its diplomats and politicians down to Washington and try to get the U.S. side to the negotiating table. But in and of itself, it’s not really that helpful for the economy if we think about the outlook for the year as a whole.  

Putting off a major shock to exports for a month won’t really provide much comfort to sectors like automotive assembly, car parts, machinery and so on that are worried about their access to the U.S. market. 

So, if this is going to be helpful at all, it will really be just that we get a bit more time for lobbying on the U.S. side from companies that are negatively affected, and for Canada to try to get the U.S. back to the table this spring and look at a broader agreement on trade that gets us away from the tit-for-tat response of elevated tariffs, and the economic damage that that would likely bring, not only to Canada, but to some extent to the U.S. as well.  

This is really a case where the potential for a trade war, or potential relief from the trade war is going to have an overwhelming impact on where the economy heads, just given the scale of the shock that would be entailed if we were, for example, to face 25% tariffs on all our non-energy exports and 10% on energy.  

Our estimate is that if that were sustained over the next couple of years, we’d see a significant recession in the Canadian economy.  

If it’s lifted and those clouds go away, then the momentum of the Canadian economy will really go back to where we looked in the second half of last year, where the interest rate cuts we’ve had were poised to stimulate domestic spending. We were starting to get better employment growth to create household income gains to fuel that additional spending. And further out, lower interest rates might have also rekindled activity in the housing sector, coming off a period where home building has been quite subdued.  

So it’s really a case of two potential roads ahead, one quite negative, if we can’t get ourselves away from this trade war, and one that looks decidedly positive for later this year and into 2026 if the trade threat goes away. And really, that’s the decisive factor, and everything else will be secondary to those developments between U.S. and Canada on the trade side. 

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We’re still, at CIBC, holding on to a base case forecast that, although dented in the second quarter by trade uncertainties, starts to see some rays of sunshine emerging later in the year.  

That would still leave 2025 showing anemic growth overall, perhaps in the range of 1% or so. But if we did get relief from a trade war, we really have some optimism for 2026, and financial markets would be responding to that better outlook over the medium term.  

So for investors, if the trade war goes away, there’s room for a substantial rally in Canadian equities, for some solid performance by Canadian business, beginning late this year and into 2026.  

Our concern, however, is that that’s by no means a certainty, and if we were, for example, to face a more protracted trade war, then we’re looking at a recession and perhaps some further weakness in equity markets.  

So this is really a year for investors to think about, not only their base case view, which might still be somewhat optimistic, but also the risks that are facing both the Canadian economy and the global economy from a protracted trade war, and the need to then position portfolios with a little bit of conservatism to take into account that there is still some significant downside risk to that economic picture, and what that will mean for corporate earnings ahead. 

Investors have to think about how to hedge against some of the risks associated with the Canadian economy facing this potential trade shock.  

So certainly, there are segments of the Canadian equity market that are not particularly cyclical or exposed to exports. There are sectors of the Canadian economy that would benefit from low interest rates. So, for example, utilities tend to do well in a lower rate environment. And of course, having a portfolio that has some weighting in the U.S. would be helpful in a trade war, that while negative for the U.S., likely is more problematic for Canada than for companies south of the border. Even within the Canadian market, there are companies that have operations on both sides of the border that may have some wins to offset some of the strains on the Canadian economy.  

And the bond market also does provide some potential shelter, because in the event that we do fall into a trade-war recession, we would expect that interest rates will come down, that will provide some reasonable returns to government bonds and high-grade corporate bonds. So a diversified portfolio always makes sense for investors. And in a world as uncertain as it does look as of mid-March, there’s even more reason to have that diversification in your investment portfolio, just given that no one can really tell you where this trade war is going right now. 

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We have certainly seen some weakness in the Canadian dollar tied to fears that U.S. tariffs will stand in the way of our exports. And for a while, that was also generally pushing up the U.S. dollar against other major currencies from countries that America trades with. 

Of late, though, the sensitivity of the U.S. dollar and other currencies to negative news on the trade-war front seems to have died down a bit. And what that’s picking up is that markets are starting to realize that a trade war is not particularly good news for the U.S. economy. It’s causing markets to start to price in some Federal Reserve rate cuts that would come about if the U.S. economy slows significantly in the face of a multilateral trade war.  

And, so, the Canadian dollar’s weakness might not be as pronounced as we would have feared early in the year, and we still have some hopes to see a bit of a recovery in the loonie, should Canada successfully engage with the U.S. and dial down this tariff threat in the coming months.

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