Canada’s economy primed for a comeback

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. 

Michael Sager, managing director and CIO for multi asset and currency management at CIBC Asset Management. 

So, what is the outlook for the Canadian economy in 2025, and how will it be impacted by the changing political landscape? We’re quite upbeat on Canada and Canadian growth. The economy had a difficult 2024. [It] was weaker than we expected, particularly in the labour market and the housing market.

The key factor for 2025 is how aggressive in easing policy the Bank of Canada has been over the last few quarters. [It was] the most aggressive easing central bank in the developed markets, and we think that’s going to pay dividends as we get further and further into 2025.

So, we’re looking for robust growth in the second half of the year from Canada. And, particularly, the housing sector is likely to be an important tailwind, given its heightened sensitivity to interest rates, and given, also, the large housing shortage that Canada is experiencing. We’re starting to see green shoots there. Residential construction has been in recession since 2022. But building permits are already pointing to a rebound.

So, good news there. We also think that the consumer will be supportive. Lower inflation has boosted real growth despite the soft labour market. And we’re still seeing shortages of employees in key sectors.

And then, just the final point, households in aggregate seem relatively well prepared for the increased volume of mortgage renewals that we expect this year and next, because they’ve got quite a lot of savings.

So net-net, our base case is for a pretty robust recovery in Canadian growth, with inflation close to the Bank of Canada’s target.

Now, how will that be impacted by politics? We don’t think domestic politics per se will have too much impact. Main drivers of economies are always the deep fundamentals around growth. And so I don’t think the outcome of the Canadian election by itself will be meaningful.

More important will be the risk of tariffs from the U.S. and having those imposed on Canada. To the extent that we do see a significant increase in tariffs, that would be an important downside risk to our positive view on growth. It would likely mean also that the Bank of Canada will continue to aggressively cut interest rates.

So that’s the big risk to our fairly positive view. 

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So, what is the outlook for the U.S. and Canadian dollars?

Since the victory of Donald Trump in November’s U.S. elections, the U.S. dollar has definitely been strong. We think that could continue for a while longer. The U.S. economy remains the leader in terms of growth, particularly in the developed world.

As I’ve said, Canada is catching up but, for the time being, the U.S. remains the leader from a GDP growth perspective. With inflation in the U.S. a little bit sticky in the high twos and above the Fed’s target of 2.0% — and likely to continue to be sticky and above the Fed’s target — that suggests that the Federal Reserve is much closer to the end of its policy-easing-cycle than is the Bank of Canada or the European Central Bank or the Bank of England, for instance.

And so that combination of good growth, sticky inflation and more conservative monetary policy will likely keep the U.S. dollar strong.

Add into the mix the risk of tariffs, and that too is a U.S.-dollar-positive factor. So, U.S. dollar [is expected] to remain positive and higher for longer, even though relative to its long-term valuation, it looks very expensive. So higher-for-longer is a cyclical story. And then, on a much longer view, dollar weakness. But let’s keep focused on the cyclical, higher-for-longer conclusion for the time being.

On the flip side of that, [the] Canadian dollar has been weak, partly because of the weak economy which, of course, we think is turning. Also because of the aggressive easing of the Bank of Canada and because of tariff risk.

All of those, at least in the next few months, are likely to keep the Canadian dollar trading weak to fair value. As of the 16th of January, we were close to $1.44 Canadian dollar versus the U.S. dollar. The risk is it goes a little bit weaker than that, and perhaps up towards $1.50 before ultimately, from a long-term perspective, strengthening. But weak for the time being, is the conclusion for the Canadian dollar. 

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So, what can investors expect from fixed income and equities in 2025?

Starting with equities, clearly, the last two years have been very, very strong for public equity markets. We don’t expect that sort of strength to repeat going forward. But we are relatively constructive.

Again, if we tie it back into our cyclical economic view, growth being positive and robust in the U.S. and gaining strength in Canada is good for corporate earnings in both markets. And corporate earnings are the primary driver of equity returns.

So, we definitely think that the balance of risks favours continued moves higher in equity markets, particularly in North America, in 2025. So that’s the first observation.

And we have a preference — given also valuation, as well as the outlook for corporate earnings — we have a preference for Canada in Canadian-dollar terms over the U.S. Turning to bonds, you know, yields are much higher than they were recently.

We expect, for instance, 10-year Treasury to be trading in a range of somewhere on the top side 5% over the next 12 months, on the bottom side somewhere around 3.25%. Bonds have sold off in the U.S. over the last few months because investors got worried about inflation and also became more pessimistic about the amount of easing likely to come from the Fed.

I think going forward from here, again, we’re fairly sanguine about the mix of growth and inflation in the U.S. So, there’s an opportunity for yields to just come down a little bit in coming months, into the middle of our range, which will be positive for bonds.

So, net-net, given starting yields and given our cyclical outlook, we’re positive also on bonds. We have a slight preference for global bonds versus Canadian. [They offer] Small pickup in carry. But overall we like the asset class. We think that equities can slightly outperform bonds in aggregate in 2025, but that’s a small preference. Net-net, we like both asset classes. 

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