The economy heats up

Pierre: Welcome to iA Financial Group’s “In Your Interest!” podcast. My name is Pierre Dolbec and I’m joined by my colleague and Chief Strategist, Sébastien Mc Mahon. Hi, Sébastien.

Sébastien: Hello, Pierre. How are you?

Pierre: I’m good. How are you?

Sébastien: I’m good, I’m good. So, snow is melting here in Quebec City. The spring is upon us. So it’s time to talk about the economic outlook for spring 2025, which is looking hot so far.

Pierre: Very hot indeed, Sébastien. During the last episodes, we discussed the Trump effect in the first month of his presidency. And now that spring is just around the corner, all of North American media and economic attention seems polarized as the United States and Canada have entered into a full-blown trade war. Can you give us an overview of the concrete measures that have been put in place by the United States?

Sébastien: Yeah, sure. So, let’s talk about what’s concrete here. Let’s avoid all of the conversation about annexing Greenland, retaking the Panama Canal and Canada as the 51st state. So, let’s focus on the facts.

And the facts are that we have some tariffs in place from the U.S. The main one is: steel and aluminum are now tariffed at 25%. So the importers, the U.S. importers of steel and aluminum are paying a tax to the U.S. government for everything that they import that has steel and aluminum content or, you know, as a natural resource directly.

The other tariffs… it’s a bit more complicated because the tariffs apply to goods that do not satisfy the CUSMA rules of origin: those are taxed at 25%. So, in short, you know, the goods that do not satisfy the CUSMA rules are about 5 to 7% of Canadian exports. The reason is that if you want to satisfy those rules of origin, you need to fill out the paperwork, and the vast majority of Canada’s exports would satisfy the CUSMA rules, but for some goods, you know, exporters never took the time to fill out the paperwork because the alternative was to be tariffed at 0%, 0.1%, 0.2%. So, it was just a decision by businesses. So, if everyone just fills out the paperwork to satisfy the rules of origin, it’s about 5% to 7% of Canadian exports.

In there, there’s also energy products and potash. Some of that falls outside the CUSMA rules of origin. Those are taxed at 10%. In short, you know, 25% on steel and aluminum and not much everywhere else.

Pierre: And what was Canada’s reaction to these measures?

Sébastien: Well, Canada, of course, we need to defend our sovereignty. So, there were some countermeasures. Some didn’t last, like the threat of taxes on exports of electricity from Ontario, but so far, what we have in place as we’re discussing this—this is mid-March, here, that we’re recording this—Canada is applying a 25% tariff on approximately $60 billion worth of American goods in retaliation for Trump’s border and metals-related tariffs.

The government is also considering tariffs on an additional $100 billion worth of American goods that will be imposed if Trump proceeds with a third round of what he calls reciprocal tariffs on goods from around the world, which should be announced on April 2.

So, until we get to the beginning of April, this is the situation so far. Let’s see if it moves. But our best-case scenario is that the trade war will last. This is a doctrine that is strong within the American administration. Will it last for long? Will it be short? Will we see more than 25% tariffs? Will we see less? Will we see negotiation? I mean, all of those options are on the table. But this environment of trade threats should continue and last through 2025 and likely into 2026.

Pierre: Assuming, therefore, that this economic conflict will not be short-lived, what are the possible effects on the Canadian economy?

Sébastien: Well, the risk of a recession is high in 2025 and 2026. It’s very hard to model a trade war. I don’t know any model that is well suited for that. But, you know, one of the best models around the world, and it is widely recognized so, is the one from the Bank of Canada. And they estimated that a recession is likely in 2025, also in 2026, because the impacts of all of this could be back loaded into the year, because of all of the order books of Canadian firms that could start to suffer with those tariffs. And that means less deliveries late in 2025 and into 2026.

So, the bank estimates that it could be a shock of about 4% on growth. Expectations were for about +2 this year, so maybe that brings us to -2% this year. And overall, if it lasts, so let’s say the U.S. puts tariffs in place, Canada retaliates and everyone sticks to their position, this is a permanent decline of 2.5% on the GDP trend.

So just imagine a line that you extrapolate into the future which is the growth of GDP. Well, you just lower the level of that line by 2.5%, and that would give you the result. But still, if you look more short term, the Bank of Canada has some surveys that it is conducting. It unveiled the first edition of that survey when it lowered its leading rate on March 12.

It showed that 25% of households plan to increase their precautionary savings. So, I always say that a recession is people keeping money in their pockets. So, if people save more, that means that they spend less.

50% of affected businesses plan to pass on the cost increase to their consumers.

40% of businesses plan to reduce hiring.

50% of businesses plan to reduce investments.

So, if you put all of this together, you see that uncertainty is already weighing heavily on the economy.

Pierre: And now that we’ve talked about the effects of an ongoing trade war on the Canadian economy, what would be the possible effects on the U.S. economy?

Sébastien: Well, in the U.S. we could also see a recession. So, the effect should be negative there as well. We’re seeing household confidence that’s already in sharp decline. We have a negative wealth effect with the market being down and, in the U.S., the richest part of the population is responsible for the lion’s share of spending. So, if you have markets down, you have a negative wealth effect, you have those people spending less as well, you have an increase in inflation expectations. This is sizeable because now the next 12 months expectations for inflation is at 4.9%, almost as high as what we had in 2022, and we all remember the inflationary pressures that we had then.

The main channel for a recession in the U.S. will be less consumer spending from lower confidence, fewer purchases of houses, fewer purchases of cars, furniture and all of this, of course, that has trickle-down effects that are pretty negative on GDP. And also for markets, we see decreased risk appetite and more pressure on markets.

So, all of this is a perfect cocktail for less support for Republicans from public opinion in the 2026 midterm elections at the back end of 2026. So that could mean that, you know, at some point, this could lead to the downfall of this administration because they could lose the supermajority that they have in the Senate and in Congress.

But so far, if you look at what you have right now, you have business confidence that remains strong for now, which is important to monitor closely as tariffs will hit several major economic sectors directly. Labour market and investment risks should rise somewhere maybe in H2, so the second half of 2025, maybe not right now.

Pierre: And we saw earlier this year that the markets didn’t react too much to Donald Trump’s statements, but we could observe that these same markets reacted strongly as soon as tariffs were applied. What can you tell us about market trends?

Sébastien: Yes. So, Wall Street is in correction territory right now. It’s very important to understand: it’s Wall Street. So, the Nasdaq and the S&P 500 are in correction territory. The TSX, so the Canadian stock market, is not. European stocks are actually up by about 15% year to date. China is up about 20% year to date.

So, if you remember at the end of last year, when we’re looking at our outlook for the next year, we’re talking about the importance of geographical diversification at the turn of the year. And this is exactly what we meant, because the U.S. stock market was expensive with expectations for perfection on earnings growth. Other markets were seen as affordable with depreciated growth expectations. So now you have this rotation which has been violent at the start of the year. So, being invested more outside of the U.S., even though the U.S. is always an important part of any portfolio, was the winning strategy in 2025 and we see exactly why right now.

But uncertainty continues to weigh heavily. The theme of American exceptionalism has slipped out of consensus and the future, for now, I think it depends on what the Trump administration decides to do.

Pierre: And one thing’s for sure, the evolution of this conflict between the two countries will remain a hot topic in the coming quarter.

That’s all for today. Thank you, Sébastien, for this springtime analysis, which sheds light on what we can expect for the rest of the year, despite all the uncertainty in which we are navigating right now.

And thanks to our listeners! See you in two weeks’ time for the next episode of the “In Your Interest!” podcast.

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