Shifts Happen

Monday, January 20, has the potential to meaningfully shift the trajectory of the US, Canadian and global economies. With the inauguration of President Donald Trump for a second term, there is a material risk that hefty import tariffs could be introduced soon after he returns to the White House. The new administration could also move to slash migration to the US. Deregulation and tax cuts are likely as well, with the latter leading to lower US federal government revenues. Increased customs duties could provide some offset, although weaker economic growth should keep a lid on US government revenues in general. Higher tariffs and larger budget deficits may also fuel inflation, leaving interest rates more elevated than they would be otherwise. Bond yields have already been climbing in anticipation (graph 1). And while spending cuts are possible, as with any ill-defined plan to find public-sector savings, the proof of the pudding will be in the tasting. 

We’ve written extensively about the potential economic impacts of President Trump’s policy plans on the US External link. and Canada External link.. On balance, these policies are likely to be stagflationary External link., hurting growth while boosting inflation in both countries. And the larger the tariff or the sooner it’s introduced, the more detrimental the economic impact External link.. Our pessimistic scenario of a 25% targeted tariff on all Canadian exports to the US could tip Canada’s economy into recession as early as the middle of 2025. If this were to occur, inflation could hit 3% y/y while the unemployment rate would likely jump to levels not seen since the COVID-19 pandemic (graph 2). The tariff headwind to economic activity would be further exacerbated by policies to slow population growth and an impending wall of mortgage renewals starting in Canada this year. 

This would be a tough environment for any Canadian government. But at the federal level, it’s further exacerbated by a prorogued Parliament, a Liberal Party of Canada leadership race, and the prospect of an election beginning as early as late March. This leaves a void in federal leadership for much of the first half of 2025, at a time when risks coming from south of the border are extremely elevated. The next prime minister, whoever it is, will need to outline a new economic and fiscal direction for Canada, potentially against the backdrop of a shrinking economy and accelerating inflation. This trend is likely to get worse before it gets better, making it difficult to cut taxes and shrink deficits without finding substantial savings in the fiscal framework.

Looking to the provinces, some are more exposed to potential tariffs than others (graph 3). Alberta, Saskatchewan and Newfoundland and Labrador could get lucky if energy exports are exempt from US duties, as we assume in our baseline forecast. Refined petroleum products, one of New Brunswick’s largest exports, could also potentially also be spared. And if fortune favours Ontario, the closely integrated North American auto industry could give cause for pause in applying tariffs to Canadian exports of motor vehicles and parts. But even if duties are not applied to these exports, a hit to the remaining non-energy exports External link. would hobble economic activity in provinces like Quebec, Ontario and Manitoba. This could drag on provincial government revenues at a time when the federal government is likely to be looking for ways to reduce spending. Meanwhile the more trade-diversified provinces of Saskatchewan and British Columbia should be better protected from some of the immediate, direct impacts of US tariffs. 

All told, a second Trump administration is poised to change the North American economic landscape. We just don’t yet know exactly how, when and by how much. But shifts happen, and policymakers need to be prepared. A focus on diversifying international trade, reducing internal trade barriers, leveraging our comparative advantages and creating a more investment-friendly environment could lay the groundwork for a resurgent Canadian economy down the road.