Canadian Highlights
- Donald Trump will be inaugurated on Monday, and Canadians are bracing for the economic threats in recent weeks to turn into action through a flurry of executive orders.
- Canada is economically tied to the U.S., with $1.9 billion in daily goods and services exported to its southern neighbour. That amounts to over 20% of GDP.
- While we aren’t expecting the worst-case scenario on tariffs, even a tapered down set of tariffs could be enough to send temporary shockwaves through the economy and financial markets.
U.S. Highlights
- December’s CPI report brought some modestly positive news on inflation. The headline CPI came in as expected and even better core inflation had a softer month after a string of hot readings.
- Retail sales also saw a solid gain in December. While consumers reduced spending at restaurants and bars, it’s likely they were just busy shopping.
- Fed officials continued to emphasize that the economy remains solid and that the central bank can afford to be patient with further interest rate cuts.
Canada – Ready or Not, Here He Comes
Donald Trump will be inaugurated on Monday, and Canadians are bracing for the economic threats in recent weeks to turn into action through a flurry of executive orders. While we aren’t expecting the worst-case scenario, even a tapered down set of tariffs could be enough to send temporary shockwaves through the economy and financial markets. To assess the magnitude of this threat, here are the areas of economic growth and jobs most at risk on Trump’s return to the White House.
Three-quarters of Canadian exports head south of the border. This amounts to $1.9 billion in daily goods and services exports, meaning that exports to the U.S. account for over 20% of Canada’s GDP. Breaking it down by sector, energy is by far the largest contributor in dollar terms, making up more than a quarter of total exports. However, non-energy exports are also highly vulnerable. As shown in Chart 1, sectors ranging from motor vehicles to forestry have more than 80% of their production destined for the U.S. An estimated 46k companies in Canada depend on exporting to the U.S., supporting around 2 million jobs (nearly 10% of total employment).
Geographically, the risk is widespread. All provinces have exposure to U.S. tariffs, ranging from B.C. lumber to Quebec metals to Nova Scotia live animal exports. However, Ontario tops the list in terms of total dollars due to its diversified industries being deeply integrated with its southern neighbour. Motor vehicle and parts manufacturing may get most of the attention, but Ontario is also home to significant production of machinery, base metals, chemicals, and even food/beverage. While many of these goods are a part of well-established integrated supply chains, it won’t assuage fears, as nearly a million jobs in the province are tied to U.S. trade. Alberta is another key province to flag given its energy concentration. There’s speculation that Trump may give Canadian oil a “carve out” from tariffs to prevent rising gasoline prices for American consumers, but still, there are over 300k jobs in Alberta tied to exports.
What President Trump ultimately implements is highly uncertain. Our baseline assumption is that Canada avoids blanket tariffs and instead faces temporary sector-specific threats as leverage for broader negotiations. However, we must also prepare for a worst-case scenario: a blanket 25% tariff with Canadian retaliation. Such an outcome would almost certainly push the Canadian economy into recession, driving the unemployment rate above 8%. However, some of the downside would be mitigated by government action, with discussions well underway on support to affected businesses and consumers. The Bank of Canada would also create a cushion by accelerating rate cuts, as would an inevitably weaker currency. A larger interest rate gap with the U.S. and the nature of this risk could cause the Loonie to test the historical low of 62 U.S. cents. This would also provide a cushion for Canadian exporters.
This is the playing field for Canada. The country faced similar risks in 2016, when Trump defied economic logic by igniting a trade war with China and imposing tariffs on specific Canadian exports. While fears were running high and many forecasters slashed their GDP outlooks, the economic impact was less severe than anticipated, as Trump’s goal was to secure a deal.
This time, Canadian officials must be strategic. Short-term supports may be necessary to assist industries and workers, but the government cannot miss acting on long-term opportunities. This crisis creates a burning platform that could enable bold action to build out Canada’s competitive advantages, such as reducing regulatory barriers/red tape, and improve tax competitiveness to incent business investment.
As the old Churchill saying goes: “Never let a good crisis go to waste”.
U.S. – The U.S. Economy Sails into Trump’s Presidency at Cruising Speed
This week was the final “quiet period” before a storm of headlines and announcements from the White House next week, following Trump’s inauguration. The incoming president inherits a robust economy, with this week’s data confirming that momentum remained strong through the end of last year.
Building on last week’s unexpectedly strong job gains, the retail sales report added more good news, signaling strong consumer spending over the holiday season. Retail sales rose by 0.6% in December, following a 0.9% gain in November. The “control group”—which excludes volatile categories like gasoline, autos, and building supplies—showed even stronger growth at 0.7%. Growth was broad-based, with especially strong spending on discretionary items like furniture, clothing, and sporting goods.
Anecdotal evidence from the Fed’s Beige Book, released this week, confirmed robust consumer spending at year-end, noting that “consumer spending has moved up moderately, with most districts reporting strong holiday sales that exceeded expectations.” This suggests that consumers ended 2024 on a high note, and it’s easy to see why. The labor market remained strong, continuing to add jobs at a good clip, while inflation has subsided (particularly in the goods category), and household wealth remains elevated (Chart 1). Even with recent volatility in the equity market, the S&P 500 is still up some 25% from a year ago. All in all, we expect inflation-adjusted consumer spending to rise somewhere in 3%-3.5% range for the fourth quarter, roughly in line with the previous quarter. Homebuilding activity also ended 2024 on a high note, breaking a three-month streak of declining housing starts.
This week’s CPI report provided a bit of good news on the inflation front, alleviating some concerns that had flared in recent months. Core CPI (excluding food and energy) increased by 0.2% from the previous month, and the 12-month inflation rate edged down to 3.2%, after holding at 3.3% for three consecutive months (Chart 2). However, this is unlikely to affect the Fed’s decision at its next meeting on January 29th. For one, CPI is not the Fed’s preferred inflation gauge; that’s the core PCE deflator, and the December PCE data won’t be available before the Fed’s next rate decision. Additionally, there’s nothing in the recent data that would prompt the Fed to change course, especially with inflation risks from Trump’s economic policies.
Fed speakers this week reiterated that the economy is performing well. FOMC member Barkin noted, “you keep seeing good numbers on retail sales, unemployment, and the like… Demand is good, solid, fine.” While the FOMC member Williams stated that the monetary policy is in “a very good position”, and the Fed “can take the time to analyze the incoming data”. Given the potential policy shifts under the new administration, the Fed will have plenty to assess in the coming months.
