The Weekly Bottom Line: Tariffs On, Tariff Off, Tariffs On?

Canadian Highlights

• President Trump kept most Canadians glued to their TVs/socials this week, announcing tariffs to take effect February 1st, before quickly delaying them for 30 days following a big market selloff and further measures at the border from Canada.
• Canadian trade data came in quite positive in December as firms appear to be frontrunning potential tariffs. Exports for the fourth quarter of 2024 are now tracking double digit growth.
• The job market continues to hum along, with a gain of 76k net new jobs in January. That marks three straight months of above-trend job growth.

U.S. Highlights

• Tariffs on Canada and Mexico have been put on hold for one month, but a 10% tariff was imposed on imports from China.
• Companies have ramped up inventories ahead of tariffs, leading to a sharp increase in the trade deficit in December. Activity has eased off in the services sector, but continued to reaccelerate in manufacturing.
• Hiring has slowed in January, however, the labor market remains solid overall. Significant upward revisions to the fourth quarter figures suggest that job growth was stronger at the end of last year than previously thought.

Canada – Tariffs On, Tariff Off, Tariffs On?

It feels like the longest week ever for Canadians. Many of us with sleepy eyes last weekend were sorting out the impact of Trump’s tariffs and what they would mean for an economy that has been on weak footing for the last two years. Then the reprieve of a 30-day delay came on Monday, creating a whipsaw effect in Canadian financial markets. Economic data this week was also headline grabbing. Trade data showed that Canada’s export dependence on the U.S. increased through the end of last year (Chart 1), while employment growth gave a glimpse of what could have been/may still be a solid growth trajectory for 2025 (Chart 2).

President Trump kept most Canadians glued to their TVs/socials on Saturday, announcing a 25% tariff on Canadian exports (10% on energy) to take effect Tuesday, February 1st. With Canadian retaliation announced, financial markets went into panic on Monday. Government of Canada yields collapsed by nearly 20 bps and the Loonie reached a low of 67.5 U.S. cents. Although the President postponed tariffs, Monday’s reaction gave everyone a view into what could be in store for Canadian markets should a trade war come to pass. In the meantime, yields have recovered their lost ground, while the Canadian dollar is hovering close to 70 U.S. cents.

Canadian trade data came in quite positive in December as firms appear to be front running tariffs. Exports for the fourth quarter of 2024 are tracking double digit growth, a big rebound from the negative growth seen over much of last year. High demand for energy and metals from the U.S. led the gain, as the trade surplus with the U.S. clocked in at over $100 billion for the year. This overall figure could be used as fodder for President Trump to validate his claims that trade with Canada is ‘unfair’, even though the trade surplus would become a deficit when energy is excluded.

In any other week, Friday’s labour market report would have been the focus. But trade risks have bumped it to runner up. Yet, the jobs market continues to hum along. Today’s gain of 76k net new jobs in January marks three straight months of above trend job growth. Importantly, the unemployment rate dipped to 6.6%, as population growth ebbs. While the labour market has been a pillar of strength for the Canadian economy, the outlook has become precarious. We have been expecting the unemployment rate to decline over this year, but our tariff scenario analysis shows that it could quickly rise to 7%, if not higher, should tensions persist.

Canada has entered a period of great uncertainty. Tariff threats have cast a shadow over the economic outlook. Market pricing for the Bank of Canada has started to move towards a greater likelihood of another cut come March. The Bank has highlighted the growing downside risks, perhaps signaling a greater willingness to take out more insurance should risks become reality.

U.S. – Canada-Mexico Tariffs on Hold

This week was anything but boring. On Monday, an 11th-hour deal was reached to delay tariffs on Canada and Mexico for a month. However, while Canada and Mexico were spared, China was not, as an additional 10% tariff was imposed on all imports from the country.

The prospect of tariffs being imposed on North America in a month, or in April when the review of current trade policies is completed, looms large. Financial markets have largely recovered from their initial knee-jerk reaction to the tariff announcement, with the S&P 500 paring back losses by the end of the week. However, inflation expectations over the next two years have risen (Chart 1) while bond yields have declined. This points to investors’ concerns that tariffs will accelerate inflation and slow economic growth.

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Businesses’ uncertainty about the looming tariffs were reflected in the trade data. The U.S. trade deficit widened sharply in December – the largest one-month increase since the early 1990s. Imports surged as companies rushed to ramp up inventories ahead of potential tariffs. Last month’s sharp increase in the trade deficit is likely temporary, but trade policy uncertainty will continue to affect trade flows throughout the year. Uncertainty about tariffs also clouds the outlook in the manufacturing sector, particularly in industries such as auto manufacturing. Even though the ISM manufacturing index has continued to improve in January, rising for the third consecutive month and finally moving into expansionary territory, supply chain disruptions could dent the sector’s nascent progress.

Activity in the services sector continued to expand robustly in January, although it dialed back a notch. The services sector is less exposed to trade than manufacturing, but it is not immune. The prices paid subcomponent remains elevated, and any supply chain disruptions and higher input prices could reignite inflationary pressure.

Additional inflationary impetus could also come from the labor market. Today’s employment report showed that the U.S. economy added 143k jobs in January. This is considerably less than December’s tally (+305k), but still a solid outturn, particularly when combined with a slight decline in the unemployment rate and an uptick in wage growth. Moreover, wildfires in Los Angeles and a cold weather spell nationwide could have also weighed on employment, suggesting a bounce-back next month could be in the cards. Lastly, revisions through the fourth quarter were notably higher, adding an extra 101k jobs to the previously reported figures and suggesting that hiring momentum was even stronger at the end of last year than previously thought (Chart 2).

With inflation progress having stalled in recent months, wage growth showing staying power and heightened uncertainties on how far the new administration will go on its policies, the Fed is likely to remain more cautious. Next week’s inflation report will likely show that the Fed’s patience is justified, as inflation remains persistently above the Fed’s 2% target.