Tariffs, trade and turmoil

A tale of tariffs

Green shoots for the Canadian economy that emerged early this year were all but undermined by the Trump administration’s “Fair and Reciprocal Plan,” which was announced by the president on April 2 (and forever etched in our collective memories as “Liberation Day”). This delivered a baseline of a 10 percent tariff on all imports into the United States. However, the president also presented a list of 60+ nations that had, in his view, inordinately large trade surpluses with America, and who would consequently be hit with far higher tariffs for their imbalances with the world’s largest economy.

This unleashed mayhem across the globe, as countries absorbed this potential blow to their economies and assessed their responses. The most punishing tariffs were reserved for countries with which the U.S. has larger trade deficits, namely China, India and Vietnam.

Based on estimates from RBC Economics, the rollout of these Liberation Day reciprocal tariffs pushed the average effective tariff rate to over 20 percent—an almost 10-fold increase, and the highest rate in more than a century. Most countries that were hit with this new round of tariffs have vowed to reciprocate; however, some will no doubt find it more expedient to negotiate with the U.S.

Fortunately, Canada (along with Mexico) was not targeted in this round. Still, the implementation of auto tariffs alone is estimated by RBC Economics to move the average U.S. tariff rate on imports from Canada to ~3.6 percent from 2.5 percent.

In the most recent and stunning turn of this tariff tale, the Trump administration announced on April 9—the very day of their implementation—that it would suspend the Liberation Day reciprocal tariffs for 90 days, allowing the 60+ impacted nations to negotiate with the White House on their ultimate tariff rate, while maintaining the 10 percent baseline tariffs. However, the one exception to this was China, which was then slammed with a 145 percent tariff on all goods imported into the U.S., apparently as a result of their own reciprocal tariffs on U.S. goods. The announcement was not well received by the Chinese government, who vowed to retaliate in kind.

For now, the only certainty is uncertainty

It is difficult to model the outcome of this growing tariff war on GDP growth in Canada and the world with any meaningful accuracy, given the wide range of outcomes and challenges in estimating second order impacts beyond merely the magnitude and scope of tariffs. With the “better than expected” tariff outcome for Canada, the risk of recession has decreased, not fully dissipated. The Liberation Day announcements and walk back may not be the last, and as such, uncertainty remains the status quo going forward.

Given the mercurial nature of the U.S. president, Canada may come into the administration’s crosshairs in the near future, with other Canadian-specific “problem” areas including the dairy and lumber industries (additional tariffs on the latter appear imminent at the time of writing), the Digital Service Tax and the country’s Online Streaming Act.

Despite the announced suspension, the sheer existence and persistence of the uncertainty around “will he or won’t he” has already begun to cast a pall over the outlook for global economic growth. GDP estimates have been downgraded by a number of analysts, with modest negative revisions specifically for both the U.S. and Canada, though not to the extent that they yet signal a recession. The volatility of the Trump administration, coupled with a general opacity around the motivations of tariffs on one of the U.S.’s closest allies, has led “once bitten, twice shy” Canadian investors and consumers to rethink and/or pause on important business investment, hiring and consumption decisions.

The sheer jump in the average U.S. tariff on imports is consequential to Canada given our reliance on trade with the U.S. The reciprocal tariffs, coupled with escalating retaliatory tariffs, poses a risk to overall U.S. economic growth, and subsequently the ultimate size of the U.S. import market in the medium-to-long term. Further, one should not underestimate the still highly integrated nature of global supply chains. Importantly, a rewrite of the global trade order could very well have adverse spillover effects on the Canadian economy.

In the U.S., the strong domestic economy and lower sensitivity to trade provides somewhat of a potential offset to trade turbulence in the near term. That said, the compounding effects of retaliatory tariffs, potentially higher inflation and weakening consumer and business sentiment are likely to undermine the narrative of U.S. exceptionalism and narrow its economic advantage relative to other developed economies. While a recession is not in our base case for the U.S. this year, RBC Global Asset Management estimates that the probability of this outcome has increased from 10 percent to 25 percent.

Uncertainty obscures the path forward for interest rates

Even after dodging the most punitive tariffs on April 2, we believe that the BoC will maintain a data-dependent stance, while also considering any potential fiscal response by the government. Given that monetary policy operates with a lag, the more immediate impacts of fiscal stimulus on the inflation and growth outlook would need to be considered. Hard lessons learned during the COVID-19 pandemic are to be leaned upon to prevent another upward inflationary spiral, an outcome that is possible should there be a confluence of generous fiscal and monetary accommodation in response to trade tensions.

In the medium-to-long term, the economic backdrop remains fluid. The unemployment rate in March ticked modestly higher, while the Q1 Business Outlook Survey (BOS) indicated that business sentiment deteriorated significantly from the previous quarter. Looking ahead, the impact of tariffs will increasingly be reflected in economic data. This could translate into economic headwinds ahead, which may put greater pressure on the BoC to deliver monetary relief.  

On the other side of the border, the U.S. Federal Reserve (the Fed) held rates steady in March at 4.5 percent for a second consecutive time, in light of inflation remaining above the Fed’s two percent target, and unemployment remaining in and around the four percent level. In an acknowledgement of increased trade-related economic uncertainty, the Fed downgraded its economic forecast, which revealed their expectations of incrementally slower GDP growth, increased unemployment and higher core inflation by year end.

Yet with the release of the latest sweeping reciprocal tariffs, the market quickly repriced Fed rate cuts for close to 100 bps this year—or the equivalent to three-to-four quarter point cuts. That is up from the consensus view just a week prior, and two earlier this year, and implies an exit rate between 3.25 percent to 3.5 percent at the end of this year. We are not convinced it will be that simple for the Fed. 

Should the current level of tariffs stay in place for an extended duration, we believe the risk of stagflation will increase. The Fed will likely be conflicted between growing price pressures and weaker growth (implying greater risk of rising unemployment). Notwithstanding weaker growth, with inflation meaningfully above its target rate and potentially rising, we believe the Fed will find it a challenge to justify rate cuts which could run the risk of further fueling inflation.

The Fed has hinted that trade-war induced inflation could be persistent, potentially limiting its ability to cut rates. We expect that it will remain data-dependent, and balance the upside risk to inflation with the downside risks to growth on a meeting-to-meeting basis. Since we have yet to see the data meaningfully incorporate the impact of the tariffs, our conviction with respect to rate cuts in the near term is low.

Markets in perspective

Since the beginning of the year, escalating trade tensions have manifested in the market through a rotation by sector, style and geography. U.S. equity markets have underperformed the global indices on a year-to-date basis, as valuations for the “Magnificent 7″—the tech behemoths of Microsoft, Meta, Amazon, Apple, Alphabet, Nvidia and Tesla—have experienced price-earnings multiple compression in line with growing negative sentiment and uncertainty. Equity markets in Canada and Europe have provided a source of relative outperformance on a year-to-date basis, which we suspect is owing to their lower interest rates and inflation, inexpensive valuations and more competitive currencies.

However, there is no way of knowing which markets will outperform or underperform by the end of this year in light of heightened uncertainty. To wit, on April 3, markets in the U.S. and around the world plummeted in reaction to the new round of tariffs, only to stage a nearly full recovery following the announcement of the 90-day pause on April 9. And yet, at the time of writing, with the equity markets selling off again, we believe in a nod to the overall lack of conviction around market fundamentals and still prevalent uncertainty regarding the Trump administration’s tariff policy in the near term.

First quarter earnings season is currently in session, and heading into the season, consensus estimates (according to FactSet) were still forecasting low double-digit earnings growth for 2025. We believe these estimates were likely stale as sell-side analysts await further guidance from corporations to recalibrate their earnings estimates. Of companies that have reported thus far in the U.S., many have called out the lack of visibility with respect to the economic backdrop, with a number of them scrapping earnings guidance altogether. In our view, the possibility of negative earnings revisions poses a risk to the overall performance of the U.S. equity markets for 2025.

Over the course of the next several months, we expect more of the same with respect to headlines related to U.S. economic policy. Subsequently, we maintain that investors avoid giving into the “fear trade,” while the role of diversification both on a geographic and asset class basis are critical.

Against such a backdrop, it’s our view that incremental portfolio tweaks in furtherance of defensive posturing in portfolios is reasonable. This might involve an upgrading of a portfolio’s quality company exposure that is backed by strong balance sheets, has resilient cash flow generation and has opportunistic valuations. Maintaining neutral to modestly overweight allocations to fixed income, where yields continue to offer above-average total returns, might improve the overall defensive ballast within portfolios. Lastly, an embrace of alternative investments within the broader portfolio framework offers the potential for enhanced risk-adjusted returns over the long term, given this asset class’s lower correlation to public markets.

In our view, wholesale changes across portfolios, particularly after severe selloffs, are ill-advised. Such selloffs in equity markets have the potential to create buying opportunities for investors who remain focused on the long term and adhere to a disciplined approach of dollar cost averaging. Ultimately, once again, we believe time in the market is more important than timing the market.

A stronger Canada

Perhaps the silver lining amongst this dark cloud is that the posturing by the Trump administration regarding Canada’s sovereignty, and their threats of an escalating trade war, seem to have driven greater unity across the nation. This is underscored by the growing “Buy Canada” movement, through which Canadian consumers are eschewing U.S. brands in favour of their Canadian counterparts.

Many Canadians have cancelled or deferred travel plans to the U.S. Concurrently, provinces and territories are seeing increased travel interest from Canadian tourists. It is too early to say, however, what positive economic impact, if any, a more Canadian-centric consumption model will have, but it is a trend worth watching.

The trade tensions with the U.S. have also sparked some critical economic discussions within Canada. Within a week of being sworn in, Prime Minister Mark Carney met with premiers across the country to build a framework for growth in response to potential impacts of tariffs on the economy. That framework considers the reduction or removal of interprovincial trade barriers, strategically deepening our trade relationships outside of North America and investing more deliberately into our energy sector and infrastructure.

To be fair, none of these actions are a silver bullet for the country’s challenges. Nor will the changes be made in the short term, but rather through critical consensus building in the medium-to-long term that threads together the political imperative with social acceptability and corporate incentives. Nevertheless, we believe the pursuit and implementation of such initiatives could be GDP-additive over the longer term. In due course, to the extent that uncertainty remains, or the tariff war escalates further, we suspect the Canadian government, regardless of election outcomes, will continue to deliver a meaningful fiscal response to soften the economic blow from the fallout.

Keep calm, it’s Canada EH!

The unpredictable whims of the Trump administration are understandably worrying for Canadians, particularly as it pertains to the economic outlook. It is worth reminding ourselves that this is not the first time we, collectively as Canadians, have faced uncertainty. Whether that be the 2008 financial crisis or the COVID-19 pandemic, Canada has prevailed. Canadian politicians on both sides of the aisle seem focused on implementing policies that could fully exploit the economic potential of our country. Should this translate into sustainable action, this could suggest improved economic prosperity here at home over the long term.

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