{"id":27083,"date":"2025-02-06T13:43:20","date_gmt":"2025-02-06T18:43:20","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-ca\/?p=27083"},"modified":"2025-02-06T13:43:21","modified_gmt":"2025-02-06T18:43:21","slug":"a-u-s-canada-trade-shock-now-in-play-first-economic-takeaways","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-ca\/insights\/a-u-s-canada-trade-shock-now-in-play-first-economic-takeaways","title":{"rendered":"A U.S.-Canada trade shock now in play: First economic takeaways"},"content":{"rendered":"\n

By Frances Donald and Nathan Janzen<\/strong><\/p>\n\n\n\n

Canada has been hit with its largest trade shock in nearly 100 years. RBC Economics <\/a> now finds itself balancing the desire to produce a clear analysis with the recognition that the evolution of trade policies, and policymakers\u2019 responses to them, still remains highly uncertain. Still, we now have a growing list of \u201cknowns\u201d compared to a week ago, allowing us to analyze this shock with greater confidence. As the landscape continues to evolve, RBC Economics will provide updates to our outlook, helping to build a deeper understanding of this major economic event. We continue to lean heavily on the RBC Economics Playbook To Measure A Tariff Shock <\/a> as a model for assessing the outlook amid these uncertainties.<\/p>\n\n\n\n

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  1. This is the most significant trade shock since the Smoot-Hawley tariffs of the 1930s,<\/strong> which are widely blamed for exacerbating and prolonging the Great Depression. This shock far surpasses the 2018 tariffs in magnitude, diminishing the value of that period as a helpful guide for the economic impact ahead. For context, in 2018, the U.S. average import tariff rose from 1.5 percent to roughly three percent. Under the new policy, the U.S. average tariff rate rose to nearly 11 percent, the highest average ratio since the 1940s. More importantly, this policy signifies a fundamental shift in a trade order that has endured for nearly a century, challenging the core economic principle that frictionless trade is a superior model.<\/li>\n\n\n\n
  2. A persistent tariff of this magnitude is recessionary for Canada.<\/strong> If sustained, our initial analysis suggests that tariffs of this size (based on many assumptions) could wipe out Canadian growth for up to three years, with the largest impacts in the first and second years. Our estimates align to the Bank of Canada\u2019s findings <\/a> which simulate that a 25 percent increase in tariffs across the board (U.S. and global) would reduce Canadian GDP ranging from -3.4 to -4.2 percentage points, compared to the baseline forecast. Similarly, an earlier model <\/a> from the Bank of Canada estimated that GDP could drop by as much as six percentage points. By our calculations, such reductions could push Canadian unemployment rates up by between two to three percentage points. While the precise impact depend on a variety of assumptions\u2014including monetary and fiscal policy responses\u2014this is a significant negative shock to Canadian growth and poses a serious risks of unemployment rate increases.<\/li>\n\n\n\n
  3. Canadian retaliatory measures (25 percent on $155 billion, phased in) appear designed to asymmetrically challenge the U.S economy more than the Canadian economy.<\/strong> However, they will still function like tariffs do for any imposing country\u2014by lowering growth and raising inflation on targeted goods. In the days ahead, we will focus on identifying where Canadians are most likely to experience inflationary pressures from these measures.<\/li>\n\n\n\n
  4. Canada\u2019s manufacturing sector is most exposed, but the knock-on effects will also matter in many other indirectly exposed industries.<\/strong> As we\u2019ve covered before, <\/a> Canada\u2019s manufacturing sector\u2014which accounts for approximately nine percent of Canada\u2019s GDP and 70 percent of total trade with the U.S.\u2014is particularly vulnerable to tariff impacts. Canada\u2019s top 15 industries by trade with the United States, most of which are manufacturing based, represent nearly 3.1 percent of the country\u2019s total workforce. A key area of concern is Canada\u2019s motor vehicles sector, which is exceptionally integrated with the United States and Mexico. Parts can cross the border multiple times, meaning an end-product like a car may incur several rounds of tariffs. Notably, Canadian raw commodity exports are less likely to see a drop in U.S. demand as Americans lack substitutes for these goods. This likely encouraged a lower 10 percent tariff on energy products for Americans, as this particular imported good is one of the most likely to create a larger and more immediate inflationary burden for American producers and consumers. As outlined in our tariff playbook <\/a>, we are mindful that secondary industries in the services sector, for example, are also likely to feel knock-on effects. Consider an auto plant that experiences reduced demand and is forced to lay off workers. These workers, in turn, are less likely to then go to restaurants, movie theatres or engage in other \u201cdiscretionary\u201d spending. This ripple effect leaves a variety of non-tariffed industries exposed to the broader economic shock, and are also somewhat challenging to model as they can be exacerbated by confidence and sentiment channels.<\/li>\n\n\n\n
  5. Tariffs are hitting the Canadian economy at a moment during which it is already struggling.<\/strong> Canada is still recovering from a major interest rate shock, and even as the Bank of Canada has cut interest rates by 200 basis points, the unemployment rate continues to rise, with the country still operating with excess supply and below full capacity. GDP per capita has declined for eight of the past nine quarters, and business investment has been stagnant. Both cyclically and structurally, Canada\u2019s economy is not well positioned to absorb a shock of this scale.<\/li>\n\n\n\n
  6. Tariffs will also be damaging to the U.S. economy.<\/strong> While the U.S. economy is starting from a relative place of strength (and is far less reliant on trade), it will face a shock large enough to adjust most forecasts downward on growth and upward on inflation. Additional retaliatory policies from Canada and\/or Mexico will likely exacerbate these impacts. Like in Canada, certain American regions and sectors will be more exposed. The U.S. manufacturing sector, in particular, has already been underperforming. Industrial production is little changed from a year ago and the sector has on aggregate shrunk since 2017. Washington\u2019s tariffs are likely to hurt U.S. manufacturing competitiveness further and, worse, as we have argued before <\/a>, will not lead to significant re-shoring of manufacturing capacity. Moreover, comparisons to 2018 tariffs imposed upon China understate the economic impact for Americans. Canada and Mexico account for a combined 29 percent of U.S. imports as of 2023 (13.6 percent from Canada, 15.4 percent from Mexico)\u2014more than twice the share combined compared to China (13.8 percent). In 2023, Canada was the top import source for 23 U.S. states and second largest for 11. Canada was also the top export destination for 36 states, and the second most important for another eight.<\/li>\n<\/ol>\n\n\n\n

    What we are watching for next<\/h2>\n\n\n\n

    The scope of economic impacts for Canada (and the U.S.) remains significant and, even with robust economic models, requires a considerable number of assumptions. As we continue to adjust our outlook based on new developments, the following elements will be critical variables:<\/strong><\/p>\n\n\n\n

    Items that will worsen the impact<\/h3>\n\n\n\n