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You can’t miss it…the metaphorical elephant in the room. That outsized awkward issue that we pretend not to see. The elephant in this case – speaking metaphorically of course – is an orange-colored version of Darth Vader intent on crushing a much smaller and presumably weaker adversary.
Too strong? Perhaps, but Canadians cannot ignore what could be an existential threat to our domestic economy. President Trump’s imposition of 25% tariffs on Canadian exports coming into the U.S. represents a direct assault on 30% of Canada’s GDP.
Certainly, America’s approach to “getting the point across” involves bold statements and fireworks, while Canadians prefer decorum and apologizing for the interruption even when we are not interrupting.
The issue is whether the tariff threat is a negotiating tactic to gain leverage leading up to a renegotiation of the USMCA or an existential threat from an incoming administration hell bent on annexing a neighbor by demolishing its economy. What we do know is that surviving this eclectic range of outcomes will require more than saying “I’m sorry!”
The first step is to understand one’s adversary. We need to recognize that the MAGA movement is a protectionist philosophy backstopped by a transaction-based administration. The trick is to ferret out the end goal, which, make no mistake, is not border security.
If what Trump “really-really” wants (with apologies to the Spice Girls) is to deliver aggressive tax cuts without expanding the budget deficit, then Trump has his Don Quixote moment, serving the nation by coercing foreign countries to pay the tab instead of the American taxpayer. None of that is true, of course, but in Trump World, fantasy is reality.
In the real world, that scenario leads to a tit-for-tat trade war. Canada will put in place countervailing tariffs on U.S. imports and may tax and/or limit exports of minerals like nickel, cobalt, copper, lithium, and rare earth elements. These are raw materials where Canada has abundant supply, that are critically important to the US and are no longer available from China.
The best way to resist a worst-case scenario is to negotiate from a position of strength, which means that whoever wins the next federal election must lower Canadian tax rates or suffer a brain drain to the U.S. Without a competitive tax system, we are playing into the hands of the U.S. administration.
At the same time, the Bank of Canada (BoC) must continue to lower interest rates to bolster industries that do not rely on exports. Lower rates will have a negative impact on the loonie, which could decline to US$0.60 by the end of 2025. And we must acknowledge that applying countervailing tariffs could push up the Canadian inflation rate as imports would be more expensive.
However, there are silver linings. A slowing domestic economy will reduce inflation pressures, which have been on a better path than in other parts of the world. If you take out rising mortgage interest costs (a direct result of earlier interest rate increases), the Canadian consumer price index (CPI) was at or below the BoC’s 2% inflation target for all of 2024. Notably, CPI ex-mortgage interest has been trending around 1.4%, which is why the BoC has been able to ease monetary policy more quickly than other G-7 members. We have already seen the overnight lending rate cut by 175 basis points since June 2024.
Inflation pressures weaken
The inflationary impact from countervailing tariffs should be muted because most of what Canadians consume is not imported. Imported consumer goods (excluding autos) represent less than 10% of total household spending, and disinflationary pressures from a broadly softer Canadian economy may be greater than the inflationary impact that would result from a weaker currency.
Then there are the psychological factors that come into play during a trade war. We suspect that Canadian consumers will shun American products and seek out Canadian-made alternatives. Snowbirds will begin re-thinking their trips to the sunny south, especially if the loonie declines as expected. These conditions will weigh on U.S. revenues.
I am also mindful of the differences in the trajectory of the North American economies. A slowing Canadian economy will allow the BoC to continue cutting interest rates more aggressively than the U.S. Federal Reserve (Fed), reflecting the underperformance (dating back to the 1960s) in per-capita GDP growth over the last five years, and a more significant softening within the Canadian labour market.
According to Royal Bank, “the situation in the United States is very different with a resilient economy driven in large part by an unusually large government budget deficit for this point in the economic cycle, reduced interest rate sensitivity, and strong productivity support that is keeping economic growth positive but also inflation higher.”
In absolute terms, these factors are meaningful, particularly when compared with the Canadian experience where interest rate sensitivity is a considerable issue. Just think about the potential impact from the tsunami of mortgage renewals that will occur in 2025.
Canadian immigration has also been a tailwind as population growth is up 10% since 2019. That open-immigration policy prevented outright declines in Canadian GDP, but on a per-capita basis, output has been falling like it historically would during a recession.
Moreover, the support from population growth is about to make a sharp U-turn. The federal government’s plans to limit new arrivals is expected to wipe out all previously expected population growth for the foreseeable future. Unless, of course, we see a wave of migrants from the U.S. crossing the border to escape deportation. While the final impact on population is yet to be known, the direction should be lower, turning demographics from a tailwind to a headwind.
The offset to dwindling population growth would be a bump up in productivity. Hopefully, GDP growth on a per-capita basis will turn the corner by mid-2025. Lower interest rates take time to work their way through the system. Household debt levels are expected to rise in the year ahead as ultra-low fixed-rate mortgages during the pandemic begin renewing at higher rates. Hopefully, that mortgage renewal wave will be manageable if the labour market remains resilient.
The Canadian labour market slowdown is likely not over yet. I expect the unemployment rate to peak at a level slightly below 7%, but it should begin to edge lower in the second half of 2025.
To that point, we are seeing some green shoots as Canada’s most recent employment data came in better than expected. The Canadian economy produced 91,000 new jobs for the month of December, and of that total, 56,000 were new full-time positions.
Regardless how Canada deals with the initial tariff squeeze, we should assume that Trump will use tariffs as a negotiating tool throughout his presidency. These threats must be factored into Canada’s growth prospects for the next four years.
The threat of a 25% across-the-board tariffs on products from Canada and Mexico would seem to be unrealistic as they would make the North American manufacturing ecosystem uncompetitive with offshore supply chains.
If the tariff threat is a negotiation strategy tied to the upcoming renegotiation of the USMCA, then I would expect Canada and the US to arrive at a reasonable compromise. If the threats are part of a larger objective – annexation of Canada, revenue enhancement to offset U.S. tax cuts, or to encourage onshoring – then all bets are off.
Regardless of the outcome, this will not be the last time U.S. tariffs will be used as negotiating levers. There is ample evidence that tariffs are in Trump’s arsenal, and we would expect the US government will periodically employ targeted measures on specific products and industries like the 2018 tariffs on Canadian steel and aluminum products. This approach was used to address external grievances in the first Trump administration and despite the questionable merits of this strategy, the risks exist and will likely weigh on already underperforming Canadian business investment.
The bigger issue for Canada’s domestic economy is our productivity gap. Canada’s per-person output significantly trails other G-7 economies and continues to be hampered by a shortfall in business investment.
Moving forward, the risk is that weak levels of business investment will persist. Lower interest rates will help reduce funding costs, but the threat of trade disruption adds to uncertainty about future projected returns.
Any investment strategy must be predicated on the view that Canadians are resilient, and Trump is not a war monger. We have a vibrant economy, and from a political perspective, we are not Greenland.
With that in mind, income investors should focus on dividend payouts from companies that export products that cannot be easily sourced elsewhere. Companies like Suncor Energy Inc. (TSX: SU, dividend yield 3.99%) and Canadian Natural Resources Ltd. (TSX: CNQ, dividend yield 4.47%) are stalwarts in the energy field. Pipeline companies like Enbridge Inc. (TSX: ENB, dividend yield 5.9%), Pembina Pipeline Corp. (TSX: PPL, dividend yield 5.05%), and TC Energy Corp. (TSX: TRP, dividend yield 5.55%) also come to mind.
The big six Canadian banks should also benefit from lower interest rates, which should immunize them from the tariff threat. For the more speculative enthusiast looking for monthly income, consider Premium Income Corp. (TSX: PIC.A, dividend yield 15.76%).
As always, consult with your advisor before investing to ensure the securities align with your risk tolerlance and financial objectives.
Richard Croft is Founder, Chief Investment Officer, and Portfolio Manager of R.N. Croft Financial Group Inc.
Disclaimers
Content © 2025 by R.N. Croft Financial Group Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
Commissions, trailing commissions, management fees and expenses all may be associated with fund investments. Please read the simplified prospectus before investing. Investment funds are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently, and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
R N Croft Financial Group Inc. is a Licensed Discretionary Portfolio Management and Investment Fund Management company serving investors and investment professionals across Canada since 1993.
Image: iStock.com/Kalawin
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