Five things we learned this week about U.S.-Canada trade

North America has seen a “reprieve” this week in what could have been one of the largest trade shocks in 100 years—25% tariffs imposed on Mexico and Canada by the Unites States that have been delayed by 30 days.

Still, uncertainty persists and hangs over the Canadian economy like an ominous cloud, likely weighing on business activity and consumer confidence. And, even as the list of unknowns remains long, the past week has taught us a few things about what a trade shock could look like for the Canadian economy.

Here are five things we learned this week that are critical for the trade discussion.

1. Trade angst isn’t likely to go away anytime soon

While we won’t speculate on the odds of whether 25% tariffs come back into play after the 30-day pause, there are a range of other trade policies that will keep conversations about American trade with Canada and its global trading partners alive.

For one, the America First Trade Policy is set to deliver recommendations by April 1st, and it involves an investigation into whether foreign countries are subjecting U.S. citizens and companies to “discriminatory or extraterritorial taxes.” Second, Mexico, Canada and the U.S. will be preparing for the July 2026 review of the USMCA trade agreement. Moreover, while Canada and Mexico averted tariffs, the U.S. imposed an additional 10% tariff on China, which prompted retaliatory measures from China. While we see these being more impactful to China than the U.S., this is another clear indication of the momentum of global protectionist policies.

Meanwhile, President Donald Trump has indicated he is thinking about tariffs on the European Union. Combined, this agenda tells us that trade uncertainty is likely to be a persistent multi-year economic force that may not only require short term forecasts to be adjusted, but also long term perspectives about global economic orders.

2. The Bank of Canada would likely cut interest rates further

Markets have suggested (and we agree) that the BoC would likely cut in response to an aggressive tariff policy.

As we noted in A playbook for how to measure a tariff shock in Canada, a central bank’s response to a trade shock is an important factor in assessing the ultimate hit to growth from tariffs. There were questions in the lead up to how the BoC might respond, even as recently as their Jan. 29th meeting when they explained their reaction would depend on whether the hit to growth or the rise in inflation would dominate. And yet, in the trading day following the news of tariffs, yields at the front-end of the Canadian bond curve swiftly priced in almost an additional rate cut from the BoC, and the Canadian dollar sharply weakened. While we typically wouldn’t take much from one day of market activity, those moves give us a taste of what enacted trade disruptions could mean for markets. It also tells us that markets expect (and we agree) that the economic growth risks from higher tariffs would offset any potential mechanical impacts on inflation from Canada’s retaliatory measures.

Sustained (lasting more than weeks) tariff hikes will likely push the BoC to cut rates more aggressively than we currently expect. Although, as we’ve discussed, the expected duration of tariffs and the extent of fiscal responses from provincial and federal governments would determine the ultimate size and speed of further cutting.

3. Canada’s retaliatory strategy would impact growth and inflation

One giant question mark in our ability to assess the impact of a trade conflict has been around what Canada’s retaliatory strategy might look like. We did get clues, at least, as to what the current government’s approach might be.

The federal government had previously hinted at a partial response of tariffs on about $155 billion of Canadian merchandise imports from the U.S.—worth 20% of U.S. goods imports. Details about the initial $30 billion of planned U.S. imports to target with tariffs were released over the weekend (with another $125 billion of yet to be specified products to be targeted in three weeks).

In our view, those retaliatory measures would raise prices for Canadian purchasers. More than a third of the initial $30 billion retaliatory products are food by our count. But the partial response means Canadian importers and households would have more options to avoid tariffs by sourcing from alternative regions or substituting with cheaper non-tariffed products.

For roughly a quarter of products targeted in the initial package, the U.S. accounts for 30% or less of total Canadian imports, implying other import sources could readily be available. And, there are other avenues for households to substitute for alternative products. For example, oranges would be hit with significant tariffs in that original wave, but apples and pears would not.

4. Sectors and provinces would be hit differently by proposed tariffs

A different tariff treatment creates a different shock for manufacturing versus energy, and their corresponding provincial exposures. Our prior work on Canadian trade has highlighted two areas of particular vulnerability in a U.S.-Canada trade conflict—manufacturing and energy.

We know manufacturing is roughly 9% of gross domestic product and tight integration leaves it exposed to the compounding effect of tariffs on parts and components crossing the border several times through the production process, and any breakdown of supply chain links arising from a loss of competitiveness. New Brunswick, Prince Edward Island and Ontario would be harder hit by U.S. tariffs, because their manufacturers are overweight U.S. exports—accounting for 71% to 78% of sectoral GDP. Quebec’s economy would also face significant challenges.

Yet, a more favorable treatment of Canadian energy exports, tariffed at 10% instead of 25%, was information that helps us frame a slightly better outlook for energy and thus, energy-related products than manufacturing as a base case. Canada’s mining and oil and gas sector also strongly depends on the U.S. market—U.S. exports represent 64% of sectoral GDP. But a lower 10% rate, and the fact that U.S. Midwest refineries may not have immediate substitutes for Canadian heavy crude oil gives a relative (not absolute) reprieve that would relieve some pressure on energy-producing provinces—mainly Alberta, Saskatchewan and Newfoundland and Labrador.

Meanwhile, broad-based tariffs would have a lesser impact in British Columbia and Nova Scotia, which have greater export market diversification.

5. Fiscal strategies suggest both outlays and reforms could be in play

Federal and provincial governments appeared more focused this past week on retaliation, but we gathered some idea of the potential fiscal direction that could be taken should trade conflicts begin to reheat.

First, the government did not announce an immediate fiscal support package as it did with 2018’s U.S. steel and aluminum tariff, but highlighted it was monitoring developments and utilizing existing government programs. That’s a possible hint governments would need to see tariffs in place for a sufficient amount of time to create a need for support. In our estimates, large tariffs would likely need to be in effect from somewhere between three to six months, depending on the policy, to accelerate the risk of recession. And yet, it appears several governments stand ready to provide support. Ontario Premier Doug Ford said his government would provide income replacement plans like the federal government did during COVID-19, along with subsidizing targeted companies and providing general economic support. However, as we highlighted before, governments will have to think hard about the correct size, scope and targets of policy—a tariff shock is a different economic animal than a pandemic.

Second, we have witnessed a lot more discussions around investment in Canada’s economy that would improve its resilience, productivity and self-sufficiency ranging from a commitment to critical minerals to tax reform. While we try not to speculate on the path of policies, the emphasis on items we have long felt would be productivity-enhancing is helping to provide us with a sense of optimism about Canada’s medium and longer-run prospects. Still, it remains to be seen whether politics become policy. We also think the renewed urgency and desire to tackle productivity-damaging internal trade barriers in Canada is a critical discussion that would support growth and lower inflation—with or without a trade conflict with the U.S.

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