Josh Nye, Senior Economist at RBC GAM, breaks down the sectors being impacted and those staying insulated
In the two trading days since trade negotiations between the United States and Canada broke down, the TSX 60 gained roughly one per cent. This comes after 50 per cent tariffs were applied to key Canadian exports like dairy, alcohol, wood, and paper products. It’s a breakdown in Canada’s most important trading relationship that, according to Josh Nye, Senior Economist at RBC Global Asset Management (GAM), could result in a drag on GDP between 0.2 and 0.3 per cent. Despite a significant setback to Canadian growth, potential devastation for several industries, and a pall of uncertainty that will hang over other Canadian businesses, the Canadian equity market is solid, the Bank of Canada looks likely to remain on hold, and bond markets are largely stable.
Nye is quick to make the point that has been made throughout the recent tariff struggles between Canada and the United States that the Canadian economy and the Canadian equity market are two distinct entities, and that the health of the former is not indicative of performance in the latter. He laid out why there has been relatively muted reaction on fixed income markets as well while highlighting the important messaging and decision points for advisors to keep in mind as they try to guide clients through a period of uncertainty.
“TSX actually outperformed most markets [on Monday], and so it does, seem to be still fairly well insulated from this trade war. Even just some of the recent developments, such as gold prices moving up. It had also looked like things were improving in the Middle East in July, and that’s gone into reverse as well,” Nye says. “There are always a lot of factors at play here. Trade policy uncertainty is one, but there are some that perhaps show up more directly in the equity market here.”
How global uncertainty supports Canadian equities
The export sectors of the Canadian economy currently feeling the brunt of US tariffs are underrepresented on the Canadian stock market. At the same time, traditional sources of stability, such as Canadian banks and gold miners are overrepresented. Those companies actually seem to benefit from some of the wider forces driving global macro uncertainty now, including the Trump administration’s trade policy, Nye explains. US foreign policy in the Middle East has also been supportive for Canadian energy names given the increase to global oil prices.
There is still an uncertainty overhang in the Canadian economy, one that has simmered since the first signs of trade tension emerged at the start of this Trump administration. Nye notes that earlier in the year we saw signs that Canadian businesses were beginning to digest that uncertainty in survey data. However, the fact that some of these tariffs now impact goods that had once been protected by CUSMA could reintroduce that uncertainty for Canadian business owners. Still, Nye’s overriding message that the economic damage from these tariffs should be narrowly based and that the sectors most likely to be harmed by the tariffs are not major components of the TSX.
Bond markets and debt levels in a trade war
While the current tariffs are likely to set back Canadian GDP growth and introduce additional inflationary pressure through reciprocal tariffs, Nye says it’s unlikely that the Bank of Canada cuts rates in response. He notes that the timeframes for monetary policy simply don’t match with trade policy, which could see the current dispute resolved at any moment. Moreover, with tariffs presenting both downside risk to growth and upside risk to inflation, the Bank of Canada may feel its hands are tied.
The Federal government has also announced a range of fiscal supports for affected industries, which does add to the wider market narrative around developed nations’ bonds and high levels of debt relative to GDP. Rather than focusing on domestic fiscal policy, however, Nye says that global bond investors are likely to tie Canadian bonds on the long end of the curve to the wider trends in developed bond markets. That means if bond yields are rising in Japan or the United States, we may see Canadian 10-year bond yields rise as well.
Setting client expectations
The relative stability and strength of Canadian assets should be a source of positivity for advisors and their clients, even as the news looks bleak and the economic outlook appears to be weakening. Nye believes that overreacting is probably the biggest mistake advisors and investors could make at this juncture. He repeats the mantra that the Canadian economy is not the Canadian stock market, and that even the impacts on the Canadian economy should be relatively narrowly based as things currently stand.
Nye also emphasizes that these tariffs and this trade stance by the United States appears more reflective of the Trump administration, and a few individuals within it, rather than indicative of a wider political consensus in the United States. He expects that any future administration, from either major party, would probably be more friendly with Canada over trade. In the near-term, however, Canadians may do well to brace for more economic volatility in his view.
“I think this does argue for a somewhat conservative stance in in in your portfolios, and perhaps not making big bets just given you know the potential for policy volatility and volatility around other themes,” Nye says.
