Trump, tariffs and the 51st state – Impacts and risks for Canadians

On U.S. President Donald Trump's first day in office, he threatened to impose 25% tariffs on goods from Canada and Mexico by Feb. 1. 

The re-emergence of tariffs as a cornerstone of U.S. trade policy underlines the significance of global economic interdependence. For Canadians, the implications of U.S. tariffs are particularly pronounced, given the depth of our economic ties. According to Government of Canada, in 2023, the U.S. accounted for 72.3% of Canada's total trade and 77.2% of Canadian goods exports. (1) This extraordinary level of integration makes any shifts in U.S. trade policy an immediate concern for Canadian businesses, consumers and investors.

Tariff mechanisms and Canadian exposure

Tariffs are essentially taxes that a country imposes on imported goods, implemented either as a fixed dollar amount or a percentage of the good’s value. While aimed at protecting domestic industries or reducing trade deficits, tariffs can often lead to complex, unintended economic consequences. For Canada, the stakes are high given our reliance on the U.S. market as an export destination for everything from crude oil to automotive parts.

The potential scenarios for U.S. tariffs vary in intensity – from a universal 10% import tariff to targeted measures like a 25% tariff exclusively on Canadian goods. Each scenario would create different economic ripple effects:

1.    Universal tariff: A 10% tariff applied globally would raise costs for U.S. importers, potentially reducing demand for Canadian goods. However, given the Canadian dollar’s recent depreciation against the U.S. dollar, the competitive disadvantage might be partially offset.

2.    Targeted Canadian tariff: A 25% tariff on Canadian goods alone would pose a far more severe challenge. The inability to redirect such a significant portion of exports could reduce Canada’s gross domestic product (GDP) by as much as 3%, pushing Canada into recession.

Economic impact on Canada

Tariffs disrupt supply chains, erode competitiveness and inflate costs. For Canada, the sectors most exposed to U.S. tariffs include:



• Energy: The U.S. is heavily reliant on Canadian crude oil, which constitutes one-third of Canadian exports to the U.S. Tariffs could initially create price volatility. However, the highly integrated nature of North American energy markets limits substitution options. Also, with breakeven oil prices for new wells in key oil-producing regions in the U.S. being between $60 to $70 per barrel (pb), oil prices wouldn’t have to fall that far from current levels (approximately $75pb for West Texas Intermediate oil) before it would become uneconomic to develop some of these higher-cost new wells. And it would be a big blow to Trump’s obvious aspirations to exploit Alaska’s even higher-cost oil resources.

• Automotive: Canada’s automotive exports depend on seamless cross-border supply chains. Tariffs would increase production costs and reduce demand, harming the sector’s competitiveness in both countries.

• Agriculture: Retaliatory tariffs could dampen demand for Canadian agricultural exports, especially in commodities like dairy, where existing trade tensions are well-documented.

Broader impacts on consumers and businesses

The inflationary effects of tariffs extend beyond exporters. Canadian businesses importing U.S. goods would face higher costs due to Canadian tariffs on U.S. goods and the depreciation of the Canadian dollar, potentially passing these costs on to consumers. This could further strain household budgets already stretched by inflation. Businesses reliant on U.S. inputs may need to reassess supply chain strategies, potentially accelerating the trend toward diversifying trade relationships.



Additionally, retaliatory measures by Canada could exacerbate these challenges. In a prior case during Trump’s first presidential term, Canada targeted politically sensitive U.S. industries in response to tariffs, such as Florida orange juice and Kentucky bourbon, creating economic headwinds on both sides of the border.

Likely scenario and implications

Based on current rhetoric and past policy actions, the most likely scenario would be the U.S. imposing a 10% universal tariff, including on Canadian goods. While this measure is less severe than a targeted 25% tariff, it’s not without consequences. We estimate that a 10% tariff would cause Canadian goods exports to the U.S. to stagnate, shaving 1% off our GDP due to reduced demand and secondary effects on investment and consumption.

Fortunately, several mitigating factors would likely prevent a recession under this scenario. The loonie’s 6% depreciation against the U.S. dollar has already improved competitiveness, partially offsetting the tariff’s impact. Additionally, U.S. demand for Canada’s largest export – energy products – is relatively inelastic, providing stability in this critical sector. However, we predict GDP growth would remain subdued, given limited scope for immediate substitution of Canadian goods by U.S. producers operating near full capacity.



A more extreme scenario – a 25% tariff targeting only Canada – would have far-reaching implications, likely reducing GDP by 3% and triggering a recession. Such a measure would lead to a sharper depreciation of the loonie, raising the cost of imports and significantly weighing on investment and consumption. While this outcome is less probable, it underscores the importance of continued vigilance and proactive policy measures.

Historical and political context

The "America first" trade policy has been a recurring theme in U.S. politics, with tariffs used as both a revenue tool and a means to negotiate foreign policy objectives. As it stands, the outcome means that Canada and the U.S. will not be trading friendship bracelets anytime soon. In the context of Canada, recent threats have tied tariff imposition to issues such as border security, immigration and defense spending. For instance, during prior tariff negotiations, Canada’s dairy sector and energy exports became focal points for U.S. demands.



The broader political landscape also matters. U.S. policies that increase economic nationalism often create ripple effects globally, compelling trade partners like Canada to adjust domestic policies and trade strategies. Moreover, the uncertainty around tariff permanence makes long-term planning for businesses and governments increasingly challenging.

Investment considerations

For investors, U.S. tariffs can introduce both risks and opportunities. The near-term volatility in equity markets could weigh on sectors heavily exposed to U.S. trade. However, tariffs can also create opportunities in less-exposed sectors or alternative asset classes:

• Commodities: Inflationary pressures from tariffs make commodities an attractive hedge.

• Diversified portfolios: A greater allocation to international equities or multi-asset strategies can mitigate regional trade risks.



• Currency: With the loonie likely to depreciate further under significant tariff scenarios, U.S. dollar exposure may protect returns on U.S.-denominated investments.

Outlook and long-term considerations

Navigating the economic uncertainty created by the threat of U.S. tariffs requires a thoughtful and balanced approach. While risks persist, we believe investors can find opportunities to protect and grow portfolios through diversification and strategic positioning. Key themes shaping our investment outlook include:

• Strength in U.S. equities: While we anticipate volatility, U.S. equities, particularly in artificial intelligence-driven and technology sectors, should continue to outperform in 2025. Elevated valuations in these sectors highlight the importance of selective exposure and active management.

• Global diversification: Non-U.S. equities and alternative investments present compelling value for investors willing to look beyond immediate headwinds. Regions like India, Taiwan and South Korea are well-positioned to benefit from shifting trade dynamics and technological advances.

• Fixed income opportunities: With interest rates expected to moderate, high-quality fixed income securities could offer stability and income in an uncertain environment.

We also see value in non-traditional strategies such as private assets and alternatives, which can mitigate tail risks and enhance portfolio resilience. However, these require careful selection and long-term commitment to realize their potential benefits.

 Conclusion

While U.S. tariffs represent a clear and present challenge for Canada and investors, they also highlight the resilience of diversified investment strategies. By focusing on long-term goals and adapting to evolving market conditions, investors can navigate uncertainty with confidence. Selling all your investments and moving entirely to cash might feel like a safe strategy during times of uncertainty, but it often comes at a significant cost. Cash provides security, but it also exposes investors to the risk of inflation, eroding purchasing power over time, especially in a low-interest-rate environment. Additionally, timing the market – knowing when to exit and when to reinvest – is notoriously difficult, even for seasoned investors. By sitting on the sidelines, investors risk missing out on market rebounds, which often generate the largest gains over short periods. A diversified, long-term investment approach is typically more effective in navigating volatility while capturing opportunities for growth.

The global economic landscape in 2025 is shaped by both risks and opportunities. Tariffs, while disruptive, underscore the importance of strategic planning and disciplined portfolio management. As we move forward, our priority remains guiding investors to make informed decisions that balance risk with reward, leveraging opportunities in equities, fixed income and alternative strategies. With a proactive approach, Canadian investors can weather tariff-induced volatility and position for a brighter future.

Sincerely,

Vice President, Asset Allocation & Chief Investment Officer

Canada Life Investment Management

Source:

[1] Government of Canada. (2024) State of Trade 2024: Supply chains. Retrieved from https://www.international.gc.ca/transparency-transparence/state-trade-commerce-international/2024.aspx?

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