A recent Bank of Canada Market Participants Survey has flagged geopolitical and trade tensions as the biggest risks facing the Canadian economy. Leading the downside are geopolitical risks led by the Middle East war, with 82% of respondents identifying it as the biggest risk, while 79% and 57% of respondents picked growing trade tensions and tightening global financial conditions, respectively. The shift from trade tensions dominating headline risks to Canada’s economy amid Trump tariffs is largely attributed to the Iran war, which has disrupted global supply chains and impacted the shipping of oil, gas, and fertilizer through the Strait of Hormuz.
Governor Tiff Macklem has warned that persistent high energy prices resulting from these conflicts could necessitate interest rate hikes to maintain the 2% inflation target. However, like many oil producers, Canada is also experiencing an “oil paradox” with high oil prices driving up domestic fuel costs and inflation while simultaneously generating significant government revenue windfalls.
Canada posted its first trade surplus in six months, with the country’s merchandise trade balance swinging to a $1.78 billion surplus in March against expectations of a shortfall of $2.88 billion, while total exports rose 8.5% to $72.8 billion, the second-highest level on record. Energy exports surged 15.6% to $17.1 billion, the highest level since September 2022, helped by a 18.9 % jump in crude oil exports thanks to a 33.1% spike in prices. Exports of metal products increased 24.0% to a record $15.3 billion, led by a $3 billion rise in gold exports thanks to a surge in safe-haven demand. Meanwhile, total imports fell 1.6% to $71.0 billion, driven by lower volumes of consumer goods, pharmaceuticals, and aircraft.
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That said, trade tensions between Canada and the United States remain a major headwind, with 82% of respondents saying easing of the tensions is the leading upside risk to Canada’s economy. That’s significantly higher than 57% of respondents who identified a larger-than-expected fiscal stimulus as the top upside or 43% who listed decreasing geopolitical risks and higher commodity prices.
Currently, there’s plenty of uncertainty surrounding the review of CUSMA (USMCA). CUSMA is a trade agreement between Canada, the United States and Mexico that came into effect on July 1, 2020 during Trump’s first term, replacing the 26-year-old NAFTA. The agreement requires, among other things, that 75% of automobile components to be manufactured in North America to qualify for zero tariffs, aiming to boost regional production. The Trump administration is required to outline its new position by July 1; however, negotiations are likely to drag into the fall, influenced by U.S. midterm election politics. While a 16-year extension is the base case, there is a risk of a severely fragmented scenario where the U.S. imposes up to 35% tariffs on all Canadian exports, potentially inducing a Canadian recession. Further, there are reports that the White House is considering splitting the agreement into separate bilateral deals rather than maintaining it as a single trilateral agreement.
