U.S. election debrief

A video of our morning-after election interpretation is still available on our website. What follows is a more detailed take in written form:

It was one of the most unusual election campaigns in history – one that included assassination attempts, a mid-stream change in the Democratic Party’s candidate and betting markets that gyrated between the two nominees. The election ultimately resolved with a victory for Republican nominee and former President Donald Trump.

While not a shock given where betting markets ultimately settled, it was nonetheless a resounding win:

• Trump captured all seven swing states.

• He claimed the popular vote (which Republican victors frequently fall short of).

• The outcome was clear within hours of the election’s end.

• The Republican party rode the President-elect’s coattails to a Congressional sweep.

Polling error

Reflecting back upon the polls that informed the election, pollsters underestimated Trump in a third consecutive presidential race. The fact that Republican voters are apparently more shy about revealing their voting intentions did not make this inevitable: pollsters adjust their findings for any anticipated biases. And yet these adjustments were again insufficient. Perhaps the polling companies were lulled into complacency by the fact that the Republican Party underperformed expectation during the midterm 2022 election.

Betting markets, on the other hand, generally got it right, pointing to a material Trump advantage in the weeks leading up to the election. Fascinatingly, it appears that the big bets placed in the Polymarket exchange were made in significant part by someone who noticed (and then commissioned a private poll to confirm) that the fraction of people saying their neighbours were voting for Trump was significantly higher than those saying that they themselves were voting for Trump. It would tentatively appear that people are more willing to “out” their neighbours than themselves. This type of indirect questioning will be important to track in future election cycles.

Key voter concerns

With the benefit of 20-20 hindsight and admittedly viewed through a macroeconomic lens, it appears that voters were expressing dissatisfaction with the economy, inflation, immigration and crime.

The economy is actually doing just fine as per a low unemployment rate and steady growth, but perceptions are otherwise: around 60% of Americans believe the economy is currently in a recession.

Inflation has made significant progress back toward target, but voters are steamed that price levels are still so much higher than four years ago.

Illegal immigration surged in recent years, and even though it has since slowed by a factor of four over the past year, it remains elevated and concerns persist.

Finally, worries about crime are still high, even as the crime rate has begun to descend over the past few years.

What isn’t assumed

The Trump campaign made a quite a number of promises. Due to a combination of legal, political and practical constraints, we don’t expect all of them to be implemented.

Undocumented residents

The deportation of 20 million undocumented U.S. residents is unlikely. This is in part because the true number of such individuals is likely closer to 11 to 15 million, but mainly because it would be quite damaging economically and logistically very challenging.

Trump governs in significant part on how the economy is doing and whether the stock market is rising. On both fronts the removal of around 4% of the population would be problematic for economic growth, for wages, for housing demand, for the agricultural and construction sectors, and beyond.

Logistically, it is reasonable to budget for a significant number of deportations, but not on the order of many millions per year. The U.S. already deports around 400,000 people per year. One might expect this to rise to 750,000 or one million per year.

Consistent with this view, Trump’s proposed border czar recently noted that those deemed to be national security or public safety threats will be a priority. This is consistent with a narrower mandate.

Logistically, it is reasonable to budget for a significant number of deportations, but not on the order of many millions per year.

From an inflow perspective, it is likely that the number of new illegal immigrants will be sharply curtailed. However, as already mentioned, the number of southern border encounters has already declined by an approximate factor of four since late 2023, and the new level is only moderately higher than the pre-pandemic trend. The reduction in illegal immigration that has already taken place may also reduce focus on the topic, resulting in less extreme policy action.

Tariff policy

Tariffs appear set to go higher under Trump, but we don’t expect the threatened blanket tariffs of 10% on the world and 60% on China. This is in part because the economic and inflation damage from this would be unacceptable to Trump and his many C-suite advisors, and in part because these tariff threats are realistically just the opening bid in a transactional exchange with other countries. If the other countries comply with U.S. demands – to open up their own markets, increase their military spending, better control their borders, and so on – then the actual tariffs implemented should be significantly smaller and more narrowly targeted. One might imagine the average tariff rate on China rising from 19% to around 30%, but not to 60% (let alone 79% if the maximum tariff were added to the existing rate).

U.S.-China tariff rates rose under first Trump administration

As of 04/01/2023. Sources: Peterson Institute for International Economics (PIIE), RBC GAM

Public servants

We similarly don’t expect the civil service or Federal Reserve to be as sharply constricted as some campaign proposals have suggested. Recall that Trump also entered his first term with promises to “drain the swamp,” and yet federal employment rose during his first term.

The plan to expand the number of government roles deemed to be “political” positions within the civil service from around 4,000 to 50,000 would be consequential but may be difficult to achieve from a logistical standpoint. Even the full number would represent just 1.7% of the nearly 3 million total federal employees.

Concerns about the U.S. Federal Reserve’s ability to remain independent are valid but probably overblown. For one, pressure on the Fed should organically diminish now that it is in rate-cutting mode and as the fed funds rate goes down. Recall that Fed Chair Powell is a Republican and was actually appointed by Trump during his first term. While Powell’s term as Chair expires in May 2026, the Senate has to approve whoever Trump appoints, presumably moderating the type of appointee.

The plan to expand the number of government roles deemed to be “political” positions within the civil service from around 4,000 to 50,000 would be consequential but may be difficult to achieve from a logistical standpoint.

Further, Fed decisions are conducted via a simple vote, with the Chair receiving the same single vote out of 12 as everyone else. Only one other governor’s term expires in the next four years, meaning Trump can dictate two of the seven Fed governors. A further five votes come from a rotating subset of the 12 District Fed offices, and these regional presidents are appointed by local panels of business leaders and citizens rather than the president. In short, Trump could conceivably control two-twelfths of the voters, but not a whole lot more.

Reasons for moderation

Yes, Trump potentially wields a great deal of power in the coming term given the Republican sweep of Congress. But that was also the political orientation at the beginning of his first term (from 2017—2018).

There are new questions to be sure. There is the potential for more forceful action from Trump this time given a stronger mandate from voters and a more seasoned and ideologically aligned supporting team. There is also a greater risk that the economy overheats given a marginally lower unemployment rate today (4.1% versus 4.8% at the beginning of his first term), and less fiscal wiggle room given a larger fiscal deficit and higher public debt. But it is not an entirely unfamiliar setup.

Reasons to expect a more moderate Trump – at least relative to the most extreme proposals on the campaign trail – include:

• His Congressional majority is slight in both the Senate and the House. This means just a few reluctant politicians can interfere with his ability to do big things. The moderate wing of the Republican Party is – by definition – more moderate in its views than Trump on several of the aforementioned issues.

•  Trump uses the stock market in particular as a yardstick for his presidency. Any action that is viewed as significantly undermining the U.S. economy or the government’s ability to smoothly function would receive a negative interpretation from markets.

•  Unlike in his first term, Trump has been supported and surrounded by a significant number of prominent corporate executives who will counsel against damaging public policy and must believe that Trump will be good for the economy.

•  Presidents usually temper their campaign promises somewhat when they implement them.

More generally, recall that in Trump’s first presidency from 2017—2020, the economy grew and the stock market rose.

Economic implications

The election obviously resolves a considerable amount of uncertainty. It is no longer a debate between Democrat and Republican policies, but instead about what degree of Republican policies will be implemented. Accordingly, expected financial market volatility has declined substantially (see next chart).

Volatility falls after Republicans secure a trifecta

As of November 15, 2024. January 2007 = 100. Shaded area represents recession. Sources: Bloomberg, RBC GAM

From a purely economic standpoint, we have Trump as the slightly more growth-positive of the two candidates in the short run. Since his election, we have further upgraded the positive impulse for growth from his economic policies because the unexpected sweep of Congress increases the scope for action. As a result, we settle on a moderately positive economic impulse from Trump in the short term (see next table).

Trump policy expectations

Estimated impacts using updated assumption of Republican sweep as at 11/06/2024. +/- indicate positive/negative impact on variable at top of column. Source: RBC GAM

To be sure, there are competing forces. Higher tariffs and constricted immigration both subtract materially from economic growth. One might expect U.S. population growth to be approximately flat given the coming policies relative to a steady-state trend of about 0.5% growth. A slight reduction in government spending likewise acts to slow the economy.

However, the combination of fewer regulations, looser oil policy, lower taxes (and, arguably even more importantly, taxes that don’t revert back to earlier, higher levels in late 2025) plus rejuvenated animal spirits all argue for more short-term growth.

On the net, we have the positive forces moderately outweighing the negatives, resulting in an extra third of a percentage point of economic growth in 2025, and potentially something similar in 2026. The effect might have been larger, but there is less scope for rate cutting due to the extra growth and inflation, which tempers the outlook.

Note that more growth isn’t necessarily “’good”, or less growth “bad.” A part of the extra growth under Trump is set to come from a presumed larger fiscal deficit, which then needs to be paid for later.

Rest-of-world growth

Conversely, the rest of the world is set to experience slightly slower growth than otherwise in 2025 and potentially in 2026. Higher tariffs will hurt. U.S. tax cuts will render other countries relatively less competitive. We could also see an increase in geopolitical uncertainty, with some countries forced to reallocate government spending toward their militaries.

To illustrate the approximate effects, we budget for 0.35ppt less growth in Mexico than otherwise for 2025, 0.15ppt less growth in Canada and 0.1ppt less growth in the U.K., Eurozone and Japan.

It is tempting to think that China may be hit quite hard by U.S. tariffs. Indeed, it is likely to be the main target, but a few things should temper the damage.

1. A key factor is that only 2% of Chinese output is exported directly to the U.S. (see next chart). If that sounds low, recall that large countries are always highly domestically oriented. China also trades massively with the rest of Asia, South America, Africa, Australasia and Europe. It would be fair to concede that this figure fails to capture China’s indirect exports to the U.S. through such countries as Mexico and Vietnam, but the point is that China is less beholden to U.S. demand that commonly imagined.

Exports to U.S. are significant for some countries

Sources: International Monetary Fund (IMF), Macrobond, RBC GAM

1. It is increasingly suspected that China is holding back in its delivery of fiscal stimulus until the U.S. hits it with tariffs or other measures. At that point additional government support is likely. This will further shield Chinese growth.

As such, we have downgraded our Chinese outlook for 2025 by 0.2 percentage points rather than by multiple percentage points despite the real threat from a Trump administration. The specific contours of the outlook will admittedly remain blurry until greater tariff clarity is achieved.

Inflation implications

The Trump win should be moderately inflationary. Higher tariffs constitute a tax that partially lands on consumers, increasing prices. The prospect of faster economic growth than otherwise is also incrementally inflationary. Conversely, looser oil policy is theoretically deflationary, with the price of oil potentially $3—4 per barrel cheaper than otherwise as U.S. drillers ramp up.

On the net, we budget for a bit more inflation and have upgraded our U.S. inflation outlook for 2025 by around a third of a percentage point as well. The effect would have been larger, but the Fed is now in a position to cut by slightly less, which provides a partial offset. Still, this leaves inflation a bit above 2.5% rather than a bit below. While the difference is not large, it would be easier to argue that inflation has essentially normalized if it were in the low 2s. Above 2.5%, there is a bit more work to be done.

Market implications

The “Trump trade” has played out exactly as envisioned, with the stock market higher, bond yields up and the dollar elevated. Based on historical precedent, there could be further room for these trends to run.

Equities

Trump is viewed as stock-market positive in part due to the business leaders who have aligned around him, in part due to his own business background, and in part because businesses did well during his first term. His proposed policy mix is also stock-market positive, which is to say heavy on deregulation and tax cuts.

Within the business realm, small- and mid-cap companies seem especially well positioned as many are less exposed to tariffs than their larger brethren and feel the burden of regulations more heavily.

From a sector standpoint, we anticipate three prime beneficiaries:

• U.S. financial firms are especially keen given the possibility of easing their heavy regulatory burden, the potential for renewed mergers and acquisitions, and the likelihood that the last leg of Basel III banking regulations will no longer be implemented. Global banks also benefit from this.

• The U.S. energy sector stands to benefit from deregulation as well, even if it means slightly lower oil prices than otherwise.

• U.S. industrials should also benefit as competition with the rest of the world eases due to additional tariffs.

Obvious losers include green industries that can no longer count with complete certitude on Biden-era incentives, and perhaps large tech firms (though the Biden administration was not especially friendly to them, either). Should deportations prove more significant than we imagine, industries that are heavily reliant on undocumented workers such as agriculture, construction and food services would suffer.

Bond yields

Bond yields should be higher under Trump due to greater tariffs (which increase inflation), faster economic growth and the likelihood of incrementally more public debt from additional fiscal stimulus.

More speculatively, one might also argue there could be an additional small risk premium on U.S. Treasuries. This would reflect concerns that the quality and stability of the U.S. government might be diminished by increased politicization of the civil service and/or executive branch overreach. This is probably best thought of as a risk rather than a base-case assumption.

The bottom line is that it makes sense that yields are a bit higher. Reflecting some of the underlying forces, the Fed may also be in a position to cut rates by slightly less than otherwise, with the upcoming December rate decision increasingly up in the air. We still favour a 25 basis point rate cut, but the combination of slightly disappointing October inflation, healthy growth and the imminent arrival of Trump policies present the possibility of a pause. Fed Chair Powell has been notably non-committal recently.

Geopolitics

Presidents have a fair amount of leeway over foreign policy. Let us examine the three hottest topics in the context of a Trump presidency.

Ukraine—Russia war

The war in Ukraine is becoming more dangerous. On the Russian side, Russia has been advancing, reclaiming a significant fraction of the territory it lost to Ukraine and also making significant gains in eastern Ukraine. Drone attacks on Ukraine are rising in intensity. The war has broadened as 8,000 North Korean troops now fight alongside Russian ones, and North Korean munitions are now being deployed. Reports that Russia planned to detonate incendiary devices on North American civilian aircraft threatens to greatly broaden the war.

On the Ukrainian side, the U.S. recently gave the country permission to use longer-range American missiles into Russian territory. The risks grow.

A Trump presidency has an uncertain effect on the war. Trump’s primary goal is to achieve a cease-fire between the two countries. An end to the war would be welcome, but it would presumably cede a large part of Ukrainian territory to Russia. It is far from certain that both countries would accept, or that Russia would not be tempted to take another bite once it had consolidated earlier gains. In the meantime, both countries are incented to scramble for favourable positioning before such negotiations begin.

Absent that, the U.S. is set to provide less support to Ukraine, leaving Ukraine to lose further ground unless Europe and other allies manage to fill the void.

A Trump presidency has an uncertain effect on the war. Trump’s primary goal is to achieve a cease-fire between the two countries.

The global economic risks in all of this are unclear, but the price of oil and agricultural products are potentially in play, as is the supply of natural gas to Europe.

Conflict in the Middle East

Trump can be expected to continue supporting Israel – potentially to a greater extent than under Biden, and to express greater antagonism toward Iran. The risk of a further escalation in the conflict therefore mounts, with potential implications for the rising human toll, as well as the price of oil.

China—U.S. frictions

China—U.S. frictions have already been discussed from a tariff perspective.

On the sensitive subject of Taiwan, Trump has conveyed mixed signals. He was highly supportive of Taiwan in his first term. For example, Trump:

• Broke more than 40 years of White House tradition by speaking with the Taiwanese president directly.

• Questioned the “One China” policy.

• Sold weapons to Taiwan.

• Coordinated high-level diplomatic visits between the two countries.

In this election cycle, he has taken a more transactional approach, indicating that Taiwan cannot expect American military support if it does not invest more in defense spending itself, and expressing dissatisfaction with Taiwan’s domination of high-end chip fabrication. This leaves some uncertainty, but it is likely that the U.S. would still defend Taiwan in the event of conflict, rendering such a conflict improbable.

Trump presidency risks

Bracketing our base-case outlook are a variety of risks associated with a Trump presidency.

There is the possibility of greater geopolitical conflict, as just discussed. But let us not forget that Trump has strong isolationist tendencies, which could limit U.S. exposure while leaving traditional allies more vulnerable.

There is the risk that some of the Trump platform’s more exotic ideas could be implemented more fully than our base-case imagines, with more negative economic and inflation implications.

Let us not forget that Trump has strong isolationist tendencies, which could limit U.S. exposure while leaving traditional allies more vulnerable.

Conversely, there is the risk that the Trump platform succeeds in generating more growth than our base-case anticipates, resulting in overheating, somewhat more inflation and a Fed that doesn’t get to cut rates, or even has to raise rates.

None of these are overwhelmingly likely, but they exist within the realm of possibility.

Some election perspective

Anticipated volatility has decreased. However, it should still be greater than normal in the coming months as analysts and markets hash out just what Trump policies will be implemented and when. Trump will take office on January 20, with a flurry of activity expected immediately thereafter, especially in directions that don’t require new legislation such as tariffs, immigration and foreign policy.

All of this is genuinely important, but for perspective let us remember that financial markets tend to generate positive returns regardless of which party occupies the White House. A single political cycle only has so much relevance to long-term investors. Other things also matter for investors, including:

• whether a soft landing is indeed achieved

• whether inflation can continue to ebb

• how much more cutting central banks can deliver

• how the rest of the world fares

• the degree to which individual companies can continue to innovate.

Favourable economic trends

U.S. economic data remains pretty good. Retail sales for October managed an above-consensus increase. Significant upward revisions to the prior month further sweetened the interpretation. Consumers appeared to be spending in September and October.

Small businesses are also starting to feel more upbeat. We strongly suspect that the National Federation of Independent Business (NFIB) Small Business Confidence Index will take another leap higher once post-election data becomes available (see next chart). Consumer confidence is also rising.

Consumers and businesses feeling a bit more upbeat

As of October 2024. Shaded area represents recession. Sources: National Federation of Independent Business, Conference Board, Macrobond, RBC GAM

More generally, business expectations are on the upswing. This is supported by a materially higher and now robust Institute for Supply Management (ISM) Services Index, among other inputs to our aggregated index (see next chart). The overall level of optimism is not high, but it is rising steadily.

U.S. business expectations rising steadily

As of October 2024. Principal component analysis using NFIB optimism and business conditions outlook. ISM Manufacturing and Services new orders and The Conference Board (TCB) CEO expectations for economy. Sources: TCB, ISM, NFIB, Macrobond, RBC GAM

No doubt informing this improving sentiment, the cost of borrowing has not only declined over the past year, but lending standards also continue to ease (see next chart, with new quarterly data).

U.S. business lending standards are reversing helpfully

October 2024 Senior Loan Officer Opinion Survey on Bank Lending Practices. Shaded area represents recession. Sources: U.S. Federal Reserve, Macrobond, RBC GAM

Finally, economic surprises remain nicely positive, not just in the U.S., but globally (see next chart). The economic environment is now a positive one.

Economic surprises have been rebounding

As of 11/14/2024. Sources: Citigroup, Bloomberg, RBC GAM

Economy is not the stock market

This chapter constitutes a reminder that the economy is not the stock market, and vice-versa.

The two are certainly intertwined: a strong economy is reliably good for stocks, much as a recession is reliably bad for them. Faster economic growth does fairly directly influence corporate revenue, which is an important variable for the stock market.

Corporate profits represent just 12% of GDP. There are plenty of other things that drive an economy, including government spending and personal income.

But there is nevertheless a significant gap between gross domestic product (GDP) and the stock market. Sustained divergences and perhaps even a structural stock market outperformance is possible.

For one, corporate profits represent just 12% of GDP. There are plenty of other things that drive an economy, including government spending and personal income.

Furthermore, the corporate profit portion of GDP has more than doubled since 1990, thanks in large part to rising profit margins (see next chart). This helps to explain how stocks have outpaced nominal GDP over that period.

U.S. corporate profits have been rising

As of Q2 2024. Corporate profits after tax without inventory valuation & capital consumption adjustments. Sources: U.S. Bureau of Economic Analysis (BEA), Macrobond, RBC GAM

Of course, the corporate profits captured by GDP are quite different than stock market earnings. The stock market excludes small businesses and the many large privately held businesses. This omission isn’t particularly stable, either: the number of public companies has declined over time.

The S&P 500 is set by far more than current S&P 500 profits. The stock market values those earnings differently depending on market conditions such as the level of interest rates and the degree of market ebullience.

Then there is the matter of foreign exposure. About 11% of nominal U.S. GDP is generated by foreign demand. In contrast, 29% of S&P 500 revenues come from abroad. In other words, rest-of-world demand is nearly three times more important to the stock market than to the economy.

The geographic orientation of this foreign demand is also quite different. Mexico, China and Canada are the three largest U.S. trading partners from an economic perspective. While China and Canada remain prominent in S&P 500 revenues, Mexico slips far down the list and is replaced by Japan, the U.K., Germany and France, among others.

Finally, the S&P 500 is set by far more than current S&P 500 profits. The stock market values those earnings differently depending on market conditions such as the level of interest rates and the degree of market ebullience. The stock market is also forward-looking, gazing out at earnings far into the future rather than dwelling exclusively on the present.

Looking at the cumulative 257.7% increase in the S&P 500 from the third quarter of 2007 to the second quarter of 2024, just 31% of the market’s index return came from higher revenues (which have the tightest connection to the economy). Rising profit margins explain a bigger 34% of the total, and rising valuations explain a further 30% of the increase (see next chart).

Factors contributing to S&P 500 Index return

From Sept 30, 2007 to Jun 30, 2024

Sources: Macrobond, Bloomberg, RBC GAM

The point is that the stock market and earnings do tend to rhyme. However, stocks have historically gone up for a multitude of reasons that extend well beyond simple economic growth. Whether that can continue in a world with somewhat higher interest rates than before (potentially restricting valuations) and if profit margins fail to continue rising at their earlier heady pace is an open question. But that’s precisely the main take-away: those variables need to be considered in their own right alongside the economy for a proper assessment of the stock market outlook.

Peak Canadian pessimism?

There have been a number of reasons to be pessimistic about the Canadian economy in recent years:

• Elevated interest rates have been especially painful given Canada’s high level of interest rate sensitivity.

• Economic activity has significantly underperformed the U.S.: growth has been quite slow, with unemployment now at an elevated 6.5%.

• The country has delivered an atrocious productivity performance (even if this was masked in the aggregate numbers by rapid population growth).

• Population growth is about to fall off a cliff, albeit temporarily.

• There is the new threat of tariffs from the U.S.

But we wonder whether the degree of pessimism is now overblown. A number of positive things are now happening, or at least brewing, in Canada:

• Interest rates are now falling, which is extremely supportive for a highly interest-rate sensitive economy like Canada.

• Inflation has already fully descended to the targeted level, enabling further rate cuts.

• Economic data has recently stabilized, with businesses expressing diminishing pessimism.

• Realized currency weakness provides a small competitive edge going forward.

• Recent talk of a 60 cent or even 50 cent dollar smacks of peak pessimism.

• Canada has a relatively small fiscal deficit versus its peers, meaning it won’t have to suffer from the same degree of economic austerity or bond market anxiety ahead.

• Any tariffs applied by the U.S. to Canada are likely to be quite modest. This is in part because the USMCA limits such acts, in part because Canada does not run a large trade surplus with the U.S., in part because Canadian wages and the Canadian economic structure are similar to the U.S., and in part because the primary U.S. beef is elsewhere.

• Housing construction should increase materially in the coming years given a significant shortage.

• Canada’s elevated household savings rate leaves room for spending growth to outpace income growth over the next several years as the burden of high interest rates falls.

• With a federal election approaching over the next year and polls pointing to a change of government, there is a fighting chance that policy will pivot in a more growth-, productivity-, and business-friendly direction.

• While Canada’s productivity performance has indeed been quite poor, it hasn’t been as bad as it first appeared after a substantial recent upward revision of 1.3 percentage points to the level of GDP.

All of this is genuinely heartening. But the big question for 2025 is whether the expected collapse in population growth (see next chart) will be offset by (hopefully) rising productivity growth.

Canadian population growth to slow with reduced immigration targets

As of 10/28/2024. Government plan estimated based on federal government 2025-2027 Immigration Levels Plans released on 10/24/2024. Sources: Statistics Canada, Macrobond, RBC GAM

On the surface, it seems quite a tall order that productivity growth will accelerate by enough to offset the two percentage point deceleration in population growth. But it remains possible, in large part because the productivity performance was so abysmal in recent years. We aren’t talking about an acceleration from normal productivity growth to incredible growth. Instead, it is just the hope that productivity revives from an epic collapse in recent years to modest growth (see next chart).

Canadian productivity has been falling

GDP, GDP per capita and productivity as of Q2 2024. Sources: Statistics Canada, Macrobond, RBC GAM

Canada’s productivity shortfall relative to the U.S. reflects the complicated interplay of taxes, the regulatory regime, a housing-centric economy, a lack of scale and immigration, among myriad other factors. Most of these are subjects for another day, and no one is expecting Canada’s productivity level to snappily revive to the U.S. equivalent.

But the immigration aspect is worth drilling into, as it is more idiosyncratic and temporary than the rest. Strong immigration was the source of Canada’s recent rapid population growth, which not coincidentally – at least once the distortions of the pandemic and the post-pandemic recovery are ironed out – coincided with declining productivity.

The two are indeed interconnected. Because Canadian immigration tilted so substantially toward international students who either did not work or who worked unskilled jobs on the side, plus temporary foreign workers imported with the express purpose of filling low-skill positions, GDP per capita fell as did productivity – for compositional reasons.

More fundamentally, Canada’s capital stock just couldn’t keep up: on an inflation-adjusted basis, the amount of capital per capita declined sharply over the past few years as population growth outpaced the growth in factories, computers and the like (see next chart).

Canadian capital stock per capita has been falling

As of Q2 2024. Sources: Statistics Canada, Macrobond, RBC GAM

So why can we hope for an imminent rebound in 2025? As the number of temporary foreign workers and international students begins to decline, there should be a mathematical rebound in output per capita and productivity. Granted, it is only a compositional effect, meaning that the average Canadian is not suddenly more productivity. But overall productivity will nevertheless be higher.

Slower population growth should also give the capital stock a chance to catch up, hopefully outpacing population growth (and in so doing, creating a rising capital intensity after a period of decline).

In our view, Canada is more likely to manage growth than not in 2025, and the aforementioned set of factors supporting the Canadian economy will likely begin to bloom with greater visibility thereafter, with the beneficial effect of falling interest rates most important of all.

It is also worth remembering that new workers often face a learning curve. Thus, after a spike in immigration and new workers – as in recent years – productivity temporarily suffers. Over time, this indigestion fades.

As such, rising productivity growth should be the default assumption, and we think Canada can get back to that after four years of stagnation or worse.

But be prepared: for all of the “Canada on the upswing” jingoism, 2025 is likely to be a choppy year. It is not entirely certain that productivity growth will snap back at the exact instant and same magnitude that population growth fades. Various quarters could be unusually down or up as this is sorted out.

In our view, Canada is more likely to manage growth than not in 2025, and the aforementioned set of factors supporting the Canadian economy will likely begin to bloom with greater visibility thereafter, with the beneficial effect of falling interest rates most important of all.

-With contributions from Vivien Lee and Aaron Ma