Transcript
Hello and welcome to a special edition of the Download podcast. I'm your host, Dave Richardson, and we are joined by Canada's hardest working economist, who's up from 25 hours a day to 30 hours a day lately. Eric, I can't believe between what both of us are up to right now that we were able to get you for 10 or 15 minutes. What's happening with the tariffs has taken another turn, and we always like to catch up with you on your thoughts and for Canadian investors, just what they need to think about, how do we interpret this? What does this do to growth forecast? What does it do to inflation, interest rates? I won't take a whole lot of time because I know you've been pulling your thoughts together. You've probably already done a couple of presentations today to different groups. So I guess a bit of a surprise in some ways, because these are big numbers, some of these tariffs for some countries, and maybe not so much for Canada and Mexico. At the same time, we were expecting something. Thought he'd probably come big early and hopefully pulls back later. But how do you pull all this together?
Yeah, I mean, gee, I think as a starting point, regardless of how hard you work as an economist these days, your forecasting record will not be great. I don't think too many people were predicting this. I was thinking yesterday before the announcement in the Rose Garden at four o'clock, what's the worst-case scenario? A 25% plus blanket tariff on Canada and Mexico. What's the best-case scenario? Maybe a 10% tariff or something like that. Middle case, of course, somewhere between the two. And seemingly, Canada and Mexico are coming off better than the best-case scenario, which, of course, wasn't on anyone's bingo card. It's almost hard to fathom how Canada and Mexico have gone from enemies number one and two to friends number one and two in the span of 24 hours. And so, it's certainly some unexpected components of this are the main takeaway, as you say, Canada and Mexico seemingly getting off lighter. A lot of other countries, though, being hit maybe a bit harder than anticipated. In fact, I would say if the focus is on the US, the cumulative US economic impact is about what we expected in terms of the average effective tariff. It just seems to be—and I will say with an emphasis on «for the moment»—less on Canada and Mexico and more on some other countries. And so, the EU is being hit at a 20% tariff, Japan at a pretty big 24%, China, I guess, is up to 54%, if you include the 20% that was applied earlier to the 34%. India is at 26%. The list goes on and there are quite a number of parties that are hit quite hard. Everyone has cracked the code for where these numbers came from. So it was not a sophisticated critique of value-added sales taxes or who has tariffs on the US or anything like that. It was really right down to who has a trade surplus, and your trade surplus with the US, divided by the total flow of trade into the US from that country, and that's actually the number that reveals the tariff. So I should say, to the extent that really the US base objection is, how come everyone gets to sell more to us than we sell to them? I can't say that's a completely inappropriate way of doing it, but it's certainly not the way that was advertised going in. And so significant damage to the US for sure, just because the average effective US tariff rate is going up, and I'm seeing a big wide range of estimates, but I'm going to call it up to a 15 or 20% number, which is significant. And so the US economy is likely in this scenario to grow on the order of a percentage point or a percentage point and a half less quickly over the next few years, which is a significant hit. And the price level is likely to be materially higher, one percentage point or even up to two percentage points higher than it would have been. And so that's a significant hit as well for the US. I should say, if we take it face value, what's emerged for Canada and Mexico, we're left saying, well, maybe Canada doesn't have to have a recession, which looked likely based on the expectation of significant tariffs. And conversely, of course, the outlook is a bit worse for everybody else, though I would say I still stand by the general thought for almost everyone else, which is that most countries are not that exposed to US trade. And so I wouldn't want to downplay the pain of a 24% tariff that Japan will face, but only 3% of what Japan makes is sold to the US. And so I wouldn't want to overstate that. I would say, and I'll let you get a word in edgewise here in a moment, Dave, but I would say, to me, the big question is, is that actually it as it pertains to the likes of Canada? And I have my doubts.
Yeah. And so is it the worst case scenario everywhere else? And as you say, around the best-case scenario for Canada, does that hold? And is this the worst of what we're going to hear everywhere else, and then it ratchets back. You probably can't tell from my background but I'm actually at our office in London in the UK. And I was just down on the trading floor talking to our bond and stock traders as the markets have been open for several hours here in Great Britain and are just opening up as we're taping this now. But I was there with them at the open. But one of the traders just saw me with my little Canadian flag pin that we're walking around with. And by the way, getting lots of love and affection as we sport our Canadian flags on our lapels as we're walking around, a bunch of Canadians in London. And he's like, wow, what are you going to do with all the Americans flooding over the border to buy their iPhone and Samsung Galaxies now because of the effective price of an iPhone in the US is going to be, what, somewhere between 50 and 80% off of this. There are so many things going on. One of the advisors said, there's a method to his madness and a madness to his method. So you say, one of the surprises was you could do the calculation, work backwards with the math and figure out how they came to these numbers. But we don't know if they're going to be the numbers longer term. And so there's a whole madness in terms of, we still really don't know how all of this plays out.
Yeah, that's exactly right. So I would say it again, from a Canadian perspective, first of all, Canada is not completely off the hook here. And so let's recognize that, for instance, anything not compliant under the USMCA is presently subjected to a 25% tariff. To everyone's shock, on March 6, it was revealed that 60% of the trade between the two countries was not actually compliant with USMCA. A lot of that was a function of paperwork, and so businesses have made those things compliant. I haven't heard too much screaming of actual flows that are encountering 25% tariffs, but there is a tariff on a subset of things from Canada, potentially 25%. The steel and aluminum tariffs are still fully on, and they affect Canada more than anyone else. That's a significant source of pain as well. The 25% auto tariff, at least as we're recording this, started this morning at midnight, my time. I guess it was 5:00 AM, your time. Very confusing. But nevertheless, those are on. As much as US value added is excluded, any Canadian value added—you don't ship those parts and cars into Canada for no reason—that Canadian value added is subjected to a 25% tariff. So that's a big problem still for the auto sector. And it's been made quite clear that there are copper, forestry, pharmaceutical, etc., sector type tariffs coming. And a number of those— forestry, obviously—but a number of those will be Canadian relevant, too. So Canada is being hit by some things. It was not a complete carve out. And then the big question is just, as you say, tariffs on today, off tomorrow or vice versa. So what is the scope for deterioration here? And we honestly don't know. I mean, it's almost certain whatever I say is going to be wrong. That's certainly been the theme so far. And the experts have gotten this almost constantly wrong. Sorry, you interjected.
We're going to come back to that in a second in terms of where we go from here. I think I've got a more important way of framing that question. But I do want to go back. I mean, what we did talk about on our first tariff podcast, which I think was on January 30th or January 31st, was the idea that if you look at the sectors in Canada, you could get from all of the language where the focus was going to be. Now I'm hearing you again in terms of where we're not exempt, and it is. It's autos, it's some of the agricultural sites, it's lumber, steel, aluminum. This is where we thought the focus would be, and that's where it ends up now.
I was saying this morning, if I'd gone to bed on November 5th and just woken up today, I might have been about right in my predictions, but there have been some surprises along the way. And again, we will just say, I don't think the surprises are fully done. Surprises have been constant. Let's not grow complacent now. Again, hard to fathom Canada, Mexico went from enemies number one and two to friends number one and two in 24 hours. And so I suspect there's just a different plan for them. We heard in the White House speech that announced these reciprocal tariffs yesterday, we heard complaints about Canadian dairy. So it's certainly not likely that that was the end of the story on Canadian tariffs. And the way I've come to think about this is that there's certainly one very viable scenario, we know the USMCA trade deal is going to be renegotiated. Not quite clear when. It could be immediately, might be on schedule in 2026, but I would say sooner rather than later. It probably makes sense to put those big tariffs or at least to threaten the big tariffs against Canada and Mexico for that, and that creates the leverage for the US to extract concessions. I still think that that 25% tariff, which has been delayed but not canceled quite, still needs to be heated. Again, I guess as per that, the US still is unhappy with border security in a North American context. It doesn't like the level of military spending that countries are engaging in, including Canada. It does not like at all Canada's digital services tax, it does not like value-added taxes in general which doesn't just apply to Canada. It doesn't like cheap currencies. Canadian dollar is pretty cheap. It doesn't like supply management. Of course, there is supply management. It has complained about some of the oligopolistic-type service sectors. And so it's hard to fathom the net conclusion from all of that is, Canada gets no tariffs. And so I'm going to assume that there is still some pain to come, but I will still say that Canada is doing an awful lot better than we would have expected 24 hours ago. And so the odds of a recession have just gone down. I'm not sure they've vanished altogether, but they've gone down. And of course, that's a welcome thing. To some extent, it's been the opposite trend in the rest of the world. But again, I think they're sufficiently limited in their exposure. They will be okay as much as no one celebrates big tariffs. And the US is potentially in for a significant hit itself. And I don't think it's a full recession-sized hit, but tongues are wagging to that effect, and that's not a bad conversation to have as well.
Yeah. And just so you know, this is a very Canadian dairy friendly podcast. As I travel around the world, the one thing I miss more than anything else when I'm on the road, when I have my milk and cookie at night, is I'm not drinking my Canadian milk. There's no better milk in the world. Anyways, that's an aside. But the growth thing, we talked a lot about this, we were talking to some of the economists and lead investment managers over here in the office in the UK this morning, and the focus was that US growth. We had Goldman Sachs come out. They had bumped their recession risk from 25 to 35%, I think. We had a couple of forecasters here in the UK who bumped it from 5 to 25%. I know you've been at the lower end, but you were starting to get more concerned the last time we spoke. Anything you see here that dramatically shifts your view on US growth for the remainder of the year?
Yes, the risk has gone up, undeniable. Anytime you downgrade a country's growth forecast, just given the error bars on either side, a bigger part of that error bar is now negative. Certainly, the risk has gone up. The number we've officially given was we had thought the risk was about a 10% chance for the US over the next year of recession. We put it up to a 25% plus. I think the plus is doing a lot of the work there right now, and so it probably is maybe a little higher than 25%. I would still really struggle to think it's 50% or higher. I certainly appreciate that tariffs do a number on growth, and there is the risk that households and businesses really just screech to a halt, and you can construct a narrative. But equally, all the modeling that we do would really struggle to say that even a 15 or 20% average tariff rate in the US, which I think is loosely where we've ended up, would be full on recessionary. 85% plus of the US economy is domestically oriented. It's a fairly small share that is imported. The outlook is down, and we're budgeting now for sub 2% GDP growth this year and next, and it could even be shy of that. But I would struggle quite to get all the way to a recession. I will say we've been tracking dusting off some pandemic era type indicators and looking for real-time metrics of is there a collapse happening right now? And not seeing it in the US right now. Jobless claims are still quite low. Some of the weekly economic activity indices seemingly still trending a little higher. We've heard some airlines complain, and probably the tourism and boycotting and so on is perhaps weighing there to some extent. And maybe I'm underestimating the extent to which Americans are tightening their belts a bit as well and doing less leisure travel. But in general, I would say less growth, absolutely, and potentially, particularly with high uncertainty recently, notably less economic growth. I'm a bit of a skeptic when it comes to a full recession. I think we need to see a bigger hit than that.
We were talking about here the consumer is still in pretty good shape. What we'll talk about when we do our Friday Jobs report podcast the next time—and oh, actually, it'll be next week. I think we stole it forward. The next time we're talking about the labor market, we'll say that the labor market because of changing immigration policy is likely tightening. So you get some upward pressure on wage growth. You probably run a little bit higher inflation, but people have money in their pockets, so the consumer is still strong. So you add it all together. Like you say, it's hard to get to a recession, but not impossible. This is going to hurt, but it's hard to get there from here.
That's the current thinking. And so we'll see how things play out, obviously, and we've had so many twists and turns. This might not be the last—almost certainly isn't the last. But as it stands now, that's our best guess.
Eric, I think, as we've said, the forecasting is virtually impossible, and it seems like that's almost by design. Let's keep everyone on edge. Let's keep everyone guessing as to what's going to happen, which, again, seems like madness, but there's a method to the madness. But if I'm an investor sitting in Canada and I'm looking at my portfolio of bonds and stocks, regardless of how things play out, what do I think about this today? As I wake up and I see these tariffs and I see the way markets are acting, what do you think I should be thinking about as an investor?
Yeah, well, I have to say, just from a regional standpoint, obviously, Canada suddenly looks a little bit more attractive than it did before. That's maybe the big obvious conclusion, though, with that caveat, that's probably not quite the final word on the subject. But nevertheless, I think it says something that Canada didn't come in for the big giant blow today. So that's promising. I would say in general that it is worth if one is bold or willing to tolerate a bit of uncertainty, there are opportunities that come along when markets decline. And so that's not me saying necessarily that the US market or international markets or the Canadian market is done its decline, but nevertheless, it is on sale relative to where it was a couple of weeks ago. And dollar cost averaging and such is not a bad idea, even if there could be a further decline. And so that's certainly very central as well. I do think that to the extent we're seeing significant moves in international markets, I do wonder whether those are overreactions, personally, just to the extent, again, that the tariff damage may not be that great for some of these countries. It depends on the European auto sector is, of course, significantly exposed and so on. But in general, I think a lot of sectors are going to do just fine internationally on this basis. Of course, they're so much cheaper than some of the other markets. I guess that's just me saying on a number of fronts that I would still be intrigued by and perhaps attracted to some of these international equity markets in particular. Then, of course, it's always just worth remembering the whole reason we have bonds in our portfolio and cash in our portfolio alongside those equities—often the strongest performer—is to provide ballast. And so as the stock market declines, your portfolio is likely holding together pretty well to the extent that glaring obvious opportunities come along. It's nice to have a little cash along for the ride in terms of the ability to deploy it as well. And so this is a time to have a portfolio that's not too wildly different from balance so that you can actually take advantage of opportunities as they come along. And of course, we're active investors, and so I don't think I would say we celebrate or entertain volatility, but nevertheless, there are opportunities that arise at times like this to take advantage of movements. We're trying our hardest, of course, to do that as well.
We had Sarah Riopelle on a couple of weeks ago who had added to the equity position in her portfolio. A little nibble, a 1% add. We asked her, why are you adding now? She said, well, we were off 10%. We think there's an opportunity to deploy a little bit. Then she was up; I saw her a couple of days later and I started to celebrate. She said, don't celebrate yet. Don't celebrate yet because with a lot of things are happening, we could fall back down. So now we come back down and maybe nibble a little bit again. And then you look at the bond side, and she had added a little bonds a couple of months ago with the US 10-year treasury up around 4.75%, I think 4.80%. And today, you're banging on the door to go below 4%. So that bond portfolio has provided that insurance as you look for where you want to really wade in on the equity side. The dollar cost averaging approach we've been talking about for a while now, it seems to have been a fantastic approach, and this is exactly why that approach can work.
Absolutely. I won't prejudge, but literally in 16 minutes, I'm going into the next such tactical asset allocation meeting. We'll see. But nevertheless, there are opportunities when markets move.
Well, that is my signal to let Canada's hardest working and busiest economist go. Eric, thanks as always for taking the time. Great update. I know you've helped investors across Canada. Thank you and enjoy your meeting.
Thanks so much. Bye, everybody.