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Hello everyone and welcome to Economic Impact. Today is January 22nd, 2025 and as usual, I am with our Chief Economist, Stéfane Marion. Hello Stéfane.

Hi Denis.

Well, we have a lot of noise on the market so far this year and as usual can we have a look at how the market performed so far?

It's a complicated world, Denis, and sometimes you have to look at what the market is saying. And at this juncture, many people might be surprised from the fact that, you know, equity markets are actually positive year to date. And maybe except for Japan and emerging Asia, which is, you know, down very slightly. It might surprise many people to say that despite all the political noise and the tariff threats, the markets saying, well, we're not sure that's the baseline scenario where the US president would come in very forcefully and put us in a situation where we have a global tariff war. So, so far, so good. Of course, it's early in the year, but it might surprise many people to see that the markets are important.

And because of what's going on today, the presentation will be a bit different. We need to talk about, you know, the trade balance, tariff and so on and so forth. But if we start with the trade balance.

I think we want to be very clear to like, we don't know what the full answer is right now. So maybe we'll find, you know, potential solutions for Canada to deal with this uncertainty that we face right now. Now what is clear that we know from Washington is the president is annoyed with the US trade balance, which is very much, it's significant trade deficit with the entire world, 3% of GDP. Denis, it's been a long time since the US actually saw a trade surplus.

And when you compare those tariffs from where they were many, many years ago, where do we sit?

It's very low and the president will say we are tariff structure is very low, but your deficit is very large. So either you want to bring that to surplus, then your tariff structure is going to have to be very high. So, what the president is talking about is going for a tariff structure that's roughly 2% right now to something that will be equivalent to something much more punitive sometimes that we see, you know, double digit tariffs that we saw 100 years ago. But keep in mind, Denis, that back then the import content of US consumption was much smaller. Nowadays for every dollar consumed in the US, about 12 cents comes from imports. So if you want to put 25% tariffs on 12% of consumption, well, you know what it means on inflation, 2 percentage point higher, that would bring inflation closer to 5%. I don't think that's palatable for the president and I'm not sure it's palatable for the bond market.

And if we just turn back a bit to performance and instead of the stock market going to the bond market, the bond market is reacting quite differently this time around. And it's probably because of all of the uncertainty that's in the air.

So, that's why I say, we can't say for sure what the scenario will be for the balance of the year. Clearly the stock market is saying, well, I don't see much chance in a big tariff structure or a very aggressive one. But the bond market is saying, well, I'm going to give you something you've never seen and that's a 10-year treasury yield that's–

Which one is right? The bond trader or the stock trader.

We will find out in the next few months. That's why we've been telling clients, well, be careful because there's no certainty in this type of world. But I think there is something to be said to that the president is not comfortable with the 10-year treasury yield moving higher by 100 basis point since the Fed started easing interest rates. Because that what it means, Denis, is that the mortgage rates are rising in the US. So a lot of people wanted to refinance their homes and say, well, the Fed is easing. I'm going to get a cheaper rate. But you're not getting a cheaper rate because the bond market for the first time in over a generation is saying “Hey, if you're too aggressive on tariffs, there's going to be more inflation and rates will go higher”. So I think this is what the president will be keeping an eye on. And this is why there's no certainty on how we can go with the 25% tariff without hitting the US economy negatively on long term rates.

Let's come back to the, you know, the commercial balance and can we explain how does it look Canada versus what Mr. Trump is saying?

So what I showed to the bond market and what's happening in equities saying, well, I don't think he can be overly aggressive without jeopardizing economic growth in the US. But from a Canadian perspective, clearly we need to find a better response to how we approach Americans. There's no, you know, having a free trade agreement is not a given, right, right. So we need to maintain good relationships with, with the US and US saying, well, I'm subsidizing you dramatically with trade on USMCA, to which I reply: listen it is true that the Americans have a slight, you know, trade deficit with us, but it's only $32 billion.

If you put things in perspective, the 32 billion versus the whole commercial deficit in the state, it's pretty small.

Well, let's put in a number. The Americans have one thousand billion dollars, so 1 trillion in terms of deficit, but with Canada 32 billion.

Its peanuts.

3% yeah, exactly not much. And of that 3%, Denis, it's all oil and gas because the Americans actually for since 2008 are actually running a surplus outside oil. So even in terms of the balance on motor vehicles, the Americans are running a surplus. Yeah. So again, this is where we need to be very good at explaining to Americans, listen, the deficit is really oil and gas.

And they want that.

They need it because without us they wouldn't have a surplus on energy exports because they can refine the crude oil that we sell them and sell it and transform gasoline, which–

And if I recall correctly, the one that because they want to have a fair sources of gas coming from Canada instead of other country that they're not that close.

We are a de facto strategic petroleum reserve for them. You're absolutely right. And the reason for that is because we now export. So the US imports 62% of the oil from Canada via pipeline, which is quite from a national security standpoint, which is quite attractive from their standpoint. So that's why, I mean, I'm not saying it won't happen for sure, but it would be, it is unlikely that the Americans would put a 25% tariff structure on oil and gas, which they need to main keep their inflation lower.

OK, let's get very clear. If they put a 25% everywhere, how does that affect the GDP?

No one wins. OK, but from a Canadian perspective, since you're asking, it would be quite ugly. It would be a GDP drawdown, or let's call it a recession, 6 percentage point, which would be the largest recession since the 1980s when interest rates were 20% in Canada. So the point, Denis, is this is the extreme case where there's a 25% tariff on everyone and there's retaliation. Obviously we're a small open economy. Even our energy would be taxed. Then we would have a problem. But again, Denis, that's not our baseline scenario. But you wanted me to give you the extreme case. This is the extreme case that we would contend with.

That's big.

It's big, but obviously the market is not pricing. But this is if you want the extreme scenario.

Those are numbers.

Bank of Canada numbers by the way, not mine.

OK, now we can shift a little bit to the industrial sector in Canada compared to the other countries where we're not at par.

Well, here's the challenge. The politicians are saying, OK, the Americans we need to diversify our export sources, but unless we want to sell them energy and it's very hard to do because our energy goes to us via pipelines. There's no real pipeline going east-west. So if we're gonna sell stuff–

We can’t put that in boxes.

Exactly. But what we can put in boxes are the widgets that are produced by our manufacturing sector. God knows we could do better there because what we've done over the past year is, we haven't been paying attention to our manufacturing sector. We were too obsessed and moving production elsewhere. Basically we were saying, oh, let's move or production elsewhere; will be less pollution in Canada. I get that it works, because manufacturing is very energy intensive, but if production moves elsewhere and forms of energy used to produce the manufacturing are more polluting in Canada, the planet doesn't win. Now I'm not happy that we now boast to have the smallest manufacturing sector in the G7 despite the fact that we have a comparative advantage on electricity prices and natural gas which are critical for the manufacturing production process.

That was one of your battles for the past year or so that we underinvested in our industries. We thought that everything can be digital nowadays. But you know, if trade is not so secured, whether southern partner, we need to have a critical base in manufacturing. There's a critical mass that we must keep in this country. And this is where I think that this is part of the solution. Let's say, well, OK, fine, the Americans don't want to. Let's, let's build a relationship where we sell within Canada on a higher proportion than what we're doing right now.

And last but not least, you want to bring us on another thinking about tariff, but tariff between provinces that are not really tariffs.

So what concerns me is that we're saying it's not fair that the Americans want to put a 25% tariff structure on us. But since you're asking, Denis, the tariff equivalent of the trade barriers that we have between us, between the provinces in this country is a whopping 21%. When you think about it–

Do people know that?

People are not paying attention. There is a way to take those into interprovincial barriers and put them in a terrific equivalent one, 21%.

You're telling me that we are as protective between us then the Americans wants between the Canada.

You know, Americans want to put 25%. We have 21% on ourselves. And that's not normal. And that's a way where I say, OK, maybe it's frustrating for producers not to have the visibility that they want to have with the Americans. But here's the thing, I can get rid of this almost overnight and say, hey, you know what, we can increase interprovincial trade that is only 40% of our production, maybe to back to 50% where it was before the free trade agreement. So, you know, it's all not doom and gloom. If you think about it, it's an opportunity that comes only once in a generation where all the Premiers sit down and you say enough with this, that's gone and we can actually provide visibility to our producers and keep a critical mass on manufacturing. So again, Denis, yes, it's annoying, yes there's lack of visibility, not sure what the market is pricing at this point in time, but not pricing the end of the world for sure. But from a Canadian perspective, this is probably the most important chart of the presentation. Please, let's get rid of this.

Well, on that Stefane, thank you very much. Thank you for that very special presentation. Hopefully it helped you. Hopefully it was constructive and we'll see you next month in February.