Tariff Pause: What’s Next? Economics and Markets Impact

Speaker 1:

Today's episode was from a live event on February 5th. Our BMO economists and market specialists focused on how US tariffs could impact the Canadian and US economies and markets.

Speaker 2:

Welcome to Markets Plus, where leading experts from across BMO discuss factors shaping the markets, economy, industry sectors, and much more. Visit BMOCM.com/MarketsPlus for more episodes. The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates, or subsidiaries.

Camilla Sutton:

Welcome to BMO's discussion on US-Canada tariffs' economic and market impacts. As we open today's discussion, President Trump has been in office for a little over two weeks, and in that time, we've had a 25% tariff imposed on Canada, all of our goods. And in that same time, we've had it quickly reversed, and we have a pause for 30 days. The scale of this economic uncertainty is unprecedented. And accordingly, we really wanted to bring together two of our experts for a quick 30 minute discussion on just how tariffs and the uncertainty around them could impact our economy and our markets.

I'm Camilla Sutton, MD and Head of Equity Research for Canada and the UK. I'm very pleased that you could all join us today, and I'll be moderating our discussion. And to start off, I just wanted to introduce our panelists, truly two of the best, Michael Gregory, Managing Director and Deputy Chief Economist at BMO, and Brian Belski, Chief Investment Strategist at BMO Capital Markets. And with that, Michael, why don't we start with you? Can you walk us through what the Trump presidency and, in particular, the looming threat of tariffs means for Canada's economic growth and our central bank policy?

Michael Gregory:

Well, thanks, Camilla. I think, number one, it's all about uncertainty. And let me take you just back. You mentioned about the on-again, off-again tariffs. Well, that also resulted in on-again, off-again prognoses for the economy. When those tariffs were first announced and then, the retaliatory measures, as far as we know, these were certain, so we sharply reduced our expectation for growth, grinding to actually a mild recession. We had a little bit of an uptick in inflation, because of retaliatory tariffs and a weak Canadian dollar. We had the Bank of Canada cutting rates sharply to provide some support for the economy. And given the combination of a stronger US dollar, in the wake of US tariffs, plus the Bank of Canada rate cuts, that led to a much weaker Canadian dollar. We were testing 1.50 on the exchange rate. Well, needless to say, a couple days later, when these tariffs move from being a risk to a certainty, back to being a risk again, the impulse was just to go back to where we were before.

Our before was we would have growth this year roughly around 1.9%. That sounds okay on the surface, but given 200 basis points of rate cuts by the Bank of Canada, you'd expect stronger growth from Canada. And the reason why we're not getting it is because we believe business investment will be held back a bit, because of uncertainty due to trade policy. We still had a couple of rate cuts by the Bank of Canada, to give a little oomph to the economy. And we had the Canadian dollar spending most of the time, at least much of the year, above the 1.40 level. So are we going to go back to where we were before? And we decided no. And really because of two reasons, and this kind of speaks directly to the implications going forward, there's a lot more risk out there now. And that risk has now been revealed.

There's a risk of tariffs being used against Canada and other countries for non-trade reasons, but it's made us even more uneasy about what to expect after April 1st. Just a little step back from that, on inauguration day, President Trump signed the America First Trade Policy memorandum. And part of that was to instruct various government departments to go ahead, research various aspects of trade, find out what's wrong, what's right, and then, report back to the President. So on April 1st, the President's going to get three separate reports, one from the Department of the Treasury, one from the Department of Commerce, and one from the US Trade Representative. And I believe that those three reports are either going to have the investigations or be indicating that investigations are ongoing for a whole slew of Section 232, in other words, national security tariffs, a whole slew of Section 301, or unfair trade practices tariffs.

And more importantly, I think it's going to establish the groundwork and build the case for a global supplementary tariff. The acronym GST is not lost on Canadians obviously. So the big uncertainty now, even more uncertainty, under a renegotiated USMCA or CUSMA, will Canada and Mexico be susceptible to these other tariffs to a global supplementary tariff? We just don't know. There's even now more uncertainty than there was before. And as a consequence, we didn't go back to our base case. We ratcheted down our base case a bit. We have growth at 1.7, instead of 1.9, and we also have the Canadian dollar, spending all of this year averaging well above 1.40. So the bottom line, the kind of environment we're living in now needs more risk. And risk is not good for the Canadian economy. It's also not good for the US economy. We initially saw the tariffs, we shaved growth by about three-tenths for the US and the higher inflation by about three-tenths, that we rolled that back completely as it was before. But the legacy here, this is a much more riskier environment for the Canadian economy.

Camilla Sutton:

Michael, you summed that up beautifully. Let's stay with the economy for a minute here. What percentage of Canadian GDP is relying on exports? What sectors maybe have the biggest exposure? Maybe what provinces are most exposed? And vice versa, what does it look like for the US economy when there are these tariffs in place?

Michael Gregory:

Well, it just looks straight, exports to the US are pushing nearly 20% of Canadian GDP. So it matters. It matters an awful lot. Across the provinces, there are various degrees of exposure. Obviously, the provinces that have some energy exports to the US, not only oil, but other forms of energy, have very high exposures to US trade. You're talking Alberta, Saskatchewan, Newfoundland, Labrador, even New Brunswick. But when you strip out the energy side, you've got other sort of exposures as well, very high trade with New Brunswick in the chemical side, Saskatchewan in agriculture and minerals. But of course, the granddaddy there is the exposure on the manufacturing side, with respect to Ontario and Quebec. And the thing about the individual industries, the biggest one being motor vehicles and parts, consumer products are in there as well, metal and mineral products also being sort of a third in terms of the exposures there.

So an important thing to keep in mind, even one region may be particularly affected, given the way strength or weakness in the oil sector ripples right across the Canadian economy, this is a Canada-wide issue with respect to tariffs. Now, the other side of the coin, you think about US exposure to exports to Canada, well, it's slightly above 7% of GDP, exports are, of the US economy. And while Canada is one of the major trading partners, about the exposure to Canada, trade is slightly above 1%, 1.2% in fact. So you're looking at just under 20% versus 1.2%. And yes, America needs Canada and Canada needs America, but put bluntly, Canada needs America about 10 to 15 times more. So this is why I do think Canada was very quick to retaliate and why this is an extremely important negotiation as we go forward here, with respect to all the other trade irritants. And of course, the big thing is what happens to the USMCA CUSMA, come next year when the agreement is formally reviewed.

Camilla Sutton:

Well, that definitely puts it into perspective. Any last thoughts here in terms of provincial, we certainly read a lot in terms of what it means, if provincial trade barriers come down between the provinces amongst themselves, any thoughts there?

Michael Gregory:

Well, the moment this tariff wall looked like it was going up, we dug up our old playbook, and unfortunately, this happens all the time. There's an old joke or old adage out there that it's easier for Canadians to trade with Americans than it is for Canadians to trade with other Canadians. The whole array of non-tariff, non-quota barriers across the country, regulations, and things like that is so voluminous that studies have shown, if we just remove them, if something passes regulations in Saskatchewan, it should be available for sale in Ontario. As long as we level that playing field for that perspective, a lot of the estimates [inaudible 00:09:22] you're looking about a four and a half to 8% increase in GDP, just from that efficiency.

So it's powerful if this crisis or this risk that we're facing now compels us to make those changes. The other thing to keep in mind, it's not just trading within ourselves, it's perhaps diversifying globally. Although it tends to get the back burner, in 2017 and 2018, Canada signed trade agreements with Europe, signed trade agreements with the Pacific Rim, Australia, New Zealand, Japan, so we have other channels to trade. We don't focus on that, because it's a lot easier just to focus on the US. But again, we have options here, and maybe now is the time we look at those options.

Camilla Sutton:

Okay, Brian, we've got to get you in here. You're always the voice of calm, no matter how much volatility we see in markets. Can you walk us through Monday, February 3rd, markets were volatile, can you walk us through what happened, which sectors outperformed, which ones underperformed, and why?

Brian Belski:

Camilla, thank you so much for having us. We're humbled and we're humbled that, with that moniker, with respect to providing that calm. I think the calm comes from a process and discipline that we have employed as strategists for 35 years. And we have the very good fortune of being the lead strategists on forecasting the US market since 1997, and of course, 13 years here at BMO. And what we find disheartening, quite frankly, is the, I would say, the emotional response to chaos and fear. It's disheartening, because I think it builds in that type of emotion that shouldn't be there, especially considering that, if you take two steps back and you look at the Canadian stock market, which we did, the Canadian stock market was up 18% last year in local currency and the small cap stocks in Canada were up 16%. And numbers are still pretty positive in terms of earnings growth.

And I think, when you have fear, that really drives things. And we were certainly seeing some of that on Monday, but compared to, quite frankly, the fear and loathing and negativity that we were trying to combat with on Sunday night, while we were penning our report that we published late Sunday night into Monday morning, Camilla, I'll tell you, from our perspective, and you'll find this hard to believe, that the market actually did, in terms of how it reacted in the beginning, before the renegotiation of pushing this out 30 days transpired. So we thought it actually could have been a little bit worse, and we were positioned for that. And that's why, quite frankly, we were focused so much in our writing, in terms of providing that calm and process and discipline. So what happened Monday morning was your question. Clearly, with respect to Canada, it's the more domestically oriented sectors that were hit the most, namely things like industrials.

Industrials were the big one, but also industries like auto components, airlines, railroads. On the flip side, however, gold did very well, meaning the material sector. More banks that actually are centered more toward the US did better than domestically oriented banks, which is of no surprise. In software companies. And so, what we wrote in our report on Sunday night was that there are several companies, quite frankly, in Canada, that can, will, and should outperform when these types of fearful chaotic things occur in the market, like happened Monday morning. Now, going back to very important industries for, obviously, Ontario in particular, auto components, auto components were down 6% before the tariff reversal in the day, ended up closing up for the day. That's really, really important. Why is that important? Because the auto components, from the day that President Trump won the election to the end of the year, were already down 7%.

So let's just do the math. Auto components were down 13%, Camilla, in that timeframe. So we've long said that opportunities come about when people and investors and markets overreact, and we believe that there was a clear overreaction to this. Why? We know that the auto components in companies in Canada are some of the best in the world, and when you see that type of a pullback, it provides longer term opportunities. One of the things that I said in the very beginning of this diatribe was it's very unfortunate that we had this emotional response.

Why is it unfortunate? Well, I believe that most investors and most people for that matter are scrolling headlines on their phone or reacting to bullet point analysis, instead of taking two steps back and taking a breather. So I think, essentially, if you're parents out there, one of the things that you teach your kids in elementary school is, if there's a fire, you stop, drop, and roll, stop, drop, and roll. So that's my advice with respect to the market, stop, drop and roll. Do not react. Act and employ a discipline. And so, the more fundamental that you are, the more that you will win. And in fact, the market became more fundamentally biased as the day progressed. And actually, the TSX opened 3.1% lower on the open, that was the low for the day, and it actually closed up for the day. So again, stop, drop, and roll, employ more of a discipline, and really use fundamentals. And that's what's kept us to remain calm and disciplined.

Camilla Sutton:

Definitely calm and disciplined. So maybe push all of those a little bit farther, Brian, talk to us about what you see for the rest of the year. 2025 looms ahead, what do you expect for Canadian-US equities for the rest of the year?

Brian Belski:

Well, there's a phrase in research analysts frame, no change in numbers and no change to rating. And so, what does that mean? We're sticking with our targets for the TSX at 28,500 and earnings of $1,600, which we've been in print in since November. That's number one. On the US, we're still very bullish and 6,700 and $275 in earnings, which are priced to about 10% of earnings. So our call has been resolute since we came to BMO in 2012. We believe the US stock market's in the midst of a 25 year secular bull market. What does that mean? Within secular bulls, you can have cyclical bears, which we clearly did in the fourth quarter of 2018. We had a clear bear market during COVID and another bear market in 2022. So you can have these opportunities from a fundamental perspective to be involved. Our call all along, with respect to Canada, is Canada is coming along for the ride. Canada clearly came along for the ride last year, much to the dismay of many macro investors that continued to believe that Canada was heading into a recession. But it worked.

Why did it work? Canada's value and cyclicality, relative to the US, which has really been bullied by, let's say, seven stocks, the Magnificent Seven, which we've had very good fortune to be exposed to, and it's helped in our research and our portfolio is that we have the very good fortune to run for our great partners in BMO Wealth. However, when you take a look at the Canadian market longer term, relative to the US, it provides a great value and cyclicality relative to the US.

And so, I think that performance that I quoted in your first question surprised most investors. Now, it doesn't mean that we're not going to be bumpy. Bumpiness and volatility provide opportunities, because if you're a fundamental investor, you're going to buy good companies, worrying more about the companies in the stocks versus the market. Lastly, I'll just tell you, so many people, Camilla, want to make the big market call. And we always like to say the stock market is a market of stocks. That's why the two words come together. So worry more about the implicit bottoms up view on the stocks versus trying to make the big market call.

Camilla Sutton:

Appreciate it, Brian. Michael, let's get you back in here for a second. Do you want to dig down a little bit into rates and currencies? How do you see those markets unfolding, given the backdrop we have now?

Michael Gregory:

Yeah, sure thing. Thanks, Camilla. Well, obviously, the Canadian dollar has become a bit of a barometer here for how the market assesses how much risk there is potentially of tariffs. And so, I do think that the fact that we sold often really came back full circle is a testament to the fact that the market right now is thinking, well, having kind of missed this first wave, potentially, there is lesser risk out there. But hopefully, as I indicated in my initial comments, I think, in fact, there's even more risks out there that Canada will not be able to shield itself completely for the wave of tariffs that are likely to unfold. So we do think the Canadian dollar broadly is going to weaken for the next little while, till we get at least through April, and I think it will remain weak from a historical standpoint, from a range perspective, I do think the currency may firm up within that sort of weak range.

So I don't want to say the currency is strengthening. Basically, it's in a weak range, a historically weak range, and it may kind of move to the stronger side of that weak range, if you catch what I'm saying here. And I think a couple things, I think we're going to move a lot of political uncertainty in Canada, once we get through the federal election, and I think that helps a lot in the direction of policy. And so, I think that in itself probably adds a bit. And I think our base case is that, yes, there's risk of pretty severe tariffs, not only on Canada, but a lot of other countries that maybe we don't see the worst of that. And that provides another lift. And part of the reason for that little of an improvement, if you like, in the Canadian dollar's fortunes, within a weak range, mind you, is the fact that the US dollar itself is broadly expected to remain as strong, where it is right now. As everyone knows, the currency has been averaging its strongest levels ever on a trade-weighted basis relative to all the other trading partners.

And that has, I think, the currency may not get any stronger, but it's going to remain within its strong range for the time being. If we do see tariffs though, particularly if we do see that global supplementary tariff, which is a tariff on everybody, I think we will see that the US dollar adjust accordingly, strengthening to basically offset most of that tariff. So it's not that much more expensive to import as an American, but the Uncle Sam is getting a lot more revenue as a consequence. And this too, as the administration admits, is one of the reasons for the tariffs, on the interest rate side, and again, our view is the Bank of Canada has got a couple of rate cuts up its sleeve, a lot of risk is going to be more. So if we get those tariffs, we're going to see more.

If we don't get those tariffs, maybe they're not as aggressive even with a couple of rate cuts, we just don't know. But one thing is pretty clear, the market is sinking, that we may be living with Canadian yields being well below US yields for quite a long time. We've been pushing past the most negative spreads we've seen, Canada-US, in the bond market, and to me, that's an indication that there is some expectation that, at least at the overnight area, at the policy level, Canada's going to be marching to its own tune, in terms of a monetary policy, there's always been this concern of how negative can Canada-US spreads get without undermining significantly the Canadian dollar.

The Bank of Canada has showed some degree of ambiguity about that assessment, but I do think that we will likely see those spreads get a little bit more negative, and in the event we do get that, that worst case scenario of actual significant tariffs, I think you're going to see those spreads get meaningfully more negative. But again, that helps contribute a little bit to the weakness of the Canadian dollar, but I don't think that's an issue really for the Bank of Canada, at least at this stage. So rates kind of where they are potentially moving down, if we get some tariffs and having to deal with those yet again.

Camilla Sutton:

Terrific. Well, certainly, over the last couple of weeks, I know that we've had a tremendous amount of reach out, a lot of questions, a lot of uncertainty. Maybe Michael and Brian, if you could both answer, what is the most common question you've gotten from clients and internals? And how have you answered it? Why don't we start with you, Michael?

Michael Gregory:

Sure. Okay. Well, I think the big question that I've always got, up until Saturday morning, was, "Are we actually going to get tariffs? Is this actually going to happen? Is it just a bargaining ploy?" Well, maybe it was a little bit of that. It's unknown, because we kind of got to the brink and pulled back. And literally, we got to the brink. And the Federal Register actually was publishing that all the details on the tariffs, specifically with Canada, not with Mexico, leading up to when the postponement happened. And so, it's the uncertainty, and I'm sort of hearing it from businesses from coast to coast to coast and even on the retail side as well. "Where should I be putting my money? I just don't know. I just don't know." The advice that Brian gives is quite compelling, and I think it's just that uncertainty. And when in doubt, if you're a business, you have to invest. We see that hesitancy, and that, in itself, creates a little bit of weakness in the economy. But it's basically, "Is this really going to happen?" And sadly, I have to answer, "I just don't know."

Camilla Sutton:

Brian, what about you? What's the most common question? And how have you answered it?

Speaker 1:

I've answered a little bit already, but mostly, it's questioning, "Why are you so positive? Why can you be positive through this?" And I go back and I use my memory bank of doing this for a long time, whether or not it was Operation Desert Storm in 1990, when many observers thought we, in the US, were going into a deep, deep recession. Six months later, we were right back into the bull market into early 1991. I go back to the credit crisis in 2008, where we were advising clients in a much different way than what was happening in the macro side of things. I go back to March 20th of 2020 and March 23rd of 2020, when many macro observers saying we were going into negative real rates of return, negative real rates on interest rates, and somewhere south of the Great Depression GDP numbers. What's the common, excuse me, threat in that, Camilla? Fear.

And so, we've long said, "How do you dilute fear, mitigate fear? It's through faith, and what's faith in our business? Fundamentals." And so, as we take two steps back and we focus on our process or as you saying, Canada process, we've long looked at four things, valuation, growth, operating performance, and the price performance of an asset, whether or not it's the stock market, an industry, the stock. And if you take a look at the United States market and you can take a look at the Canadian market and you look at valuations, which we talked about, and value cyclicality of Canada versus the US, we talk about growth, the discernibility of growth in the US is very tight, meaning you get what you pay for. But earnings growth in the US is very consistent, and it's becoming more consistent in certain areas in Canada as well. Then you go to the operating performance of companies, you look at things like free cash flow and a return on invested capital, debt to equity.

The equity markets in Canada and the United States, relative to other developed markets in the world, are in much better footing. Then lastly, price performance. So price begets opportunity, and sometimes, when things get a little too frothy, you want to become more diversified. When things are maybe overdone to the downside, if those other first three things fit your discipline, that's when you should act. And I think this is one of these times, Camilla, I do believe that. And we would say this, BMO has an amazing relationship manager network from all facets of the bank, and this is now time to rely on those relationships. After all, our business is a relationship business, and we're blessed to be at BMO and blessed to have all of these channels with respect to relationships. Now's the time to really focus in on the process and the discipline.

Camilla Sutton:

We just have a couple minutes left. Michael, why don't we close out with you first? Can you just sum up what you'd like to leave everyone who's dialed in and who's listening? What can you leave us with, in terms of how you think about where we are in the world, tariffs, Canadian and US economy? Over to you, Michael.

Michael Gregory:

Yeah, thanks, Camilla. Well, I think there is more risk out there than we had sort of a year ago, perhaps even a month ago, and we just have to live with that and plan accordingly. And I do think, with that risk, it's sort of incumbent upon us to say, okay, we got to maybe hope for the best. And clearly, we got the best, compared to what the alternative was, but in some cases, you got to plan a little bit for the worst too, just so we're not caught off guard. And I think, whether that's in your own personal portfolios, whether that is in your businesses, this stuff could happen.

And I do think that the bottom line is that the Canada-US trade relationship specifically, yes, America has a trade deficit with Canada, but it's mostly energy. But US has a trade surplus and manufactured goods, and so, it's a benefit. We give you materials, and America gives Canada finished stuff. And that's a relationship that works, it's worked for scores of years, and I think, as long as we focus on that relationship and how important it is for both economies, we can get through this. It's when we get caught up in rhetoric and that that I think that's when we end up going a path that we really don't want to go down.

Camilla Sutton:

Brian, you want to close out here, with some final thoughts on how to think about investing for the rest of 2025?

Speaker 1:

Sure. Again, thank you so much. We're humbled that we're able to be on this call today for everyone. And I would say this is, and we said it in our report, control what you could control. And how do you do that? You do that through being very mindful and very disciplined in terms of how you're looking at things. And if you know the sport of baseball, we're not hitting home runs here. Now is not the time to be hitting home runs. Now is the time to be hitting singles and doubles, and it's time to be more fundamental. It's time to turn off the rhetoric. It's time to kind of take two steps back and look at the mosaic. And the mosaic is that the US and Canadian stock market, relative to other developed markets and other areas in the world, remain the most fundamentally sound, period.

Camilla Sutton:

Thank you, Brian. Thank you, Michael. You are both very insightful. Your expertise and experience absolutely shines through. Very pleased that you could both join us today. Thank you. And to all of our clients who are listening, thank you for taking the time out to join us today. There'll be a podcast and a recap article that you can find on either www.BMOCM.com or www.commercial.BMO.com. And if you have any questions or want to understand more, please don't ever hesitate to reach out to your BMO relationship manager. And with that, thank you all for joining us.

Speaker 2:

Thanks for listening. You can follow this podcast on Apple Podcasts, Spotify, or your favorite podcast app. For more episodes, visit BMOCM.com/MarketsPlus.

Speaker 1:

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