Financial markets have largely shaken off worries of the recently-escalating trade war between Canada and the U.S. In doing so, they may be underrating the downside risks from a deeper trade conflict, says CIBC World Markets.
In a report released Monday, the bank’s economists note that their base case is for trade talks to restart at some point this year — possibly between the mid-term elections on Nov. 3 and the end of the year — which ultimately results in a rollback of the latest tariffs by both sides in early 2027.
In that scenario, “the Canadian economy still faces a headwind from the remaining tariffs on autos, metals and lumber, and we’ve pared back our 2027 growth rate as a result,” the report said. “But it will benefit from a reduced drag from housing, more elbow room for consumers as gasoline costs and mortgage renewal pressures abate, and increasingly as we move into 2028, a lift from large scale capital projects.”
However, there’s a large downside risk to this scenario too — the prospect of a prolonged trade conflict — that would weigh more heavily on GDP growth and drive wider budget deficits, along with weaker inflation and lower interest rates, the report said.
“[T]he risk of an impasse, and a longer trade war, is now greater, given what the last round of talks revealed about the degree to which the U.S. was willing to reach a mutually beneficial deal,” it said, citing the recent unpredictability of U.S. policy.
The report also warned that equity markets appear to be underpricing the risk of prolonged trade conflict.
“Equity markets barely blinked when August trade talks collapsed, and markets are expecting the Bank of Canada to take the overnight rate well above neutral,” it said.
Yet, given the growing risk of further trade conflict, the report said “corporate treasurers need to hedge against the wide range of plausible outcomes for interest rates until we know more about where trade talks and oil markets are headed.”
And, while many Canadian public companies “are well insulated” from trade-related disruptions, “equity investors should carefully consider their weightings in Canadian non-resource export sectors with a high exposure to U.S. tariffs where a diversion to domestic or other markets is less viable,” it said.