Economic impact

The prospect of broad and perhaps enduring U.S. tariffs on Canadian goods with retaliation from Canada has not only generated headlines but also increased uncertainty for Canadian consumers, businesses and investors. 

As new tariff negotiations persist, Vanguard has adjusted its outlook for the Canadian economy. This change stems from economic data momentum and heightened policy uncertainty. In our base case scenario, we estimate an average 10% across the board tariff on Canadian goods by the U.S. with commensurate retaliation from Canada.

If this scenario materializes, we expect 2025 GDP for Canada to be reduced by 50 bps, from 1.8% to 1.3%. This reduction can be explained by two key drivers. The “uncertainty tax” arising from continued trade discussions and negotiations are impairing the Canadian labour markets and business investment and will result in 0.25% lower growth for the year, in our opinion. Additionally, the actual implementation of tariffs and retaliation will lower growth by another 0.25%. Lower exports by Canada will result in weaker terms of trade and reduce potential GDP as excess supply is created in the short run. 

GDP Growth expected to remain below trend

_{Source: Vanguard research, Statistics Canada} 

Our core inflation expectation at year-end has increased to 2.4%, up from 2.2%. Higher import prices on U.S. goods will put upward pressure on domestic costs however a rise in unemployment will contribute negatively to aggregate demand for goods creating a larger issue. Additionally, excess supply of goods due to lower imports by the U.S. will put downward pressure on prices. Businesses are also likely to absorb some of the cost increases. 

We’ve adjusted our year-end Bank of Canada (BoC) policy rate forecast to 2.25% from 2.5%. The lower growth scenario will incentivize the BoC to cut rates further despite the possibility of higher inflation. BoC officials have been clear about monetary policy being a “blunt instrument” that supports or restricts demand across the entire economy. Fiscal programs are “much more targeted” to support the hardest-hit workers and businesses. Therefore, we don’t anticipate the BoC lowering policy rates below 2% this year. Finally, we’ve increased our estimate for the year-end unemployment rate upward from 6.7% to 7.0%. 

_{Source: Vanguard Research}

Impact on Industries 

With its integrated supply chains across all borders, the Canadian auto industry may see some of the greatest impacts. Finished goods and components typically move back and forth across borders, accruing tariffs each time and creating additional costs for auto manufacturers and eventually, consumers.  

A lower tariff on Canadian energy imports reflects the importance of Canadian oil to the U.S. economy. Canadian energy products will face a 10% tariff, compared with 25% on other Canadian goods. Canada was the source of more than half the oil imported in 2024 into the U.S., where the refinery infrastructure is geared to processing Canada’s heavier-grade oil.  

Other significant exports that we expect would be hit by tariffs include Canadian lumber, which could affect U.S. homebuilders.  

Key considerations for advisors

1. Recently, the Canadian dollar has sold off, the TSX hit a four-month low and the S&P 500 was in correction territory. Our message to investors is to try and tune out the noise of daily headlines and focus on the long-term, as geopolitical sell-offs are typically short lived. 

Geopolitical sell-offs are typically short-lived¹

Sources: Vanguard calculations as of December 31, 2024, using data from Refinitiv.​

_{Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.​}

_{All investments are subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account.​}

2. U.S. equities are currently overvalued and priced for perfection. Consider diversifying exposure within equities. The economic and policy risks for 2025 will help determine whether momentum (reflecting past winners) or valuations (referring to the long term driver of returns) dominate investment returns in the coming year. Our analysis reveals that profit margins would have to double from 12.8% to 26.8% or the price to earnings ratio will have to rise from 28.1 to 54.3 to justify current valuations within U.S. equities. For those comfortable with the risk of deviating from a benchmark, known as model risk, you may consider a higher allocation to ex-U.S. equities.

Returns greater than 13% would require record-high profit margins, record-high valuations, or a combination of both²

_{Source: Vanguard calculations, as of December 31, 2024.}

3. Reconsider fixed income. Fixed income was not a strong ballast when rates were very low in the 2010’s. Now, the narrative has changed as rates have risen. Real yields are positive, and the coupon wall is asymmetric (more upside potential than downside risk).  In the chart below even if rates rise by 100 bps, the coupon wall will almost mitigate the impact of lower bond prices. Above all else, refer to Vanguard's Principles of Investment Success for a time-tested strategy of what works for clients regardless of market cycles or geopolitical events.

Expected returns for a given change in yields are asymmetric³

Source: Vanguard calculations, based on data from Bloomberg as of February 28, 2025

¹Notes: Returns are based on the Dow Jones Industrial Average through 1963 and the Standard & Poor’s 500 Index thereafter. All returns are price returns. Not shown in the above charts, but included in the averages, are returns after the following events: the Suez Crisis (1956), construction of the Berlin Wall (1961), assassination of President Kennedy (1963), authorization of military operations in Vietnam (1964), Israeli–Arab Six-Day War (1967), Israeli–Arab War/oil embargo (1973), Shah of Iran’s exile (1979), U.S. invasion of Grenada (1983), U.S. bombing of Libya (1986), First Gulf War (1991), President Clinton impeachment proceedings (1998), Kosovo bombings (1999), September 11 attacks (2001), multiforce intervention in Libya (2011), U.S. anti-ISIS intervention in Syria (2014), and President Trump impeachment proceedings (2019 and 2021).​

² Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.​ Note: The chart shows different scenarios for the components of total returns to reach 13% annualized, assuming revenue growth of 5.9% and dividends of 1.8% (annualized, over the next decade), and the decomposition ​of our December 31, 2024, median forecast.​

³ Notes: The chart shows the expected one-year total return (x-axis) for a given change in yields (y-axis) for the Bloomberg Global Aggregate Canadian 10+ Year Float Adjusted Bond Index, the Bloomberg Global Aggregate Canadian Float Adjusted Bond Index and the Bloomberg Global Aggregate Canadian Government/Credit 1–5 year Float Adjusted Bond Index. Calculations assume a single-period increase in yields at maturities corresponding to the key-rate durations for the index that occurs in the first half of the one-year holding period.