Focus
February 07, 2025 | 14:03
Canada-U.S. Trade: The Risk-man Cometh
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Canada-U.S. Trade: The Risk-man ComethThe risk of tariffs being used for both trade and non-trade reasons has risen. |
|
|
During the final days of January, we were bracing for potential tariffs on U.S. imports from Canada. Then, on February 1, President Trump signed an executive order placing a 25% tariff on all non-energy goods imports with a 10% levy on energy imports (which include critical minerals), effective February 4. The rationale was Canada’s “failure” to do more to address the “unusual and extraordinary threat… to the national security and foreign policy of the United States” posed by the flow of illicit drugs and illegal migrants. We factored the tariffs into our Canadian and U.S. economic forecasts along with Canada’s retaliatory tariffs (25% on $155 billion worth of goods from the U.S.). For Canada, compared to our base case, the broad themes were weaker growth (flirting with recession), moderately higher inflation (due to retaliatory tariffs and a weaker loonie), much lower Bank of Canada policy rates (as growth worries trumped inflation fears), and a much weaker Canadian dollar (owing to a stronger greenback and BoC rate cuts). For the U.S., the broad themes were modestly slower growth and faster inflation. (The latter also reflected the 25% tariff on imports from Mexico and the additional 10% tariff on imports from China.). Then, hours before coming into effect, Canada was granted a one-month reprieve. (This followed the same reprieve for Mexico, but China’s tariffs went into effect.) The new order said: “I have determined that the Government of Canada has taken immediate steps designed to alleviate the illegal migration and illicit drug crisis through cooperative actions. Further time is needed, however, to assess whether these steps constitute sufficient action to alleviate the crisis and resolve the unusual and extraordinary threat beyond our northern border.” It’s unclear whether, by March 4, any “action” will have been determined to be “sufficient”, allowing the original order to be rescinded. But we reckon, for all intents and purposes, this specific tariff threat has been pacified, but not eliminated. In the span of just several days, these tariffs went from being a major risk, to a near-certainty, back to a major risk. While the negotiation channels now seem to have opened (raising hopes for a permanent off-ramp), we also have more details on the size and scope of potential U.S. tariffs and Canadian retaliation (thus making it a less abstract scenario). More concerning, the episode raises the risk of tariffs being used more often for aims other than international trade policy. And it leaves us more uneasy about what to expect on (and after) April 1. By that date, there will be three reports delivered to the President (under the America First Trade Policy memorandum) that should be full of tariff recommendations backed by formal investigations (or soon-to-be) along with making the case for a ‘global supplementary tariff’. And it also leaves us more uneasy about the upcoming trilateral review of the USMCA (CUSMA in Canada), due July 2026. The President has already ordered public consultations concerning the review to start early. In turn, we suspect pressure will mount to not only start the official review process earlier, but also to renegotiate parts of it. And top of that latter agenda would appear to be regional value content in the auto sector and access to Canada’s supply-managed dairy industry. Recent formal trade disputes in both these areas have not ruled in favour of the United States. |
The escalating unease and risks have left a mark on our economic forecast. Our original base case had factored in some degree of U.S. trade policy uncertainty. Our new base case dialled this up, resulting in slightly weaker Canadian growth (1.7% vs. the original 1.9% for 2025), a weaker loonie (staying above With negotiators now working towards a further postponement, if not a rescindment, of these tariffs, U.S. trade data for December (and full-year 2024) were released this week. (Canadian trade data were also released, but we’re focusing on the bilateral relationship from the U.S. perspective. All dollar figures are denominated in USD, unless otherwise specified.) The total trade deficit in goods was a record $1.20 trillion last year, which will, no doubt, add fuel to the Administration’s protectionist fire. The shortfall as a percentage of GDP is far from being a record, however, coming in at 4.1% for 2024 compared to the all-time high, topping 6% in 2006Q3—and the ratio has been trending more sideways than up. But the Administration appears focused on the mounting record dollar amount. And what’s Canada’s role in this? Table 1 shows the largest contributors to America’s goods trade deficit (those accounting for at least 1%; there are 13 countries/regions in this pack). The top four alone (China, EU, Mexico, and Vietnam), with whom the U.S. sports $100 billion-plus deficits, account for nearly 70% of the total shortfall. Canada is ranked eighth, with a 5.3% share, but stands out for the sheer volume of two-way trade. Canada is America’s second-largest export market behind the EU, and it’s the largest looking just at the Euro Area members. And while total imports from Canada are still larger, bilateral trade is more balanced than in any other ‘deficit relationship’. The U.S. exports 85 cents to Canada for every dollar it imports from Canada. |
|
Nevertheless, there’s still an overall $63.3 billion trade deficit with Canada. In Table 2, we break this out by sector. The entire trade shortfall, and then some, is driven by U.S. imports of Canadian energy (specifically oil and gas). These net imports totalled $94.4 billion last year. This means, excluding the oil and gas sector, the U.S. has a trade surplus with Canada totalling $31.0 billion. By itself, this would be the largest U.S. trade surplus with any individual country. (Note these balances exclude services trade, where the U.S. also runs a large surplus with Canada.) The non-oil & gas trade surplus reflects a $23.7 billion surplus in manufactured goods and a $47.2 billion surplus in all other goods combined (see below), partially offset by a $16.2 billion deficit in ‘net returns and re-exports’. The latter reflects the fact that goods can be exported, then re-imported and exported again as part of a highly integrated production process, such as in the auto sector. |
Chart 1 shows how these items have trended over time. Note that, in October 2024, the Canada Border Services Agency began phasing in a change to how it tracks imports, which likely results in more U.S. manufactured goods not being readily classified (and getting recorded as ‘other’). This will eventually sort itself out, but it is causing more frequent revisions to both Canadian and U.S. trade data. Meanwhile, U.S. officials continue to say that America’s total trade deficit with Canada amounts to being a ‘subsidy’. However, continuing this line of reasoning, this would also mean that Canada is ‘subsidizing’ U.S. factory jobs and output. This is clearly not the case. The bottom line is that across the countries and regions for which the U.S. has a goods trade deficit, two-way trade with Canada is the most balanced and among the largest volume. And the U.S. even runs a trade surplus with Canada excluding the oil and gas sector. But with the Administration focused on the record total trade deficit (in dollar terms) and arguing that ‘unfair’ trade practices are the culprit, such nuances can fall by the wayside. |
|
