North American Outlook

June 08, 2026 | 12:41

U.S. Resilience Versus Canadian Fragility

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Key Summary

The U.S. economy appears set for another year of solid growth, while Canada is struggling to gain traction. A bigger push from AI-led investment and smaller drag from trade uncertainty explain much of the divergence.
Stronger U.S. growth comes at the cost of higher inflation, which threatens to derail Chair Warsh's earlier easing plans.
A weak economy and subdued core inflation should dissuade the Bank of Canada from pulling the tightening trigger.

United States: Hard to keep a good economy down

Apparently, neither the trade war nor a real war can hold the U.S. economy back. After recovering by 1.6% (annualized) in the first quarter from the earlier government shutdown, real GDP is expected to increase about 2% in the second quarter. And, assuming oil prices retreat, the economy appears on track for another year of similar growth in 2026.

Providing thrust to the expansion are three forces: business investment in AI-related systems and infrastructure; the positive wealth effect from record-high equity values (much of it powered by AI enthusiasm); and, expansionary fiscal policy (larger personal tax refunds have removed some of the sting of higher oil prices). In fact, a 34% annualized surge in business spending on computer equipment, software, and data-centre construction in the first quarter added a hefty 1.4 ppts to annualized growth, although soaring imports of computing gear erased much of the lift. Tourism and fan spending tied to FIFA World Cup matches will provide a modest growth bump in the weeks ahead. However, these tailwinds are partly tempered by a soft housing market (mainly across the southern states) and continued weakness in commercial construction (outside of data centres), including a prolonged slump in factory construction that suggests tariffs have yet to incent reshoring.

The expansion has helped the labour market regain its footing. Monthly gains in nonfarm payrolls have averaged 114,000 in the first five months of the year, compared with average losses of 22,000 in the previous five months, and hiring has broadened beyond the health care sector (which continues to punch above its weight due to an aging population). Meanwhile, layoffs remain subdued, apart from ongoing restructuring in the technology sector that is partly due to AI, according to Challenger. Renewed hiring has stabilized the unemployment rate at 4.3% in the past three months, unchanged from a year ago.

Still, a few stress points could pierce the economy's armour. The personal saving rate has fallen to levels (2.6%) often seen before periods of economic and market stress, such as the 2022 inflation surge, the 2008 financial crisis, and the 2000 tech bust. The low saving rate reflects two forces: the torrid rise in equity values, which is boosting demand among higher-income households; and the renewed climb in inflation, which is eroding the spending power of lower-income earners. Annual CPI inflation jumped to 3.8% in April and will likely exceed 4% in May. Assuming a peace deal leads to the reopening of the Strait of Hormuz, inflation is expected to retreat in the second half of the year. Strong productivity growth (2.8% y/y in Q1) has unit labour costs running at just 0.5%, implying limited cost pressure in labour markets.

Still, the renewed rise in headline inflation, alongside broader stickiness, poses a dilemma for new Fed Chair Kevin Warsh. He may still want to lower policy rates once oil prices retreat, believing AI-driven productivity gains will cool inflation. However, more policymakers are inclined to stand pat until inflation shows clear signs of easing and to raise rates if it does not. The market is pricing in a quarter-point increase in the fed funds rate by year-end. Assuming a resolution of the Iranian conflict leads to lower oil prices, we lean toward the Fed trimming rates two more times, though we have delayed the timing to next year.

Canada: Hard to keep a weak economy up

Unlike its neighbour to the south, Canada's economy is struggling to move forward. Real GDP has contracted in three of the past four quarters to Q1. Back-to-back quarterly declines meet the popular definition of a "technical recession" and the slight dip in the past year checks the duration box for an official downturn (assuming it is not revised away). The slump reflects persistent headwinds that have sapped the economy's vitality, including tariffs that are holding back exports; uncertain trade policies that have discouraged business investment; and, more recently, higher gasoline prices that have clipped consumer spending power. In addition, structural impediments include a shrinking population and declining productivity, the two main long-run drivers of growth.

Still, the contraction lacks the depth and breadth that are hallmarks of an official recession. The 0.6% annualized decline in the past two quarters compares with a cumulative decrease of more than 5% annualized in the worst two quarters of the past three recessions (excluding the pandemic). Moreover, the slump is not spread across regions, sectors, or expenditures. Instead, it is largely concentrated in tariff-hit Ontario and Quebec; in the manufacturing and construction sectors; and in exports, business investment, and some regional housing markets. The C.D. Howe's Business Cycle Council, the official arbiter of recessions, notes that "GDP increased in more than half of the sectors in each of the first three months of 2026", one reason that it is "too early to call a recession". Although dampened by resetting mortgage payments, consumer spending growth remains decent (2.0% y/y). Expansionary fiscal policy and business investment in computer hardware and software (up 7.9% y/y in Q1) are providing some support. Also noteworthy, an alternative measure of economic performance, real gross domestic income, rebounded in Q1 (2.7% a.r.) and remains positive in the past year (0.6%).

Reassuringly, real GDP rose 0.4% in April, according to the flash estimate, and looks to increase 1.0% annualized in Q2. Although the poor start to the year could limit growth to just 0.5% in 2026, we continue to expect a pickup to 2.0% in 2027, assuming the Strait of Hormuz reopens. In addition, while the sharp rebound in May employment (87,800) did not fully erase the losses of the prior four months (-112,300), it did reduce the unemployment rate to 6.6%, which is down from a peak of 7.1% in September. Employment is up 147,000 in the past year (0.7%), though four-fifths of the increase is in health care.

The weak economy is acting to contain inflation. Although rising fuel costs pushed CPI inflation to 2.8% y/y in April, the ex-gasoline measure is tracking the 2.0% target, and most core measures are in this ballpark. Still, the market is fully pricing in a quarter-point rate hike by year-end, and Bank of Canada Governor Macklem has warned of potential "consecutive" rate hikes if rising fuel costs trigger a broader rise in inflation. We continue to see steady rates for the foreseeable future.

Uncertain U.S. trade policies remain the biggest threat to Canada's economy. The country (and 59 others) was recently cited by the U.S. for unfair trade practices related to the enforcement of a ban on imports produced with forced labour. While Canada could face a new 10% levy, the duty-free exemption on USMCA-compliant goods would still apply, mitigating the economic impact. The greater threat is if the U.S. exits the North American free-trade deal, as large, widespread tariffs would likely lead to a Canadian recession.