North American Outlook
February 04, 2026 | 10:42
2026 Outlook: Resilience and Risks
Economics
Economics
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United StatesAfter exceeding expectations last year, economic growth looks to remain solid at 2.6% in 2026 as tailwinds persist while headwinds subside. A solid push from AI-driven business spending, record equity values, and stimulative fiscal, regulatory, and monetary policies should more than counter lingering effects from the trade war, federal government cutbacks, and immigration curbs. On the tariff front, the second half of 2025 brought some relative stability, though little clarity on policy direction. The Supreme Court could rule that the international emergency duties that account for the majority of new tariffs are illegal. But this would only partially curb the Administration, and largely result in new duties under other trade acts. The USMCA will be reviewed this year and we assume talks will extend at least into next year. While Canada and Mexico have more to lose if the U.S. withdraws (after giving six months' notice), the economy would slow moderately amid disrupted supply chains and new counter-duties. We also assume the U.S. will extend a one-year trade truce with China, averting a sharp rise in tariffs between the two countries. Cuts to federal government spending and jobs peaked last year, suggesting a diminished drag in 2026. The same applies for immigration curbs, even as deportations continue. The previous shutdowns in the federal government, the longest on record, likely shaved about one percentage point from Q4 GDP growth, though the subsequent reopening will support a Q1 rebound. The recent partial closure was too brief to make a mark. Easing headwinds will allow prevailing tailwinds to dominate in 2026. Big Tech plans to boost spending on AI infrastructure (data centres, chip plants, and even energy sources to run it all), while other businesses are investing heavily in AI systems to drive productivity. The latter will weigh on employment, though evidence of a material effect to date remains mixed (our research suggests it's too early to tell). Whether AI spending can deliver a meaningful productivity payoff will likely determine whether the equity rally continues or corrects. An equity correction—with ten mostly AI-related companies accounting for over 40% of the S&P 500 market cap—would reverse the wealth effect that's driving upper-income household spending. |
The OBBBA's full impact will be felt in 2026 amid increased spending on defense and border security and lower taxes. The latter reflects increases in the State and Local Tax deduction, the standard claim for seniors, and the child tax credit, along with no taxes on most overtime pay and tips and accelerated deductions for business capital expenses. On net, tax breaks will reduce personal withholding rates and boost refunds this year, lifting consumer spending moderately. However, reduced subsidies for private health insurance and Medicaid, student loans, and food stamps will provide a partial offset. Total fiscal support could add half a percentage point to economic growth this year. The strong economy, however, is not translating into much job creation. Companies are trying to cut costs by improving efficiencies, with annual labour productivity growth trending at more than a 2% rate. Nonfarm payrolls rose just 50,000 in December, about a third of long-run norms, though the earlier deceleration is at least stabilizing. We expect the current unemployment rate of 4.4% to edge higher this year before declining in 2027. Despite the soft job market, inflation remains somewhat elevated, partly due to tariffs. While annual CPI inflation has slipped to 2.7% in December and the core rate to a near five-year low of 2.6%, shutdown-related data distortions (especially in calculating rents) likely greased the moderation. The Fed stood pat on January 28 after three straight rate cuts. The policy statement offered little guidance on the direction of future moves; however, Chair Powell hinted that the FOMC could remain on hold for some time, given improved economic growth and somewhat elevated inflation. He also said it was hard to tell whether lingering upside risks to inflation and downside risks to employment were evenly balanced, emphasizing that future policy decisions will be data driven. As a result, we no longer expect a rate trim in March, though we still see three more moves totaling 75 bps by year-end. This will require continued weak job growth, further progress on inflation toward the 2% target, and the ability of incoming Fed Chair Kevin Warsh (assuming he is confirmed by the Senate Banking Committee) to push the 12-member FOMC in a more dovish direction. However, even with easier monetary policy, concerns about the Fed's independence, inflation, and a large federal budget deficit will likely limit the 10-year Treasury yield from falling below 4% this year. Recent U.S. threats to use force to annex Greenland and impose new tariffs on several European nations came and went in Davos, but talks with NATO, Denmark and Greenland could still go off the rails. Iran and Venezuela are other possible flashpoints, though tensions on the latter have simmered down. CanadaThe best that can be said about Canada's economy in 2025 is that it likely skirted a recession, thanks to the tariff-free status of most goods shipped to the U.S., supportive fiscal and monetary policies, and the TSX's 28% rally. Still, real GDP growth likely slowed to 1.7% from 2.0% in 2024. Moreover, the annual average figure likely understates the true deceleration in activity, with GDP likely rising just 0.8% on a Q4/Q4 basis after surging 3.1% in 2024. We expect stronger 1.8% growth in 2026 (Q4/Q4, or 1.4% annual), assuming no nasty surprises on the trade front. Our critical assumption for 2026 is that the USMCA review will extend past this year, keeping the U.S. in the Agreement and preserving the compliance exemption on most Canadian goods. Potential issues for discussion include supply management and the Online Streaming and News Acts. The review could lead to a reduction of some sectoral duties, notably the 50% import tax on steel, aluminum, and some copper products, trimming the U.S. average tariff on Canadian imports from its current level of around 7%. Apart from a few hard-hit industries, the economy will largely adjust to the lower level of exports. Ongoing uncertainty, however, could cast a longer shadow on business confidence and investment. The impact of a USMCA breakdown would be far worse, potentially boosting the average tariff rate and triggering a moderate recession in Canada, even with significant policy support. Manufacturing industries that depend heavily on U.S. sales, including automobiles, electrical equipment, machinery, computers, and chemicals, would face dire consequences. Stimulative fiscal policies at both the federal and provincial levels should continue to cushion current tariff effects in 2026. Combined budget deficits are projected near 4% of GDP this fiscal year, or more than 2 percentage points above FY2024/24. Federal initiatives aim to jump-start investment by accelerating infrastructure, mining and energy projects, while reinstating full and immediate capital expense deductions and supporting tariff-impacted industries. The economy will also benefit from last year's 100 bps of rate cuts from the Bank of Canada. However, with the current policy rate (2.25%) at the low end of neutral, the easing cycle is probably over. The Bank held firm at the last two meetings, while indicating no need for further rate cuts, barring a surprise in its outlook of modest growth and inflation holding “close to the 2% target”. Still, given ongoing trade-policy risks, we suspect the Bank is more open to cutting than hiking should push come to shove. Although household-survey employment has rebounded strongly after contracting last summer, ongoing weakness in the establishment survey likely better reflects reality. The unemployment rate rose modestly in the past year to 6.8% in December and could inch higher, before declining as economic activity improves and labour force growth slows in response to immigration curbs. The latter have already brought the population to a near standstill in the past year, and little increase is expected this year and next. A stagnant population isn't helping the housing market. Still, home price risks are largely contained to Ontario and British Columbia, where affordability (though improving) remains poor. The Toronto area faces additional price risks from a glut of unsold condos, a surge in purpose-built rental construction, and a slightly shrinking population. However, so long as mortgage rates remain near neutral levels and the jobless rate holds relatively steady, home prices in the two provinces should stabilize this year. Elsewhere, prices could climb modestly, with regions currently seeing outsized gains, such as Quebec City, St. John's, and Moncton, reverting to more normal increases. After rising moderately against a weak greenback in 2025, the Canadian dollar is expected to appreciate further to The main risk to Canada’s economy stems from its tenuous relationship with its largest trade partner. Tensions recently rose when President Trump threatened a 100% tariff on all Canadian goods if the country makes a ‘deal’ with China. This follows Canada and China agreeing to reduce tariffs on some Chinese EV’s and Canadian canola products. Presumably, ‘deal’ means a free-trade deal, which Canada has already ruled out (and would be a violation of the USMCA), so the threat is unlikely to materialize. |
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