Potential Impacts of U.S. Tariff Threats

Canada has more to lose from a trade war, but there would be impacts to the U.S. economy as well. According to the U.S. Energy Information Administration, 60% of U.S. crude oil imports originated from Canada in 2023. Additionally, Canadian crude oil was responsible for 24% of U.S. refinery throughput in 2023, highlighting the importance of Canadian energy products to the U.S. Across the board, tariffs on Canadian goods would lead to higher gas prices for U.S. consumers and higher input costs for corporations. The U.S. administration is aware of this possibility, which is likely why it subjected Canadian energy imports to a lower 10% tariff rate on February 1.

While the tariff threats should be taken seriously, there is a chance they could be used as a negotiating tactic. President Trump opted to delay tariffs for Canada and Mexico when both countries vowed to increase their security presence at the U.S. border. Willingness to make concessions to the U.S. administration throughout the negotiation process could soften the blow.

Impact on inflation and central-bank policy

As expected, the Canadian Department of Finance announced retaliatory tariffs of 25% on roughly $155 billion worth of U.S. imported goods, which would have gone into effect on February 4. These tariffs were ultimately delayed for one month following the agreement on February 3. If the U.S. imposes tariffs on Canadian goods in the future, we’d expect Canada to retaliate, as it did in early February. Under this scenario we’d expect the combination of retaliatory tariffs and a weaker loonie to put upward pressure on Canadian inflation, particularly goods prices.

However, we’d expect these inflationary pressures to be offset by weaker economic growth. The Bank of Canada (BoC) would likely view a rise in inflation due to tariffs as transitory and continue normalizing monetary policy through interest-rate decreases. Without tariffs, we expect the BoC to bring its policy rate down to around 2.5% over the course of the year, but more aggressive rate cuts are possible if the U.S. moves forward with its 25% tariff threat.

South of the border, given the heavy reliance on Canadian energy imports, tariffs on Canadian goods would likely lead to higher U.S. headline inflation through a rise in energy prices. However, a lower 10% tariff on energy imports would lessen the sting. While the Federal Reserve (Fed) targets the core personal consumption expenditures price index as its preferred measure of inflation (which excludes food and energy prices), a rise in energy prices would be unwelcome, as it can lead to higher costs down the supply chain if elevated energy prices are sustained. We still believe the bar for a Fed rate hike is high, but a 25% tariff on Canadian goods and a 10% tariff on energy imports would likely put additional Fed rate cuts on hold in the near term.

Impact on markets

If tariffs are implemented, their effect on the stock market could be less pronounced compared with their impact on the broader economy. Approximately one-third of the revenue generated by companies in the S&P/TSX Composite comes from the United States, with the technology, industrials and utilities sectors having the highest share of U.S. revenue.* However, some of those sectors that export large amounts of goods to the U.S. have small representation in the Canadian equity market. For example, automotive components are the second-largest category of exports after oil, gas and minerals, accounting for 10% of Canada’s exports to the U.S.** Yet, the industry only represents 0.5% of the TSX’s total weight.* The primary companies producing and exporting these goods to the U.S. are Ford, GM and Stellantis, all domiciled in the U.S.

Conversely, many of the largest sectors in the TSX don’t export physical goods to the U.S., and therefore wouldn’t be directly impacted by tariffs. For example, the financials sector, which comprises roughly one-third of the TSX, would see limited direct impact from a tariff on goods exported to the U.S. However, the indirect effect of slower economic growth could weigh on broader performance over time. 

The sectors most exposed to tariffs in the near term are energy and materials. For these sectors, however, commodity prices – not tariffs – are likely to be the primary driver of performance. Trump’s energy policies may have a greater influence on earnings than tariffs.