CIBC's Benjamin Tal at his Toronto office on Friday, June 7, 2019.Tijana Martin/The Globe and Mail
2025 will be a tale of two halves for the Canadian economy, according to CIBC’s deputy chief economist Benjamin Tal, with U.S. President Donald Trump’s tariff threats triggering a semi-recession in the first half of the year.
On Feb. 14, The Globe and Mail spoke with Mr. Tal who shared his thoughts on tariff threats and provided his outlook on the economy, markets and interest rates.
The stock market has been resilient with major North American indexes trading at or near record levels. Are investors dismissing the economic risks or are they optimistic that the deferral of tariffs may lead to reasonable outcomes?
You cannot talk about Canada without talking about Trump. So, we have to start with Trump.
The long end of the curve, namely the U.S. 10-year yield, went up dramatically. In September, it was 3.65 per cent. Now, it’s about 4.5 per cent. So, we’ve seen a significant correction in the bond market, and I believe that this correction was mostly because the market sees Trump as inflationary. I believe that the bond market is wrong on that.
Now, the stock market is much more optimistic about Trump barking but not biting. We have to realize that Trump, although extremely powerful and he’s using the might of the U.S. economy on his side, he has some weaknesses. Superman’s weakness was kryptonite, so I call it the Trump kryptonites.
Trump has a few kryptonites, and one of them is the stock market. Trump cannot stand the idea of the stock market falling under his watch. I think that’s basically what the market is believing - believing that he will not do something that will upset the stock market. I don’t think it was a coincidence that he extended the tariffs on Mexico and Canada to March on the same day that the stock market went down 2 per cent. So, I think that the market is believing that Trump is being guided by the stock market. He’s looking at these policies and what the stock market is doing. If the stock market is not liking it, then he will reverse it. So, that’s one vulnerability.
The other vulnerability is gasoline prices. Gasoline prices are extremely important to him, and therefore I’m convinced that, despite talking a lot about it, a 10-per-cent tariff on Canadian energy will not happen. In the U.S., they are consuming 21 million barrels of oil a day. They produce 13 million barrels per day, so they are short 8 million barrels of oil a day. More than half of these 8 million barrels are coming from Canada. Can you imagine if you impose a tariff on that? Canadian exporters will have the pricing power. All the increase of the tariff will be absorbed by the consumer through higher prices. So, that’s another vulnerability that he has.
Another vulnerability is inflation. At the end of the day, if he imposes tariffs, at least in the short term - and the short term can be a year - it’s inflationary. You don’t see any positive coming from a tariff in terms of employment and more investment. It takes time to change the supply chain, but the inflation story is immediate. Inflation is a major factor, and it’s already above the Federal Reserve’s target of 2 per cent, and now you’re risking more inflation and inflation expectations are rising. Remember, he was criticizing Biden during his election campaign about inflation, so you cannot have inflation under his watch.
The fourth kryptonite is time. We have to remember that mid-year elections will be two years from now. So, if you impose tariffs, the negatives will be visible immediately. Inflation will be visible immediately. The impact on many American companies will be immediate. The positive, if there is a positive, will take much longer and will be after the elections. So, you can lose the House of Representatives.
All those considerations are making him less powerful than perceived.
What do you think will occur on or before March 4, when tariffs of 25 per cent are set to be imposed on Canadian goods going into the U.S.?
I doubt that will happen. I think it would be way too much damage to the U.S. economy, and I think he’s using it as a negotiation tool. And if he is going to impose it, if I’m wrong, it will be for a relatively short period of time.
We have to ask ourselves the question, ‘What is the ultimate goal?’ Now, in my opinion, the ultimate goal is uncertainty and the tool is chaos.
I don’t think it’s a coincidence that he continues to postpone things because by postponing things, you keep the uncertainty going without any cost because you are not imposing tariffs.
It’s not a coincidence that he’s talking about180 days of studying reciprocal tariffs. That’s 180 days of not imposing tariffs but talking about it to add to the uncertainty. Again, you get the benefit of the tariff without the cost of the tariff because you are not really imposing the tariff, but people are trying to compromise with you.
Earlier, you said the correction in the bond market reflects the market’s expectation that tariffs will be inflationary – a view which you disagree with. Could you expand on your reasoning?
So, one of the reasons why the market believes that Trump is inflationary is the undocumented migrants.
There are 11 million undocumented migrants, and, if you deport them, as he suggests that he’s going to do, that will be a major hole in the U.S. labour market. Remember, those are low quality jobs that nobody wants to do. So, people will request higher wages to replace them. That’s inflationary because wages will go up. If you eliminate 11 million people from the labour market, it’s inflationary because there will be a shortage of those workers. He knows that. In my opinion, they don’t have the capacity or will to deport 11 million people. What they’re going to do is deport 500,000, 600,000 people, basically criminals. He’s not going to deport 11 million people. Therefore, it’s not as inflationary as perceived.
The point that I’m making here is that by making the lives of the 11 million people difficult, this is actually controlling the flow. So, the hidden agenda is not the stock of 11 million people because he knows that they need them, but the hidden agenda is the flow. So, if you are somebody from Mexico and you were thinking about going to the U.S., now will go to Canada or somewhere else, and that’s the challenge that we are facing. But that’s exactly his agenda.
The other reason why the bond market has been reacting the way it has been is due to the belief that fiscal policy under Trump will be out of control. Some numbers estimate Trump’s spending will lead to a $7 trillion increase in the debt over the next 10 years. The bond market is saying if the budget deficit is going to go up, there will be more issuance of Treasury bonds. That’s put upward pressure on the long end of the curve. I don’t think that will happen.
First of all, they’re talking about significant cuts in government spending with Elon Musk’s Department of Government Efficiency, which will reduce the amount of issuance necessary.
Another factor is Congress will not allow everything they want to do - the tax cuts for tips, Social Security and overtime - it’s too expensive. There are many fiscally conservative people in Congress, even from the Republican Party, so it will not be easy. Therefore, I think that the assumptions that he will be able to get whatever he wants in terms of spending will not happen and therefore, the budget deficit will not be as significant as perceived. That’s another reason where the bond market might be too enthusiastic.
And then the bond market is discounting a significant increase in inflation due to tariffs, I think that at the end of the day it will not be as bad because the tariffs will not be imposed the way the bond market is assuming.
If you understand what’s driving the 10-year Treasury yield, and if you follow it, it tells you what the market believes about Trump. To me, that’s where all the secrets are.
If we see long-term interest rates go down, it means that the market is getting less nervous about Trump and the inflationary impact of Trump. And I think that will occur in the second half of the year.
What are your 2025 Canadian economic growth and inflation expectations?
We believe GDP growth will be below 1 per cent in the first half of the year, basically a semi-recession, because of the uncertainty - even without tariffs. The slowing economy will be the number one factor impacting inflation and therefore we see inflation going below 2 per cent in 2025.
I’m getting a bit nervous about tariffs because he’s promised so many of them and nothing has happened. At some point, you will have to do it, otherwise you will lose all credibility.
So, I think it will be, especially in the case of Canada, tariffs, more targeted. I think he will go after steel. I think he will go after aluminum, but much less than a 25-per-cent tariff because they consume a lot of aluminum and they don’t have an alternative. If I’m in the dairy industry in Canada, I’m very nervous because I think he will go after dairy. And also forestry. I don’t think he will go after energy. I doubt he will touch the auto sector because the auto sector will have a negative impact on their auto sector. Tariffs will be narrow, not broadly based, but deep. I think there are a lot of people out there that will advise him to go with some tariffs, but where you’re not really causing too much damage to your base.
Whenever we talk about tariffs, we have to consider two things: how large the tariff will be, and, more importantly, for how long. Even if he imposes some tariffs, I don’t think that they will not last too long because of the damage to the U.S.
In my opinion, at the end of the day, we have the USMCA (United States-Mexico-Canada Agreement) being negotiated in 2026 - that’s way too far away for him. He wants to do it much earlier and he wants to change it. So, I think that he’s using all those tariffs threats as a way to start negotiating the USMCA.
Given that you forecast GDP in Canada will fall below 1 per cent in the first half of this year, what are your expectations for the overnight rate, which currently stands at 3 per cent?
I believe that the Bank of Canada will have to cut interest rates to 2.5 per cent or maybe 2.25 per cent.
What is your outlook for the Canadian labour market?
I find it hard to believe that the labour market will improve over the next six months. In fact, it will deteriorate. We see the unemployment rate getting very close to 7 per cent in the second quarter of the year before starting to go down.
We see peak uncertainty happening now and over the next few months. I doubt that companies will be adding jobs and some of them will have to reduce costs because of the lack of investment. So, I see that the labour market deteriorating over the next six months and then start recovering when the fog starts clearing.
Will tariff uncertainty prompt trade diversification in Canada?
We have been talking about diversifying our export and import markets away from the U.S. for a long time. Pierre Elliott Trudeau was talking about it back in the 1970s.
And despite the fact that we have a free trade agreement that includes 51 countries, our reliance on the U.S. is more or less the same as it was 10, 15 years ago.
Everybody’s saying we should diversify our export base, our import base away from the U.S. -easy to say but very difficult to do. Our supply chains are so integrated.
Ironically, I think that one of the compromises in a new USMCA will be that Canada should buy more from the U.S. So, I think that instead of diversifying away from the U.S., we will be more reliant on the U.S. Our dependency on the U.S. will rise over time, it will not decline. That will be part of the compromise.
Trump will say, ‘Let’s close this trade deficit, you have to buy more from the U.S.’. That’s exactly what he did with China in 2018. That’s exactly what he did with the European Union in 2018. It’s counterintuitive but I think that’s the direction Canada’s going.
Can you touch on the Canadian dollar weakness relative to the U.S. dollar?
It’s reflecting the fact that the Bank of Canada will be cutting its policy rate and the Fed will not be cutting.
We see the Canadian dollar trading between 69 cents and 71 cents, more or less where it is today. We will probably see the Canadian dollar rise in the second half of the year, or maybe 2026, as the U.S. dollar will start losing ground once the fog of uncertainty on tariffs starts clearing.
Anything else that you want to add that we didn’t discuss?
One thing that’s very important is the GIC story.
In the past year, year and a half, people invested in the safety of GICs with 5-6-per-cent interest rates. Now, interest rates are going down, which means GICs are less attractive. We estimate that between $200 and $300 billion of excess savings are now sitting in GICs looking for the exit.
And what is the closest proxy to GICs? It’s high-quality dividend paying stocks. Because remember the people that take GICs are relatively risk adverse. They’re looking for something that is a close substitute and that close substitute is high-quality dividend paying stocks. I think over the next six months we are going to see a significant transfer of money from GICs to those stocks.
And because these investors are risk averse, they would remain invested in the Canadian market then?
I think so.
How would you summarize your 2025 outlook for the Canadian economy?
I think it will be a tale of two halves. The first half will be semi-recessionary, very close to recessionary conditions. Then, it will improve in the second half, reflecting the fog clearing with regard to Trump.
This Q&A has been edited for brevity and clarity.