Stephen Meurice: Canadians are breathing a sigh of relief, at least for now. The threatened 25% tariffs by the United States on Canadian goods did not come into effect on Tuesday. But they haven’t been canceled. They’ve just been paused for 30 days while the U.S. and Canada negotiate some economic issues. So, what are Canadians to make of all this? As always when we need help breaking down major economic news - we turn to Scotiabank’s Chief Economist, Jean-François Perrault. He’s here to give us his analysis on what’s happened the last 72 hours, the impacts these proposed tariffs could have on the Canadian economy, why there’s potentially some light at the end of the tunnel, and much more. I’m Stephen Meurice and this is Perspectives.
JF, welcome back to the show.
Jean-François Perrault: It's lovely to be back.
SM: So we are speaking on the morning of Tuesday, February 4th, first thing in the morning. And I'm only mentioning that because, as we know, things tend to change fairly quickly these days. But we'll just rewind a little bit. The last 48, 72 hours have been a whirlwind, to say the least, from President Trump announcing the imposition of tariffs on Canada, ultimately, the Canadian government responding with retaliatory tariffs of its own on Saturday. Everybody worried on Sunday. Monday comes a couple of phone calls. Can you just catch us up on what happened yesterday and where we stand now?
JFP: Well, for the moment, because this is important to note, because things are extremely dynamic with President Trump, we seem to have gotten a 30-day extension on the tariffs. But it's a little bit more conclusive than just kind of a 30-day extension suggests, because the plan that we proposed on the border and on fentanyl seemed to meet his approval. And, of course, the reason that he was well, one of the reasons that he was threatening tariffs on Canada was this border issue. And illegal crossings and fentanyl, which really are not big issues from a Canadian-U.S. perspective. But he was focusing on those. So, the plan was presented to him yesterday, the same plan I think, that was presented many, many, many weeks ago from the Canadian side. And now he certainly indicates that that seems like it does the trick on those issues.
SM: Although it seems there's a little bit of extra money and a couple of extra details around that as well.
JFP: Sure. I mean, so we're creating a fentanyl czar. And the Americans are actually putting some money into some intelligence-sharing resources. So, it's a little bit more than what was offered a few weeks ago, but at the margin. I think the more interesting part of this going forward is he also indicated that over the next 30 days, he looks forward to negotiating an economic deal or making progress on an economic deal with Canada. So that puts it more into the proper trade camp. Thinking about trade issues from a trade perspective as opposed to from a national security perspective. We're not sure what that means. Does that mean that we’re going to accelerate the renegotiation of CUSMA, which is due for next year? Are there some other things there? But it does sound like it's going to be a more grounded discussion around the economic realities and the economic complementarities of Canada and the U.S. and Mexico as well. So that suggests a little bit more certainty to the outlook. We're coming back to I think, hopefully, to some basic economic concerns here.
SM: Right. As you said, his stated main concern was around these border issues that certainly you can argue about, many people have, the extent to which that was a real issue. Other things were floated at various times. His reasoning does seem to change a bit.
JFP: That's been one of the challenges with Trump. Sorry to interrupt you, Stephen. But that's been one of the challenges with understanding what President Trump wants. So there's a real shotgun approach to reasons to want to be interventionist on the trade side, which has made it very difficult to get a real sense of, okay, what is it that President Trump ultimately is trying to achieve out of threats, to get a bead on, ‘Okay, what is a likely outcome at the end of the day from all these things?’
SM: Right. So, and as you said, he specifically mentioned economic issues. And probably a good thing, as you as you said, that now we're moving into sort of firmer territory in terms of there are specific issues that we can discuss and that perhaps there can be progress made on. Are there any of those, and I know as you just said, it does tend to move around, a bit of a shotgun approach when it comes to the president. But are there some specific trade irritants that are likely to come up that Canada potentially could be pressured into making concessions on?
JFP: I mean, the one he's talked about the most and it's not an irritant, but it's the auto industry. And the fact that we have auto plants and auto parts plants in Canada that ship stuff to the U.S. and shipped out to Mexico and back and forth. And that's the one he's probably been the most vocal on. Now, there are no irritants there. I mean, there's a trade deal that governs that relationship, which was, in fact, renegotiated when he was president the first time around with a specific focus on autos. The operating conditions to the auto sector is one in which President Trump agreed to a few years ago. That's the one that comes up the most often. But it's not really an irritant. We know that in the campaign he talked about dairy a couple of times and post-NAFTA renewal during his first term, where he said this was the greatest deal in the history of trade deals once it was done, I mean, he did once in a while talk about Wisconsin dairy farmers not being able to sell into Canada. Now, that's, I think, a pretty minor irritant in the greater scheme of things. I mean, I suppose he could come back to that. But it's not, again, it's not clear at all that he's got a specific objective in mind, a specific irritant in mind. You know, he's talked about the Canadian banking system more recently. These are all things that he says, none of them appear to be based on a high degree of conviction or high degree of analysis.
SM: But one way or the other, he will come back with some kind of a list of demands or something. So, there will be a negotiating process that will go on and hopefully it'll take place in the way that these things normally do, as they did with the renegotiation of NAFTA. And we'll see. So, all that will happen. We'll see what happens over the course of the next 30 days. What is the impact now? Because this is a pause. It's a reprieve. It's not the end of the issue. What is the ongoing impact for the Canadian economy and Canadian business? Even though markets seemed to react pretty tepidly, even yesterday before this agreement was struck.
JFP: No, I mean, clearly the fact that we're not subject to tariffs now is good news. There’s no question about that. But the reality is that there was this issue of uncertainty. The threat of 25% tariffs was a really dangerous threat. 25% tariffs on us from the U.S. is probably a significant recession in Canada. And of course, as you get closer to the time in which you said we're going to do these things, the more there's some anxiety out there. Understandably so. So, the short run impact of trade threats is more on the uncertainty side and how businesses and households respond to that. Right, if you're not sure if your inputs are going to cost you more, you're not sure what your access to the American market is going to be, you’re not sure what the exchange rate is going to be, then you think about capital spending a little bit differently, more cautious. Maybe you bring in a whole bunch of imports ahead of time to get around what might happen on the tariff side. Maybe you try to sell a whole bunch of stuff ahead of time in the U.S. to get around some of these things. Maybe you think about planning differently from an operational perspective. You know, ‘Do I need to fix my supply chains? Do I need to look for another market for this good that I haven't been selling anywhere else?’ So all this stuff creates uncertainty that depresses to some extent, business activity, economic activity. So, we're expecting to see a little bit of softness, even if we get a break on tariffs, a little bit of softness because businesses have been careful and cautious and worried about the world in which they operate.
SM: Because they can think about ways to mitigate potential tariffs, whether it's trying to find new markets, all the things that you mentioned. But they're going to hesitate even to make those changes in their own supply chains and their own investment decisions until they know what the actual what the actual situation is.
JFP: Of course. Businesses are gaming things out, ‘What if this happens? What if that happens? What of this?’ Because that's part of the issue with not knowing exactly what Trump wants is you're not sure which lane you're going to be in for how long you’re going to be in that lane. So, you got to you got to do scenario analysis, ‘Okay, what if this or that or this or that? And how do I think about running the business in that context?’ And running a business is difficult in the best of days, when you're adding on layers of complexity in the environment you're operating or potential layers of complexity, it makes it even harder.
SM: Right. And that's not going away for the next little while.
JFP: It's probably not going to go away. So yeah, we can take comfort from the 30-day thing, but there is going to possibly be tariffs in 30 days. Probably not. But possibly. So, we might be in the situation where there’s this kind of rolling uncertainty. I doubt very much we're going to be in a world where Trump against any country says, ‘I'm never going to put tariffs on you.’ And that's something that we're probably going to get accustomed to. And we saw some of this in the first term. Uncertainty was elevated. The first few months of his presidency were like traumatic for Canadian businesses and global businesses. Like, ‘Okay, how do we how do we think about this? How do we manage all this uncertainty?’ And over time, you know - things normalized.
SM: Right. So we've heard some politicians recently and others I suppose, talk about the need to tariff-proof Canada and in some way that in the longer term we have to change things in such a way that we are less vulnerable to this kind of action from our main trading partner. Now we live right next door to them, they’re the biggest, richest economy in the world. So, it only makes sense that that's where most of our trade would go. It's what? Over 70% of our exports go to, they go to the United States? Which just makes sense. So, what does tariff-proofing Canada mean in reality? And what are the things that governments in Canada or businesses could do to try and achieve that if it's even achievable?
JFP: So long as you're trading with countries, there is tariff risk. That could always happen with China, could always happen with Europe. So, it's less about tariff proofing your economy and more about how do you transform your economy that makes you less vulnerable to tariff shocks or to trade policy shocks. So, the more competitive you are, the more productive you are, the more resilient you are in the face of these things. So there, one of the one of the I think, really good things about what's occurred as we are forced to reevaluate our relationship with the U.S. is there is, I think, a bit of a reckoning going on in the political class and the business class and across everyday Canadians that we need to do things a little bit differently here. We can't surf as we have to some extent. So, we need we need to fix our productivity issue. We need to find ways to raise investment. We need to trade more inter-provincially. We need to remove regulations around various things. We need to improve permitting. We need to use our natural resources more than we have been able to or willing to do the last number of years. So I hope there's going to be a lot of stuff happening on that front over many months, perhaps many years. None of those things are going to have a big impact in the short run. But they have the potential to transform our economy in a pretty significant way over the next number of years. It's not at all impossible that we come out of this as a country three or four years down the line in a much stronger shape than we are currently on track to be, just because we've kind of been shaken out of our torpor. And people are taking this seriously.
SM: Maybe unfair under the circumstances, given all the uncertainties that you've already spoken about to ask about the direction of interest rates or growth in Canada. I mean, I'm sure you and your team are rethinking your projections on those things. Any initial thoughts?
JFP: We are rethinking them and it's not an obvious rethink. I mean, clearly uncertainty is high. Clearly, there's some threats on the trade side that are more real than perhaps some would have thought many months ago. Some in the markets do. So that's obviously no good for growth. That gives you a bit of a damper on the growth side. You set that against, though, what oddly enough, we're seeing on, say, the household spending side, which is there really hasn't been much of an adjustment so far. In fact, we just got auto sales for the month of January yesterday. Very strong increase in the month of January. So, households are still seemingly engaged. On the one hand, we've got kind of backward-looking economic data which suggests the economy is in better shape than we thought, which would lead you to revise your forecast upwards. Set against probable we some weight from uncertainty is lowering business activity of some sort. So, we had 2% growth forecast in our December forecast, which is our most recent forecast, which is a bit dated, but the numbers have kind of worked out in line with that. We'll probably take that down a little bit. We had thought the Bank of Canada was more or less done. We're more open to a cut because of course, if the economy's a little bit weaker because of these trade things and you don't get the tariffs and you get the inflation coming from that, it actually gives the Bank of Canada maybe a bit of scope space to react to this uncertainty shock. But even in a world where there are tariffs, the government made it clear over the weekend that their retaliation to tariffs from the Americans on us would be partial. For whatever it's worth, about a third based on what we announced over the weekend. And that degree of retaliation is really important in calibrating how the central bank responds. So, if, in fact, we end up with tariffs in 30 days, and it's, I don't know, 10%, like some number. And we do we respond on a third of those. That is probably a response that allows the Bank of Canada to focus more about the growth impacts of the tariff shock as opposed to the inflationary consequences of the tariff shock. If we're in a world where the government responds more. 100%. One for one. As the Prime Minister said he was going to do a little while ago, then you’re importing a lot, you're creating a lot of inflation domestically, then it makes it much harder for the Bank of Canada to cut because you got a lot of inflation, in part because of tariffs and shrinking growth. Now that balance is, I think, tilting on the favour of allowing the Bank of Canada to help out a little bit more. So, we're probably in for a little bit more cuts on the Bank of Canada side.
SM: So if we wanted to be sort of Pollyanna-ish about this, we've got this 30-day period where we're going to be discussing economic issues with the United States, I guess the same thing goes for Mexico. I guess that at least leaves open the possibility that you have something like what happened with renegotiation of NAFTA and things kind of normalize after that. And then we go back to having these three significant economies trading back and forth in a positive way.
JFP: Yeah, And certainly that seems much more likely now that it was 24 hours ago. [laughs] Now, is that so likely two weeks from now? I mean, depends on, I guess, how President Trump responds to various things. But it seems that he's adopting a much more constructive tone on Canada-Mexico-U.S. trade relative to the last several weeks. And if that lasts, then, yeah, I mean, there is reason for some optimism. Now, that being said, he's also threatening Europe with tariffs. And a U.S.-EU trade war could be damaging. He's also threatening tariffs on a broad range of commodities and certain types of imports, which could hurt the Americans. And of course, hurt Canada and Mexico at the same time. So we're nowhere near out of the woods, even though we might have resolved over the next several weeks through kind of bilateral, trilateral issues. There still is this perspective on like, what is this question about what is President Trump's end game on trade? Is it to eliminate the trade deficit? Is it because he wants revenues or is it – and that creates uncertainty in markets, it depresses economic activity while causing a lot of worries.
SM: Okay. We'll just wrap up. What's the main thing Canadians should take away from what's happened in the last 72 hours?
JFP: Well, I mean, firstly, no question that there's some positive momentum here. That this is a less risky environment than we feared for the last several weeks. It's not a no-risk environment. But there's significant improvement in kind of the climate. The second is, that as a result of that, the risks, the downside risk to the economy are probably muted relative to these worst-case scenarios. And maybe we end up with a little bit lower interest rates on the part of the Bank of Canada. So, it's a much less worrisome economic outlook. It's not to say that we're out of the woods. But the risks are significantly reduced relative to the fears that we had over the last couple of weeks that we were basically facing economic chaos.
SM: JF, thanks so much for joining us. Really appreciate your insight.
JFP: Thanks, Steve.
SM: I've been speaking to Jean-François Perrault. He is the Chief Economist at Scotiabank. Thanks for listening.
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