How will a second Donald Trump term impact the Canadian economy?

With notes from Brooke Thio.

Donald Trump is now ensconced as the 47th U.S. President Elect, and with his stunning re-election comes many questions – including what a second Trump term means for the economy.

Deeply protectionist “America First” policies have been a cornerstone of Trump’s election campaign, calling for widespread deportations, challenging the independence of the Federal Reserve, as well as introducing steep tariffs on all imports.

According to Trump, these measures will “eradicate” inflation, boost American jobs, and lead to a prosperous middle class – but economists have raised concerns that they’ll actually stoke inflation and cause an American recession. Such an event would have deep consequences for the country’s trade partners – particularly Canada.

Let’s break down how these promised economic policies could play out, should they actually be implemented during Trump’s term.

The immediate election aftermath: Markets are up

Markets around the world surged on the news of Trump’s re-election due to the “Trump trade” effect – expectations that the deep corporate tax cuts, loose regulations, and increased fiscal spending that earmarked his first term will once again boost business earnings and stocks. 

Wall Street, the Dow, S&P 500, and the TSX all experienced strong futures rallies the morning of November 6th, with similar activity in the European and Asian markets. Commodities are also set to benefit from relaxed rules and tax cuts.

The U.S. Dollar surged, trading at 71.92 U.S. against the loonie, compared to the previous range of 71.69 U.S. cents to 72.35 U.S. cents.

Rising bond yields could push fixed mortgage rates higher

Bond yields have also shot upward, with the yield on the 10-year U.S. Treasury note – which acts as a benchmark for the cost of American and global debt – up to 4.460% on the news of Trump’s victory, a daily jump of 17 basis points. Two-year yields have increased seven basis points to 4.278%. That’s the highest both yields have sat since July. When yields – especially the 10-year term - rise, it can reflect growing fears of future economic risk, including recession and rising inflation.

In Canada, the five-year government of Canada bond yield, which underpins the cost of five-year fixed mortgage rates, is currently at 3.116%, up from its open of 3.062%.

As lenders take their pricing cues from the bond markets for their fixed-rate borrowing products, this could put upward pressure on Canadian fixed mortgage rates in the weeks to come.

Re-ignited inflation fears

Of course, the main impetus behind rising yields are renewed fears of runaway inflation, and that central banks won’t be in a position to cut interest rates as aggressively as previously thought. 

While Trump has claimed that inflation will “vanish completely” under his watch, economists’ analysis beg to differ, saying his protectionist policies will aggressively drive prices higher. This will more than undo the efforts of the Federal Reserve, which, like the Bank of Canada, has toiled to tame the Consumer Price Index with a series of rate hikes between February 2022 and July 2023. That progress was notable this September, in which the measure fell to 2.4% after reaching a 40-year peak of 9.1% in June 2022.

These risks were outlined in a letter written and signed in June by 16 Nobel Prize-winning economists. In it, they state:

“Many Americans are concerned about inflation, which has come down remarkably fast. There is rightly a worry that Donald Trump will reignite this inflation, with his fiscally irresponsible budgets. Nonpartisan researchers, including at Evercore, Allianz, Oxford Economics, and the Peterson Institute, predict that if Donald Trump successfully enacts his agenda, it will increase inflation. The outcome of this election will have economic repercussions for years, and possibly decades, to come.”

The letter points to research conducted by the Peterson Institute for International Economics, which found that should Trump’s policies come into force, inflation could skyrocket between 6% and 9.2% by 2026, rather than the 1.9% it’s currently on track for. The report also forecasts that US GDP would fall between 2.8% to 9.7% lower than its expected average annual baseline between 2025 to 2040. Employment, while initially enjoying an increase, would ultimately fall by 2.7% to 9% by 2028.

The impact on the Bank of Canada and variable mortgage rates

None of this bodes well for the Canadian economy, which follows similar inflation trends to the United States. Recent economic data has shown both inflation and economic growth are slowing in Canada, which has prompted our own central bank to start cutting its benchmark borrowing rate, which it has done four times since June, bringing it down from 5% to 3.75% in October. 

Should inflation start to rise again without corresponding economic growth, that will put the BoC in the position of having to tighten its monetary policy – either by holding rates, or eventually hiking them. This will further squeeze Canadian consumers, who are already feeling the effects of a higher cost of living, and trend of higher interest rates. A rate hold or hike would have an immediate impact on variable mortgage rates and variable rate loans, which are directly based on the BoC’s benchmark Overnight Lending Rate.

Higher inflation in the U.S. also reduces the chance that the Fed will slash its own interest rate at a quick pace, which could also put the two central banks on different rate cutting paths; should the BoC continue to aggressively cut rates while the Fed holds or hikes, that will further weaken the Canadian dollar.

The impact on Canadian banking products

In contrast, however, rising bond yields can be good news for Canadian savers and investors.

Banking products such as high-interest savings accounts and GICs have already seen their rates coaxed down by the BoC’s rate cuts. That said, with their relative stability and secured capital, these remain an essential piece of any financial portfolio — and could be a lifebuoy for consumers amid market volatility for stocks and other high-risk investments.

Rising yields further pad the pockets of Canadian lenders, which could lead them to increase the savings rates on these passive investment and savings products.

The pain of promised tariffs

What packs considerable consequences for Canada – and economies worldwide – are the stiff import tariffs Trump has proposed for all goods entering the U.S., including a 60% upcharge on Chinese imports, and 10 - 20% on everything else.

As the U.S. is Canada’s main trading partner – a whopping 77% of Canadian exports go south of the border, totalling around $650 billion in 2023 – should this policy be affected, it will have serious impacts on Canadian GDP, productivity, and individual income.

A report authored by Trevor Tombe, Professor, Department of Economics at the University of Calgary for the Canadian Chamber of Commerce’s Business Data Lab, posits that a 10% tariff, combined with “retaliation from other countries” would lead to a loss of $45 billion for the Canadian economy, and a 1.6% dip in productivity. The policy would cause downturns in critical sectors such as energy, motor vehicles, transportation equipment, and chemicals, and potentially impact 2.4 million Canadian jobs within the exports industry. 

However, Tombe points out, the pain of these policies won’t just be felt on our side of the border; Canada is a crucial supply chain partner for many American companies, and is the “export destination for 34 U.S. states.” Furthermore, about 12% of the  total value of Canadian exports to the U.S. consists of value added that originates from U.S. producers – meaning those exports to the U.S. also support jobs and wages for businesses there.

“Several U.S. state economies are surprisingly dependent on Canadian trade. In Montana, trade with Canada accounts for 16% of the state economy, in Michigan it’s 14% and in Illinois it’s 10%,” he writes. “Even as far away as Texas, trade with Canada still accounts for 4% of the state economy.” 

Tombe adds that, according to Statistics Canada, the total value of Canadian investment in the United States was just under $1.1 trillion. “In comparison, U.S. direct investment in Canada was nearly $620 billion that same year.” 

Finally, Tombe points to a similar –and very short-lived 10% tariff policy that was enacted by President Nixon in 1971. “That policy—which was much narrower than Trump’s recent proposal—was a disaster and was quickly reversed,” he says.  

The bottom line: A weaker economy and rising inflation for Canadians

Overall, the implementation of protectionist U.S. trade policies, and their inflationary effects, pose challenges for Canadians businesses, consumers, and our central bank. While it remains to be seen just what will be put in force (these are election promises, after all) there’s plenty of reason for mortgage and savings  watchers to pay attention to where yields – and rates – are headed.

Also read:

• Bank of Canada cuts target interest rate by 0.5% in October announcement
• August GDP sees 0% growth, supporting future rate cuts
• US Federal Reserve ends four-year rate hold with jumbo rate cut