What does Trump’s victory mean for Canada? All roads lead to a weaker loonie

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By Dylan Smith

While the whole world is engaged in a massive “risk-on” Trump trade, the mood is far from buoyant in the “51st” state, with concerns over the economic implications of Donald Trump’s agenda for Canada top of mind on Bay Street and Parliament Hill.

We should point out that nobody really knows the implications of Trump’s win for America yet, never mind Canada. United States Federal Reserve chair Jay Powell said it best in his press conference last week: “We don’t know what the effects on the economy would be, specifically whether and to what extent those policies would matter …” So, we’ll admit right off the bat that we’re engaged in some second-degree speculation here.

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Put more concretely, we don’t know yet if there is a congressional majority for tax cuts (fiscal conservatives on both sides of the aisle are conscious of the already precarious fiscal starting point); we’re not sure if tariffs are a policy priority (as former U.S. trade representative Robert Lighthizer thinks) or a bargaining chip (the view of most other Treasury Secretary candidates); nor whether they’d include tearing up the United States-Mexico-Canada Agreement. It is also too early to say whether the administration will have the stomach for an unpopular and unsightly mass deportation scheme.

First, interest rates will continue to diverge. The Bank of Canada has been easing aggressively — delivering 125 basis points of cuts this year — and needs to go a lot further just to get its stance to neutral. The Fed has been easing too, of course, but, though we think it’s also going to “neutral” at the very least, its cuts will be more gradual since the U.S. economy is stronger than Canada’s.

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As a result of these two distinct easing paths, the margin between two-year U.S. Treasury yields, at about 4.25 per cent, and the Canadian equivalent, at about 3.1 per cent, is 115 basis points, the widest since (get this) 1997.

And while we don’t agree with the markets that the Fed’s terminal rate should be closer to 3.5 per cent instead of the Fed’s estimate of below three per cent, it’s true that the risks to our view have shifted to the upside, especially on the two-year-plus segment of the yield curve. So, if we’re wrong on the Fed, that only means higher U.S. interest rates relative to Canada, a larger interest rate divergence, and a weaker loonie.

66-cent loonie

If anything, the loonie looks a little too strong at the current level, about 71.4 cents U.S. We get a valuation of 66.7 cents on the nose when we run a simple model of the exchange rate on the differential between two-year government rates, and that’s before you consider that tariffs would strengthen the U.S. dollar (and weaken the Canadian dollar) further.

The second factor is fiscal developments, which also point to a wider rate divergence and a stronger U.S. dollar. Should Trump’s plan of cutting corporate and other taxes be implemented, the U.S. looks set for even larger deficits. And even if the 2017 tax cuts are only extended, the prospect of a much-needed fiscal consolidation remains slim: deficits will remain high and the interest burden will continue to grow as a share of total expenditure.

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This is the risk that bond markets have priced in as a result of the election (excessively, in our view). The fiscal implications of a Trump presidency on the margin mean that rates could be even higher in the U.S. relative to Canada compared to if the Democrats had won. What’s more, should the Conservatives win a Canadian election (as their overwhelming polling lead suggests), we could see a fiscal consolidation in Canada that would strengthen this dynamic.

Poor productivity

Third, the loonie could suffer from a further erosion of Canadian competitiveness. Canada has already been sliding in the global competitiveness rankings, falling to 18th in 2024 from eighth in 2020, according to the World Economic Forum. Canadian productivity is stagnant while the U.S. surges ahead, a major structural headwind for the loonie, which must weaken in response to keep Canadian exports competitive.

Indeed, eroding competitiveness has been a major reason for the pushback against the Canadian government’s capital gains inclusion rate hikes in the 2024 budget (most of those proposals are still held up in Parliament).

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Commodities a wash

Fourth, commodities look like a wash from a macro perspective for Canada. Trump will certainly be pro-oil, boosting domestic oil production and lowering prices compared to what a Kamala Harris administration may have done. But Trump is starting with the oil price relatively low (West Texas Intermediate is under US$70 per barrel) and with limited room to fall before bumping up against U.S. producers’ marginal cost of production.

Meanwhile, we think gold prices will continue to rise under a Trump presidency due to the generally high levels of policy and geopolitical uncertainty and the perceptions of fiscal and inflationary risks pushing “gold bugs” back into their natural asset class (and supporting Canadian exports).

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What does this all mean for markets? Obviously, we would recommend hedging out loonie exposure wherever possible, and we retain our high-conviction bullish call on the long end of the Government of Canada bond yield curve.

We can also make a few suggestions on equity positioning based on our prior analysis of the correlations between S&P/TSX composite sectors and the exchange rate. Back then, we suggested piling into technology, media and telecom and staying away from financial services and import-sensitive sectors such as materials and consumer staples.

What changes in the Trump context is that it’s harder to recommend going long on goods producers with a large U.S. export market considering tariff risk (despite the benefits of a weaker loonie). That said, service exports are less likely to see tariffs, so those stocks look like a sweet spot.

Dylan Smith is a senior economist at independent research firm Rosenberg Research & Associates Inc., founded by David Rosenberg. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.

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