Canada Best Ideas 2025: Living on The Edge

Overview:

• The Canadian household sector has shown resilience but with risk in upcoming 2026 mortgage resets.
• Upcoming key catalyst events include the 2025 Canadian budget, rate decisions and the USMCA renewal deadline in 2026.
• The Canadian macroeconomic outlook themes include:
  1. Tariff Uncertainty: The outlook is clouded by U.S. trade policy.
  2. Fiscal Stimulus: New federal spending commitments and a more expansionary fiscal policy.
  3. Immigration Policy: The largest source of domestic uncertainty as the government aims to reduce the share of temporary residents.

Canada enters late 2025 under a cloud of uncertainty. Soft labour market data and negative Gross Domestic Product (GDP) growth in Q2 point to a deteriorating economic backdrop, though the household sector has nonetheless been more resilient than feared. We see risks skewed to the downside given ongoing trade uncertainty and slowing population growth, though fiscal policy stands out as a potential offset.

Catalysts and Milestones to Watch

• Late October: Canadian 2025 budget
• September/October/December: Bank of Canada rate decisions
• July 2026: United States-Mexico-Canada Agreement (USMCA) renewal deadline
• September/October: U.S. Supreme Court ruling on tariffs

What Are the Main Risks to Our Call?

As cliche as it sounds, the Canadian economy faces significant uncertainty as we head into the late stages of 2025. The starting point for the economy is fairly weak. The GDP contracted in 2025Q2, and we look for growth just above zero in 2025H2. We do not look for a recession, but the margin for error is razor thin. Inflation pressures appear to be moderating, and as such we believe the conditions are in place to support two more Bank of Canada cuts this year.

We see three key risks to our view:

• Broadening tariff impacts,
• More fiscal stimulus and
• Mortgage resets in 2026

Many of the risks facing the economy are, to some extent, two-sided. Take the tariff situation: while there is clearly scope for the Canada-U.S. trading relationship to deteriorate further, it's also plausible that the two countries could resolve the recent dispute. Nonetheless, it seems likely to us that the full impact of U.S. tariffs has yet to be felt in Canada, as the trade outlook has been too volatile for businesses to fully adjust to the new reality.

Fiscal stimulus risks are theoretically two-sided, but we'd be very surprised to see the government deliver less stimulus than promised. Certainly, recent announcements from the government suggest a risk of more spending, not less.

The final risk really focuses on the health of the consumer sector. Canadian household spending has been more resilient than expected over the last 18 months, despite painful mortgage resets in 2024 and sharply slower population growth through 2025. However, a large swath of low-rate mortgages renew in 2025; high household savings rates should provide a buffer, but there is still a risk that the next round of mortgage resets weigh on household spending. The overall balance of risk around our forecast tilts slightly to the negative side of the scale.

Theme 1: Tariff Uncertainty

The Canadian outlook remains clouded by uncertainty around U.S. trade policy six months after tariffs were first imposed. Exemptions for USMCA compliant goods have helped cushion the blow, but we still estimate that the effective tariff rate on Canadian exports will settle near 8% with 60-80% of Canadian exports already eligible for preferential treatment. An effective tariff rate of 8% would still preserve some advantage for Canadian dollar exports against other advanced economies, but direct comparisons are more difficult with inconsistencies between policy-implied tariff rates and the lower effective rate from calculated duties. Nonetheless, it is hard to see further relief without changes to sector-specific tariffs on autos and metal products.

Economic data is still giving off mixed signals on the impact from tariffs. Take the 2025Q2 National Accounts for example. Net exports shaved approximately 8pp (percentage points) from headline growth, but there was far less evidence of tariffs spilling over into other sectors. Real machinery and equipment spending is sitting at the lowest level on record (going back to 1981), but household spending had one of its best quarters since the pandemic. Headline GDP would have been much softer without the resilience in household consumption or residential investment, not to mention the 5% increase for government spending.

Broadly speaking, it's still hard to escape the notion that tariffs are leaving a mark on the economy, but a recession is not a foregone conclusion. We look for essentially no growth in 2025Q3, and a modest increase in economic activity in 2025Q4, bringing Q4 on Q4 GDP growth to just 0.4% year over year. For context, the Bank of Canada had this at 0.7% year over year for 2025Q4 in their July Monetary Policy Report, and 2024Q4 growth clocked in at 2.3% year over year. Ongoing resilience from households will be a key theme to watch.

CAD Tariffs Among the Lowest Globally Effective Tariff Rate on U.S. Imports (June 2025)

Theme 2: Fiscal Stimulus Incoming

The Federal budget should arrive by October, but until then we're left to speculate how the Canadian prime minister's fiscal priorities have evolved through 2025 and what makes it into the budget from his election platform.

We track nearly CA$20 billion of new spending for 2025-26 that has already been announced or implemented ahead of the budget, with defense accounting for about half of the total. That should drive the 2025-26 deficit above CA$60 billion with spending cuts providing an offset to defense commitments from 2026-27 onward. The shift to a more expansionary fiscal policy should help underpin a modest rebound in GDP growth in 2026.

Removing internal trade barriers will be another key focus of the 2025 Budget (and fiscal updates), but these should take a back seat to new spending, both in terms of messaging and economic impact. Canada passed Bill C-5 in late June to streamline permit approvals for large infrastructure projects and recently launched a Major Projects Office, but we do not see government infrastructure spending as a significant theme for 2026. The government has not committed to any specific projects but has signaled that ports and other transportation infrastructure will be a key focus, especially if some of those investments can be put towards NATO targets on non-core spending.

Government of Canada (GoC) funding requirements have increased sharply in recent years, with the 2025/26 Debt Management Strategy projecting bond issuance worth CA$316 billion this fiscal year, up from CA$241 billion last year and CA$204 billion in FY 2023/24. Refinancing needs will be lower next year, but we nonetheless look for GoC issuance of approximately CAD$275 billion in FY 2026/27. Heavy GoC supply has been a key theme in the bond market this year, with10s30s steepening and Canadian fixed income underperforming versus the U.S. If the upcoming budget meets expectations, it is unlikely to trigger a reversal any time soon.

Higher Government Spending is Driving Higher Issuance

Theme 3: Immigration Switching from a Tailwind to a Headwind

We see U.S. tariffs and the federal government's plans to confront them as the key risks to the Canadian outlook heading into 2026, but the largest source of domestic uncertainty remains the immigration outlook. We are now 18 months into the government's pledge to reduce the share of Temporary Residents (TRs) to just 5.0% of the total population; this is starting to bear progress, with the share of TRs declining in each of the last two quarters, but the government is still a way off from achieving its target after upward revisions to the level of TRs in 2024.

Temporary resident levels have declined for each of the last two quarters, but the pace of outflows continues to lag official targets from October 2024. Net outflows would need to rise by approximately 80% per quarter to hit the annual rate of 445,000 targeted by the feds, and even if those targets are achieved from 2025Q3-2026Q4 it would still leave approximately 2.3 million TRs in Canada (5.6% of the population), before hitting 5.0% in mid-2027.

The measures in place have already made a notable impact by taking pressure off shelter inflation, reducing labour supply amid softer job creation and (theoretically) helping to stem productivity declines. Rent inflation decelerated by 3.3pp between July 2024 and July 2025, marking the sharpest slowdown over the last 40 years, and new lease rates have been falling since October 2024. Immigration reforms have helped prevent further buildup of labour market slack; at its 2024 peak, trend labour supply was rising by approximately 60,000 per month and, had that continued into 2025, the unemployment rate would be sitting at 8.1% in July instead of 6.9%.

Softer population growth has also coincided with a sharp acceleration in per-capita consumption, which had contracted for six consecutive quarters (year over year) between 2023 and 2024. That supports the notion that population growth was not the primary driver for consumption, but that thesis is not fully tested. Softer population growth has also coincided with some recent improvements to productivity, which fits with temporary residents accounting for a larger share of the workforce across industries with lower output per hour worked.

Temporary Resident Population Inching Towards 5% Target