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Mike Miranda:
Welcome back to Beyond the Portfolio, the podcast where we go deeper than the headlines, and explore the forces shaping wealth markets and the future for investors. I'm your host, Mike Miranda, and I'm delighted to have you with us today. We're recording this episode on October 20th. Over the last few episodes, we've been digging into some of the most dynamic corners of the market, private markets, and the evolving landscape and growth in family offices. Today we're pivoting back to the economic narrative, the big picture that underpins everything we do. While trades and tariffs have been less of a driving force in markets over the past few months, recent volatility has picked up as investors have grappled with the renewed US-China trade concerns. That makes today's conversation anchored on these developments between US and Canada, especially timely.
As we look ahead to 2026, you can expect more of these forward-looking outlooks in our upcoming episodes, helping you set the stage for what's next. Later next month and in December, we'll provide our official updates on our capital market assumptions, some of the themes that we see driving the markets, and our return estimates for markets in the coming year. But today, our focus is on the North American trade outlook. And I'm thrilled to welcome our guest, Aaron Goertzen, Senior Economist at BMO Capital Markets.
Aaron is the author of the recently published special report, Paths Forward and Backward for Free Trade, which dives deep into the current state and future scenarios for US-Canada trade relations. We'll unpack the report's findings, discuss the implications for cross-border investment, and explore what the evolving trade landscape means for investors. So Aaron, thanks for joining us today. Let's dive right in.
Aaron, to set the stage for our listeners, can you walk us through the historical context of the US-Canada trade relationship? What are some of the key milestones and turning points that have shaped the economic ties between our two countries?
Aaron Goertzen:
Absolutely, and it's a history that I find fascinating by the way, and that I think has a lot of lessons for today. If you want to take a very long view, then of course, the US and Canada did not start off on the very best terms. Of course, Canada governed by the British for most of the 1800s, and as we know, there's a little bit of a history there. But by the time you get to the early 20th century, you start to see early pushes for continental free trade. There were advocates on both sides of the border for this, but overall, still a lot of skepticism in Canada at the time, just given the much larger size and power of the US economy.
So in the early 1900s, the Canadians actually ended up saying no to free trade. And as you get to the Great Depression, of course, we had a huge increase in protectionism, Smoot-Hawley that came with that, and a big step back in cross-border integration and cooperation. Really, it was in the postwar era that things started to change. Of course, coming out of World War II, Europe was in ruins, commercial trade across the Atlantic was weak. And after side by side overseas, closer economic ties between the US and Canada started to feel much more natural, and particularly with the emerging threat posed at that time by the Soviet Union. And so the need for very close security coordination in the north.
So the two countries second half of the 20th century started signing big bilateral deals, we first had the Auto Pact in the mid-1960s, that integrated vehicle production across the border. That was later followed up by the US-Canada Free Trade Agreement in the late '80s that removed most tariffs on cross-border trade. And then we had NAFTA in the mid-1990s, which brought Mexico into the framework. I think worth emphasizing here, rising trade obviously not just a North American phenomenon during that period. The second half of the 20th century was a period of rapid globalization for the world as a whole. You had Japan's economic miracle, you had the East Asian tigers, the emergence of Europe as a single economic bloc for the first time, and then of course later the rise of China as well.
So between 1950 and 2000, with the US at the center of all of this globalization activity, the share of trade in the US economy roughly tripled. And Canada, very much at the center of all of that as well. Now, if anything, the early 2000s were, I think it's fair to say a high watermark for US-Canada trade. Over the past couple of decades we've seen both countries pivot to some extent toward Asia, and then global trade in general has just expanded more slowly. And then of course NAFTA came under direct and intense criticism from the US during the first Trump administration. That deal NAFTA ultimately being discarded in favor of a renegotiated US-Mexico-Canada agreement, the USMCA. Now under the hood, the USMCA is not so different from NAFTA, but where it differs enormously and what's coming to the fore, is that it has a built-in sunset mechanism. So this is something that's set the stage for where we are today. The first renewal deadline is looming in the middle of next year, July 2026. And so we're now facing down all of the questions and uncertainties that surround that.
Mike Miranda:
Thanks, Aaron. That's extremely helpful to get that history. I'm thinking about 2025, which obviously feels like a departure for some of that history. So maybe give us your perspective on some of the notable shifts that we've seen in '25 on trade dynamics, especially with that recent volatility in tariff escalations. Can you summarize the major developments for us in 2025? And how has that impacted US-Canada trade? And then bigger picture, how does this fit into the broader global trade narrative?
Aaron Goertzen:
Yeah, and of course we could spend an entire podcast trying to rehash all of this year's comings and goings, on trade. Just focusing on the broad strokes here, rewind back to after last year's presidential election, and Canada really was finding itself at that time right in the US administration's cross hairs on trade, and on tariffs of course alongside USMCA partner Mexico. And for a few days in early March, the administration actually did impose 25% across-the-board tariffs on imports from Canada. Of course a harrowing situation, not just for Canada, although Canada obviously depends much more on trade with the US than the other way around. But also for many of the US states and industries that rely heavily on northbound cross-border trade.
Now, fortunately, after just a couple of days, those tariffs ended up being narrowed to only non-USMCA compliant goods. So goods not covered by the Canada-US Trade Agreement. That amounts to only about 5% of cross-border trade. So obviously created a much more manageable situation for trade within North America. Since the spring, of course, the administration has been much more focused on global trade. So we've had Liberation Day, reciprocal tariffs, we've seen sectoral tariffs, as well as tentative trade deals with major US partners like Japan, the UK and the EU, although notably not yet with China, so still a wild card there. Now Canada has been affected by some of this. Tariffs on steel, aluminum and lumber for example, are having a big impact north of the border. And the tariff on non-USMCA goods, it was increased further to 35% a couple of months ago.
As you would expect in that environment, the bilateral trade numbers have weakened. So we've seen US-Canada cross-border trade down about 4% so far this year compared to the same period in 2024. But overall, I think it's fair to say the US-Canada relationship has done better than feared. Canada is subject to much lower tariffs than trade between the US and the rest of the world, in particular. So by our estimate, the average US effective tariff rate against all countries is now up to about 18%, from 2% last year as a reference point. But the average tariff rate for Canada is more like six 7%.
So this is something that's, it's a damaging situation, but with the tariffs where they are today, it's also a manageable one. Really the big question now is where do we land with the approaching review of the USMCA? This is something that's going to put continental trade back on center stage, and of course is going to open a whole host of challenging questions and uncertainties.
Mike Miranda:
So let's touch on that. Aaron, you mentioned USMCA and you talked about the sun setting. What should investors know about this upcoming review process in 2026? And what are some of the possible paths forward for the agreement?
Aaron Goertzen:
Yeah, so when the USMCA was negotiated during the first Trump administration, one of the most fundamental changes relative to the predecessor NAFTA agreement, was the addition of that sunset clause. And this was something that was insisted on by the US side. Under the sunset clause, all three parties to the USMCA need to explicitly renew the deal in order for it to remain in force, and this is something that they have to do every six years. So the USMCA first took effect in mid-2020, the math checks out, mid-2026, we are up for our first renewal. Now, a crucial point that I try to make right at the beginning here is that if negotiators cannot reach a deal by July 1st, it is not as though the USMCA immediately goes up in smoke. And actually within the deal itself, there's a pretty long runway built-in.
So the three countries, even absent a deal next year will have 10 years to come to an agreement, and it will only be in 2036 that the USMCA will automatically self-destruct, so to speak. There is though what I call the nuclear option, and this is a clause built into the USMCA that allows any of the parties to exit the deal completely with six months notice. And the US administration at this point has already made it very clear that what it wants to do is renegotiate the terms of the deal, not renew as is. So we're not going to be talking about a simple checking of a box here. This does seem to hint that we probably are in store for more fireworks on North American trade. I think if the NAFTA renegotiation is any indication, this is something that's not going to be a walk in the park. There are real trade irritants here, and we're probably going to see some brinksmanship on this.
For me, the hope is that we get a deal that if anything, adjusts the terms of the USMCA around the edges, but that keeps free trade as the core principle of the thing, so that cross-border integration and interaction remains viable. It is possible though, we can't rule out that the US could see deeper change with all of the disruption and potentially damage that that could involve.
Now, one more related point that I'll make about the USMCA's sunset mechanism. This is something that economists have never liked very much from day one. And the problem here is that, and we're really seeing this now, with free trade, if you have too many off ramps, if businesses view it as potentially temporary, then they're not going to make the types of investments that make free trade so valuable to begin with. So you're not going to get the specialization, you're not going to get the economies of scale. And what you end up effectively doing is you throw the baby out with the bathwater. So if we had our way, if I had my way, the USMCA would, if anything, get rid of this sunset clause altogether. I certainly will not hold my breath though for that happening on this cycle.
Mike Miranda:
That's very helpful, Aaron. You talked about obviously not just the sunset provision, but also how this is going to evolve. I loved in your report this framework that you identified three scenarios for trade resolution. So I talked in the beginning, the report is paths forward and backward for free trade. And in there you outlined three potential scenarios for how the US Canada trade relations could evolve. So can you walk us through these scenarios, what they entail and what the economic impacts might be under each of those three?
Aaron Goertzen:
Yeah, obviously one of the most challenging aspects of the current situation is just the unpredictability. And ultimately I don't think anybody knows exactly where US trade policy is going to land. So over the course of this year, we've been increasingly falling back on scenario analysis, so working through the hypothetical possibilities, and then war gaming the impact on the economy. So in our report, what we did was we pinned down three potential outcomes for the USMCA review that we think are first of all plausible, and that we think also are important reference points. So reality of course could end up landing somewhere in between, but we want to establish these guideposts in our thinking about this.
Now, of the three, the most benign possibility that we considered is that free trade muddles through, we call this the muddle through scenario, in something like its current form. You have US tariffs targeting maybe some Canadian industries, and then a relatively mild response in the other direction. So I would describe this as a scenario where you have a more or less successful renegotiation, renewal of the USMCA maybe with some minor changes around the edges. I think worth saying here, not literally is a best case scenario. I think best case you would hope for the removal of all tariffs put in place this year, maybe even progress in other areas of continental cooperation.
But what this is, is a scenario that feels highly plausible to the point that we actually would propose this as a reasonable baseline expectation. We view this as the most likely of the three scenarios that I'll talk through here. And actually this is more or less the operating assumption that we've built our economic forecast on top of. So in an outcome like this where free trade muddles through, what you end up with in Canada, slower growth but still positive, so no recession. Some industries of course facing significantly higher duties, thinking about areas like autos, steel, aluminum, copper, lumber. These are parts of the Canadian economy that come under greater pressure. But from a macroeconomic perspective, things hold up reasonably well overall. Over time, we would estimate Canadian real GDP falls maybe 1.5% Below pre-tariff growth expectations. So relative to that pre-tariff growth trajectory.
Now in the US, the macroeconomic impact of this scenario is relatively minimal, a long-term impact on real GDP amounting we estimate to maybe a 10th of a percent or so. Now, a more damaging outcome would be that Canada loses its privileged access to the US market, and ends up facing similar tariffs to what the US has negotiated with some of its other major trading partners. So thinking Japan and the European Union where tariffs are sitting at about 15%. Now that's more than double the rate of tariffs that Canada's facing today. And so this is something that we're calling a no special treatment scenario, where the playing field is effectively leveled across all US trading partners.
Now, an outcome like this would obviously create a more challenging economic environment in Canada. We would flag a real possibility of a technical recession, though we do think that any downturn would probably be fairly short-lived even in Canada, just given that you would expect a relatively strong fiscal and even monetary response to this type of an outcome. Over time and overall though, real GDP probably falling around two point a half percent2.5% Below pre-tariff trends north of the border. Now in this scenario, we assume that Canada retaliates with tariffs of its own against imports from the United States. We assume Canadian tariffs stay lower, so we've penciled them in at 5%, just given that the country would seem to want to avoid further escalation back and forth.
But of course this does still create challenges for US exporters. And so with such an outcome, you do start to see a more measurable impact on the US economy. Not a huge one. GDP losses in real terms over time, amounting to maybe half a percent, but something that you can point to as material.and of course you start to see a greater impact on inflation as well. The most severe outcome that we considered is not an outright worst case scenario, but it's what we call a continental divide, where average US duties on Canadian products rise to 35%, which is the rate that's currently being paid on exports not covered by the USMCA. And in the other direction we assume Canada applies 15% tariffs on imports from the US.
Such a scenario, obviously much more damaging. In Canada, you almost certainly see a moderate recession, despite what would be significant policy support. And of course efforts to redirect exports to other markets, that would take time. In all likelihood, you're probably talking about 1.5% Increase in the unemployment rate in Canada. So the labor market goes from soft to downright weak, and then real GDP over time probably falls around 5% below pre-tariff trends.
Now, in this scenario, of course you get a more material impact on US economic activity as well. So not a recession, but a significant slowdown, permanent real GDP losses south of the border, maybe 1%. And of course, pricing pressures in an outcome like this become much more difficult to ignore. Over time. We would expect Canadian prices to increase by around 4%, not just because of tariffs, also a weaker Canadian dollar, while US prices probably rise in the range of 1%. Getting to the point that's a little bit trickier for the Fed to ignore. So obviously a damaging scenario from a macroeconomic lens. There is a lot at stake here on both sides, but worth also emphasizing industry, the regional impacts would be highly uneven. And so tough to generalize about the impact on a given sector or a given firm.
Mike Miranda:
That's helpful, Aaron. You did talk a little bit about sectoral impacts, so I want to come back to that. Let's talk about the practical implications here. Maybe dig a little deeper, which sectors and regions in Canada and in the US are likely going to be affected by changes in this trade policy and tariffs? And how should investors be thinking and watching this closely?
Aaron Goertzen:
As I say, tough to generalize. And one of the things that makes it tricky is that it's not just about the amount of the tariff, and the reliance of an industry on trade. It all really comes down to industry structure. And it gets complicated, because the importers that are responsible for paying the tariffs, of course, once prices adjust, aren't necessarily the ones that are actually shouldering that burden. So if you think about things at the level of a firm, if you really wanted to get a handle on the potential impact of tariffs, you need to understand pricing power against foreign buyers, against foreign suppliers. You need to understand the competitive environment. Are there substitutes? Are there switching costs? Is this a commodity? Is this something differentiated? There end up being a huge number of questions that come into play, and you can see how things get complicated very quickly here.
So what we've done in order to just get our arms around this thing is just tackle one piece of the puzzle. And we've looked at the share of continental exports in industry-wide sales. So for a given industry, what share of its sales are being driven by exports to USMCA parties? Now in Canada, the numbers are, as you would expect, pretty eye-opening. There are a whole host of sectors that rely on the US for well over half of sales. So in auto production, around 90% of Canadian sales are made straight south of the border. Now, worth saying, I think in the same breath here, just given the integrated nature of that industry, Canada also imports a large volumes of vehicles and parts from the US, if you want to tell the whole story. But it's more than just autos, of course, it's products like appliances, computers, electronics, chemicals, for all of these, for textiles, well over half of the Canadian industry's sales are exports to the United States, and so a great deal of vulnerability in those spaces.
Now, when you do the same exercise for the US and look at reliance not just on exports to Canada, but to Canada and Mexico combined, so the USMCA bloc, the numbers are smaller but still concerning in some areas. So there are plenty of US industries that rely on continental trade for 10%, 20% of sales. Products like again, appliances, electronics, machinery, and transportation equipment, which includes auto production. So lots of industries in the US of course have plenty at stake here. 20%, 10% of your sales, nothing to sneeze at. From a regional perspective, reliance on continental trade varies pretty widely across the US states, mainly just depending as you would expect, on distance from the border. Ultimately, the Midwest states have the greatest reliance on trade with Canada, as well as North Dakota, you could lump into the same group. But with the Midwest just given its proximity to Ontario and Quebec, Canada's largest provincial economies, tightly integrated across the border, relying on exports to the Canadian market for a meaningful share of GDP.
Regional sensitivity, of course greater across the board in Canada, but it does still vary widely. Overall, the largest dependence on US trade is actually found in Alberta, but Alberta largely exports energy products to the US, which we've seen are much less at risk of high tariffs. So for Canada, if you look just at non-energy trade, the greatest vulnerabilities lie in maybe as you would expect, Ontario and Quebec given manufacturing integration, but also some of the maritime provinces where exports to the US can amount to 15% of GDP or more. In contrast to that, British Columbia over on the West Coast, less reliant on US exports, and a more diversified trade portfolio that spans across that Pacific, and so less sensitivity there.
Mike Miranda:
All right, Aaron, thanks. We've covered a lot here and I really appreciate the depth that you've gone into on Beyond the Portfolio today. We covered a lot here on your report, Paths Forward and Backward for Free Trade. Love the context that you provided here, not just on the history of the US-Canada trade relations. Obviously we talked a bit as we have in prior podcasts about some of the major developments of 2025. Really enjoyed our discussion there on the critical path ahead for USMCA next summer in 2026. And then obviously some discussion about the scenarios, which I think are very helpful. We certainly don't have a crystal ball, as you said, to know how this might unfold in the coming nine to 12 months, but it's helpful to think through the various scenarios, and what that might mean for our clients and investors.
As we continue to navigate this rapidly changing economic landscape, understanding these dynamics and the dynamics of the North American trade will be essential for us making informed investment decisions. As I said at the outset, we'll be bringing you more forward-looking outlooks in the coming few episodes, so please stay tuned to those. It'll help us set the stage for all of us for 2026 and beyond. Thanks again to Aaron for sharing his deep insights. And thank you to everyone who joined us and for our listeners broadly.
Thank you for listening to Beyond the Portfolio. You could follow us on Apple Podcasts, Spotify, or your favorite podcast app. Until next time, I'm Mike Miranda.
Disclosure:
For BMO disclosures, see episode description in your podcast player.
