Investing.com -- A recent report by Capital Economics has stated that tariffs are more impactful for Canadian markets than the upcoming election. The report suggests that the outlook for Canadian financial markets relies heavily on how monetary policy responds to the fallout of US tariffs, rather than potential shifts in Canadian fiscal policy.
TheUSD/CAD, also known as the loonie, and Canadian government bonds have remained largely unaffected by tariff announcements and political developments, the report noted. This includes the recent decision by Prime Minister Mark Carney to eliminate the country's carbon tax, which is expected to reduce CPI inflation by nearly 1%.
The loonie has shown resilience likely due to interest rate differentials moving in its favor. Market expectations for central banks' terminal rates have fallen more in the US than in Canada since mid-February, which can be attributed to weak activity data in the US and strong GDP and employment data in Canada.
The report further states that the outcome of the Canadian elections later this year is unlikely to significantly impact the loonie and Canadian government bonds. Both Mark Carney and Pierre Poilievre, the leader of the opposition Conservative Party, are expected to take a strong stance against Trump's tariffs, adopt a business-friendly approach, and maintain a tighter fiscal policy than their predecessor, Justin Trudeau.
The future of the loonie and Canadian government bond yields largely depends on whether Trump follows through on his tariff threats and how the Bank of Canada reacts to the economic fallout. In a scenario where Canada faces an average reciprocal tariff of about 10%, the report predicts quarterly GDP growth of just 1.0% annualized on average over the next year.
The report suggests that Canadian government bonds will end the year around 3.00%, only slightly below their current level. However, it also highlights a few risks, such as a persistent weakness in the US economy leading to lower US Treasury yields and a stronger dollar.
In addition to this, the recent decision by OPEC+ to increase output could impact oil prices, offering little relief for the loonie. The report forecasts that WTI oil prices will remain at their current level of $67/bbl until the end of the year, but may fall to $56 in 2026, potentially further weakening the loonie.
The report concludes that the recent resilience of the loonie to Trump’s tariff threats and political developments in Canada can be explained by interest rate differentials moving in its favor. However, with the Bank of Canada expected to lower interest rates more than anticipated and the Fed to keep its policy rate on hold, the USD/CAD rate is expected to weaken from 1.43 now to 1.50 by the end of the year.
