{"id":2809,"date":"2024-12-11T05:00:05","date_gmt":"2024-12-11T05:00:05","guid":{"rendered":"https:\/\/www.rbc.com\/en\/economics\/2024\/12\/11\/tangled-up-in-trade-the-steep-cost-of-closing-doors\/"},"modified":"2025-03-26T04:54:39","modified_gmt":"2025-03-26T04:54:39","slug":"tangled-up-in-trade-the-steep-cost-of-closing-doors","status":"publish","type":"post","link":"https:\/\/www.rbc.com\/en\/economics\/financial-markets-monthly\/tangled-up-in-trade-the-steep-cost-of-closing-doors\/","title":{"rendered":"Tangled up in trade: The steep cost of closing doors"},"content":{"rendered":"<p><script src=\"https:\/\/code.highcharts.com\/11.4.8\/highcharts.js\"><\/script><br \/>\n<script src=\"https:\/\/code.highcharts.com\/11.4.8\/maps\/modules\/pattern-fill.js\"><\/script><br \/>\n<strong id=\"highlights\" class=\"anchor\">Highlights:<\/strong><\/p>\n<ul>\n<li>International trade risks are back in focus as the incoming Trump administration prepares to take office\u2014but for now, economic data is tracking broadly in line with prior expectations.<\/li>\n<li>The U.S. labour market continues to show enough signs of gradual cooling in Q4 to warrant additional, but limited, interest rate cuts.<\/li>\n<li>The Canadian economy\u2019s underperformance stretches on, arguing for more aggressive interest rate cuts from the Bank of Canada (even if that means a weaker Canadian dollar).<\/li>\n<li>The European Central Bank will keep cutting as much as tight labour markets and elevated wage growth allow. A similar backdrop, plus fiscal uncertainties, means a more cautious stance from the Bank of England.<\/li>\n<\/ul>\n<p><strong>Issue in focus:<\/strong> The severe tariff threats from the incoming U.S. administration will cost more than what they protect. The goal of those tariffs, i.e. narrowing the U.S. trade deficit would also be at odds with the reality of a persistently large and growing government deficit.<\/p>\n<h2 id=\"forecast\" class=\"title-main anchor\">Forecast changes: Developments tracking in line with expectations<\/h2>\n<p>Adverse risks have increased, particularly for Canada, with the incoming Trump administration\u2019s threat of another round of U.S. trade protectionism. However, \u00a0we view the likelihood of tariff hikes that would substantially destabilize North American supply chains as limited (read more below).<\/p>\n<p>Canadian and U.S. data releases since the last Financial Markets Monthly have gone largely as expected. We didn\u2019t feel compelled to make big changes to our forecasts in December.<\/p>\n<h3 class=\"subtitle\">U.S. economic outperformance stretching on<\/h3>\n<p>U.S. labour market data has been distorted by strikes and hurricanes in recent months, but underlying details point to further softening. The unemployment rate, which is typically less impacted by distortions, was up 0.5% from a year ago, in line with our expectation of a gradual normalization.<\/p>\n<p>That should be enough to warrant further, but limited, interest rate cuts from the U.S. Federal Reserve. In 2025, we think much of the ongoing resilience in the U.S. economy will continue, thanks to the historically large government deficit (see <a href=\"https:\/\/thoughtleadership.rbc.com\/running-up-that-bill-u-s-growth-gains-debt-pains\/\">here<\/a> for more implications on growth).<\/p>\n<p>That, however, will also leave risks to the inflation outlook on the upside, and is why we still think the Fed will pause after 25 basis point cuts in December and January with the Fed funds rate at 4% to 4.25%.<\/p>\n<h3 class=\"subtitle\">BoC to keep pushing interest rates lower with or without the Fed<\/h3>\n<p>In Canada, November\u2019s consumer price index saw a small reacceleration in core inflation measures, which should mark volatility rather than a trend. The BoC is likely to keep focusing on broader softening in growth and labour markets, which should continue to press down on inflation pressures in the year ahead. Per capita gross domestic product saw a sixth consecutive decline in Q3, and the unemployment rate rose to 6.8% in November.<\/p>\n<p>With inflation back at the target, any additional softening in the economy could risk an undershoot. To reduce those odds and bring labour markets back into balance, we think the BoC will need to ultimately cut interest rates to \u201cstimulative\u201d levels and expect the overnight rate to be lowered to 2% by mid-2025. Rising inflation remains a risk and will be watched closely in the meantime.<\/p>\n<p>Wage growth is still elevated, especially when compared to sluggish productivity growth, but we expect it will continue to slow as slack builds in the labour market. Housing market activity also started to heat up more as yearend approaches, but we expect affordability will ultimately keep a lid on the rebound.<\/p>\n<p>Growing monetary policy and economic growth divergence between Canada and the U.S. is likely to keep some downward pressure on the Canadian dollar. We expect the loonie will keep depreciation against the dollar but not to an extent that will stoke inflation in Canada. That means the BoC should have a clear path to cut the overnight rate down to 2%, as we expect.<\/p>\n<div id=\"everviz-a-Apn9f8n\" class=\"everviz-a-Apn9f8n\"><script src=https:\/\/app.everviz.com\/inject\/a-Apn9f8n\/?v=9 defer=\"defer\"><\/script><\/div>\n<h3 class=\"subtitle\">Tight labour markets limit ECB and BoE rate cuts<\/h3>\n<p>A strong Q3 GDP print, driven by robust spending, is bringing demand-side factors back to the forefront at a time when European economies are already considered \u201cinflation prone\u201d due to supply-side constraints.<\/p>\n<p>Indeed, ongoing tightness in the labour market has been shoring up wage growth in the euro area and the U.K., stalling progress on inflation when residual pressures are mostly stemming from the services industries. In the U.K., there\u2019s also the added layer of uncertainty from the recent Autumn budget, the impact of which will likely take longer to untangle. It should keep the BoE on its toes when it comes to the pace of rate cuts.<\/p>\n<p>We expect the BoE will go by a slower pace of one 25 bps cut per quarter, while the ECB keeps cutting by 25 bps at each meeting. That is expected to continue until the policy rate reaches 2.25% for the ECB by April 2025, and 3.75% for the BoE by November. Despite the difference in pacing, those levels should be more or less around where we think the \u201cneutral\u201d rate of interest rates are for those regions.<\/p>\n<h2 id=\"bank\" class=\"title-main anchor\">Central bank bias:<\/h2>\n<p><!-- Central Bank table starts here --><\/p>\n<div class=\"central-bank-table\">\n<p><!-- Headers --><\/p>\n<div class=\"col-wpr bg-lightblue mar-b-0 pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Central Bank<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Current Policy Rate<br \/>\n(Latest Move)<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Next move<\/p>\n<\/div>\n<\/div>\n<div class=\"col-wpr table-border mar-t-0 pad-tb pad-lr text-center eh-wpr\">\n<p><!-- Block 1 CANADA --><\/p>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" class=\"alignleft size-full wp-image-42691 w-35 pad-r\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_Canada-Flag.png\" alt=\"\" width=\"626\" height=\"626\" \/>BoC<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">3.25%<br \/>\n<span class=\"h5\">-50 bps in Dec\/24<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">-25 bps<br \/>\n<span class=\"h5\">Jan\/25<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">As expected, the Bank of Canada in December cut the overnight rate by another 50 bps to 3.25%, right to the top end of the BoC\u2019s \u201cneutral\u201d range estimate. Macklem\u2019s opening statement suggested \u201ca more gradual approach\u201d to monetary policy adjustments, in line with our own forecast that for a downshift to 25-bps reductions in their future meetings. A weak economy will still push the BoC to cut all the ways down to 2% in 2025.<\/div>\n<\/div>\n<\/div>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" class=\"alignleft size-full wp-image-42709 w-35 pad-r\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_US-Flag.png\" alt=\"\" width=\"626\" height=\"626\" \/>Fed<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.50-4.75%<br \/>\n<span class=\"h5\">-25 bps in Nov\/24<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">-25 bps<br \/>\n<span class=\"h5\">Dec\/24<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">The Fed in November slowed the pace of rate cuts down, amid signs of persisting strength in the economy and stickier than expected inflation. Recent communication from Fed speakers continue to hint at further but smaller rate cuts. We expect a 25-bps cut next week will be followed by another one in January but expect the Fed to move to the sidelines after that with no additional cuts in 2025.<\/div>\n<\/div>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" class=\"alignleft size-full wp-image-42711 w-35 pad-r\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_British-Flag.png\" alt=\"\" width=\"626\" height=\"626\" \/>BoE<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.75%<br \/>\n<span class=\"h5\">-25 bps in Nov\/24<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">0 bps<br \/>\n<span class=\"h5\">Dec\/24<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">BoE policymakers voted in favour of a 25-bps rate cut in November. While larger planned government budget deficits aren\u2019t expected to stop the BoE from cutting interest rates, it will certainly play a role in terms of the pace of said rate cuts. With a more cautious mindset, we expect the BoE will skip the cut later this month before resuming next February and keep cutting 25-bps per quarter until the Bank Rate reaches 3.75% by November.<\/div>\n<\/div>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" class=\"alignleft size-full wp-image-42708 w-35 pad-r\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_EU-flag.png\" alt=\"\" width=\"626\" height=\"626\" \/>ECB<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">3.25%<br \/>\n<span class=\"h5\">-25 bps in Oct\/24<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">-25 bps<br \/>\n<span class=\"h5\">Dec\/24<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">The ECB lowered the deposit rate by 25 bps in October while maintaining their guidance of flexibility and data-dependency. At the meeting later this week, we expect that policy stance will be retained, and the ECB will cut by another 25 bps to lower the Deposit Rate to a still restrictive 3%. Inflation has undershot but strong labour markets and elevated wage data should leave the ECB on a moderate path lower, to 2.25% by April 2025.<\/div>\n<\/div>\n<div class=\"col-wpr table-border table-border-bot pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" class=\"alignleft size-full wp-image-42710 w-35 pad-r\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_Australia-flag.png\" alt=\"\" width=\"626\" height=\"626\" \/>RBA<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.35%<br \/>\n<span class=\"h5\">0 bps in Nov\/24<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">0 bps<br \/>\n<span class=\"h5\">Dec\/24<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">Persistent inflation pressures are still holding the Reserve Bank of Australia from joining global peers in the easing cycle. The cash rate was held at 4.35% in December. The macro forecast was mostly revised lower, underpinning a shift in the policy bias further towards neutral. Moving forward, clearer progress in core inflation is required before the RBC can commit to a first cut \u2013 we think that\u2019ll happen later in Q2 2025.<\/div>\n<\/div>\n<p><!-- End of Central Bank table --><\/p>\n<h2 id=\"focus\" class=\"title-main anchor\">Issues in focus: One case study on U.S. tariffs worth watching<\/h2>\n<p>During the first Trump administration, tariff threats were regularly made to leverage other trade or policy concessions. The most punitive and aggressive ones, however, particularly those that would severely damage the U.S. economy, were typically not enacted.<\/p>\n<p>For example, in 2018, the Trump administration threatened to impose <a href=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2024\/11\/USautotariffs_June2018.pdf\">20-25% tariffs<\/a> on Canadian auto exports to gain leverage in NAFTA renegotiations. That was not enacted with the U.S. and Canada concluding the renegotiation shortly after.<\/p>\n<p>In 2019, the Trump administration floated 25% tariffs on Mexico in a response to illegal immigration but called it off in the following week after a deal on enforcement was reached. These days, modelling broad comments vs. clear economic policy can be incredibly challenging as the amount of economic scenarios is massive.<\/p>\n<div id=\"everviz-H83B2nLTO\" class=\"everviz-H83B2nLTO\"><script src=https:\/\/app.everviz.com\/inject\/H83B2nLTO\/?v=3 defer=\"defer\"><\/script><\/div>\n<p>There are also many different tentacles through which tariffs can flow through an economy: lower growth, higher inflation, heightened uncertainty and weakened business investment. For Canada, we\u2019ve started to explore <a href=\"https:\/\/thoughtleadership.rbc.com\/canadian-industries-and-provinces-most-exposed-to-u-s-tariff-threat\/\">these scenarios<\/a>. Here\u2019s one extra angle that gets less attention that we find interesting.<\/p>\n<h3 class=\"subtitle\">The goal of tariffs is at odds with a large U.S. government budget deficit<\/h3>\n<p>One of the most common goals of tariff policy is to close a trade deficit. In this case, the U.S. has been running a persistent international trade deficit since the 1980s.<\/p>\n<p>Shrinking the U.S. trade deficit however isn\u2019t just about re-balancing trade flows.<\/p>\n<p>At its core, a net trade balance is a form of borrowing \u2013 it means the value of imports is less than can be purchased out of export sales, and that shortfall needs to be made up for by selling assets or borrowing abroad. Balancing the trade gap, therefore, would essentially require re-balancing economy-wide net borrowing, and the biggest net borrower in the economy is (surprise surprise) the federal government.<\/p>\n<p>In the past, the ideas of a trade deficit and government budget deficit are closely linked (often referred to as the \u201ctwin deficit\u201d phenomenon.) And while it\u2019s not impossible to balance international trade deficit while running a government deficit (<a href=\"https:\/\/www.stlouisfed.org\/on-the-economy\/2023\/nov\/what-lessons-drawn-japans-high-debt-gdp-ratio\">Japan<\/a> has done it for decades), it would be very hard with government deficits running as large as they are currently in the U.S.<\/p>\n<p>Indeed, the U.S. government deficits at 6.4% in fiscal 2024, are too large for it to be solely financed by domestic savers. Trying to shrink the trade gap with tariffs in this scenario is a bit like squeezing a ballon, as in the trade deficits will just be directed elsewhere.<\/p>\n<div id=\"everviz-31GBWQHw6\" class=\"everviz-31GBWQHw6\"><script src=https:\/\/app.everviz.com\/inject\/31GBWQHw6\/?v=12 defer=\"defer\"><\/script><\/div>\n<p>This was evident during the first Trump administration \u2013 the tariffs imposed on China at the time did not close the U.S. trade gap, but effectively just <a href=\"https:\/\/thoughtleadership.rbc.com\/proof-point-u-s-import-tariffs-havent-reduced-reliance-on-foreign-goods\/\">shifted deficits<\/a> away to other peripheral Asian economies and Mexico. After decades of borrowing from abroad, the U.S. now owes $22.5 trillion in foreign liabilities, or 78% of GDP.<\/p>\n<p>The only scenario where tariffs could be trusted to narrow the U.S. trade deficit is if they\u2019re so punitive that economy starts to outright contract. In historical downturns, consumption tended to fall more than income, leading to a rise in U.S. saving rates and declines in imports.<\/p>\n<p>In this case, however as outlined above, we do not see a shock to U.S. tariff rates of a magnitude large enough to cause that outcome as likely.<\/p>\n<h4><b>See previous editions of <a href=\"https:\/\/thoughtleadership.rbc.com\/economics-articles\/economy-and-markets\/financial-markets\/\">Financial Markets Monthly<\/a>.<\/b><\/h4>\n<div class=\"rds-callout-white\" style=\"border: 1px solid #c4c8cc;\">\n<div class=\"rds-gcw\">\n<div class=\"img w-mob-100 download-img\" style=\"display: inline-block; vertical-align: top;\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-58414\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/23\/2025\/03\/Download-PDF-button-03.png\" alt=\"\" width=\"572\" height=\"362\" \/><\/div>\n<div class=\"rds-inline pad-hlf\" style=\"display: inline-block; 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expectations.<\/p>\n","protected":false},"author":300,"featured_media":2807,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"advgb_blocks_editor_width":"","advgb_blocks_columns_visual_guide":"","footnotes":""},"categories":[48],"tags":[],"rbc_econ_content_type":[],"class_list":["post-2809","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-markets-monthly"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v27.2 (Yoast SEO v27.2) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>Tangled up in trade: The steep cost of closing doors - RBC Economics<\/title>\n<meta name=\"description\" content=\"International trade risks are back in focus as the incoming Trump administration prepares to take office\u2014but for now, economic data is tracking broadly in line with prior expectations.\" \/>\n<meta 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