The global economy succeeded in a “soft landing” in 2024, albeit some countries stuck the landing better than others. To the surprise of many, U.S. equity markets rose at a breakneck speed, and never looked back after President Trump was elected. Expectations that Congress’s red wave would be good for business superseded concerns of renewed tariff wars. Policies will come fast and furious in 2025, be it changes to immigration, regulations, taxes, let alone the overlay of tariffs that will no longer be reserved only as a tool to address trade irritants on goods and services. We suspect analysts will display a wider range of forecasts, as models reflect more judgement to assess a broad swath of new policies. 

Fortunately, both the U.S. and Canadian economies are exiting 2024 in a stronger position than expected. As such, both forecasts were set to be revised higher for 2025, but we backed away from this view due to tariff risks, as well as a tightening U.S. labor force. Likewise, areas that could become growth-enhancers, like corporate tax changes, are not incorporated into our forecast in the absence of specific guidance from Congress, which holds the purse on these decisions. That leaves some upside risk to the U.S. outlook. In the end, the outlook for both countries is little changed despite the potential for significant movement underneath the hood. 

Across the pond, Europe’s economic outlook has dimmed relative to last quarter, as the forecasted improvement in the latter half of 2024 has not transpired. Lower inflation has boosted real incomes, but consumers are still reluctant to spend. Now, we are layering on a hit from some U.S. tariffs on European exports. Fiscal policy is also a wildcard in Europe as challenges balancing the budget have toppled the Prime Minister in France. Conversely, Germany’s economic malaise could improve next year if a new government loosens borrowing rules. Overall, the U.S. will remain in the pole position in our forecast, even with slowing momentum (Chart 1). 

U.S. - Over to you, President Trump

The U.S. economy has been the envy of its peers, on track to grow by a healthy 2.7% this year. At the same time, inflation has cooled, and the job market has softened only a smidge. An unemployment rate at 4.2% is bang on the Federal Reserve’s long-run trend estimate. The new administration in Washington has inherited a solid economic backdrop and President-elect Trump will have every desire to keep the economy and stock market humming. This suggests some incentive to curb the most extreme policies proposed on the campaign trail, but there will be follow through on priorities related to border control and tariffs. In isolation (and in its extreme), this risks a stagflationary impulse to the outlook. But a counterbalance would stem from reduced regulation, tax cuts, along with a strong U.S. dollar. We, along with other forecasters, will be updating views with higher frequency as we learn more about policies that will be implemented. For now, the U.S. economy is forecast to slow to a still solid 2.0% in 2025. This is not due to expectations on GOP policies, but rather a reflection of the natural business cycle path towards normalization. Excluding the pandemic, which was not a market-driven event, the U.S. is amid the longest expansion in history, suggesting at best an economy at mid-cycle. This creates a natural gravitational pull back to its sustainable, trend pace, particularly after sustaining a long period of restrictive interest rates. 

Fortunately, the underlying fundamentals of America consumers still look sound. Job gains bounced back in November, after hurricanes and strikes had weighed on hiring in the prior month. But broader labor market indicators are consistent with an ongoing cooling in job market conditions. The duration of unemployment has risen, hiring rates are low and the wage premium associated with switching jobs has come down. Hiring is expected to continue, which should keep decent income growth intact, supporting strong spending (2.5%-3%) in Q4, before slowing to a trend-like pace of 2% in the first half of next year. Consumer spending is set to drift a bit below trend later next year as expected tariffs cause some erosion in household income. Likewise, immigration policy is likely to have become more restrictive at that point, weighing on labor force and employment growth. 

Business investment is looking soft in the near term, with equipment spending likely to contract after two-quarters of solid gains. Structures investment is expected to follow suit, as spending in manufacturing spurred by Biden administration incentives will have largely run their course. Higher interest rates in recent months have also slowed activity in the housing sector. We expect residential investment to improve in the second half of next year, and provide a more meaningful lift in 2026. 

There is a lot of uncertainty on the growth impacts of policy shifts from Washington, but there is more certainty on how tariffs and restrictive immigration tend to edge up inflation (Chart 2). The Fed’s key inflation gauge is likely to track higher as a result, leading to a more cautious Federal Reserve next year. We expect the Fed to cut rates by a total of 125 basis points between now and the end of 2025, including the upcoming meeting in December.

Canada’s economy hit from all sides

Canada’s economy had a tough go of it for the past couple of years, with high interest rates weighing heavily on a highly leveraged household. But, the clouds are already parting. Canada’s traditional growth-drivers, the consumer and housing, are once again engaged and the source of upside momentum to the economy. Even with an expectation that Canada will absorb some tariffs from the U.S. administration, economic momentum in combination with lower interest rates will help it gain a step to 1.7%, from a tepid 1.3% this year. 

Canada’s forecast will materially depend on how successful it will be at managing its relationship with the incoming Trump administration. The president-elect has already threatened 25% tariffs on grievances related to border security. Tariffs of this scope would certainly pressure the country towards recession, particularly since the economic ties between the U.S. and Canada have deepened since the USMCA came into effect. Even if only a 10% blanket tariff is imposed on Canada, a period of extended stagnation would be expected over the next two years. Due to the energy-heavy nature of Canada-U.S. trade, we expect Canada will avoid the full 25% tariff, but the constant threat of tariffs could be enough to send a chill through businesses considering investing in domestic capacity. As such, we have pared back the degree of improvement in business investment next year to reflect a negative sentiment penalty. This will place even more emphasis on Canada’s domestic drivers related to consumers and housing to carry more weight, which runs the risk of repeating the mistakes of the past in heavily leveraging households. 

Several crosswinds are buffeting the consumer. Lower borrowing costs are boosting spending power, but slower population growth in the wake of the Canadian government’s immigration policy changes (see report) will restrain aggregate consumer spending. Putting the pieces together, spending per capita is set to grow after retrenching for much of the past two years. This could reflect a more confident household, particularly as both the Ontario and Canadian governments pump up bank accounts with more fiscal stimulus (Chart 3). 

The Bank of Canada has its work cut out for it, balancing all these competing forces as it tries to calibrate interest rates. The Bank has cut rates by 175 basis points since June, and we expect them to cut another 100 basis points to reach our estimate of the “neutral” rate of 2.25%. But the next stage of the process is likely to be slower as the central bank enters a probing phase, testing the level of rates needed to support growth, without adding to inflationary pressures or unhinging household financial risks. If tough rhetoric from the Trump administration and punitive tariffs hurt the Canadian economy more than we expect, the BoC would likely cut interest rates faster and deeper, however we are doubtful those rates would breech 1.50% even in the event of a recession. On the other side of the risk, the consumer is closing out the year with far more resilience than we had expected. When stimulus cheques are piled on, it’s just as likely the Bank must be more cautious to the inflationary risks this could present.