Questions? We've Got Answers 

Q1. How has the global economic outlook changed in light of recent tariff developments?

Acting on his campaign promise, President Trump immediately leveraged far reaching tariffs on Day 1. He directed the secretaries of Treasury and Commerce as well as the U.S. Trade Representative to open an investigation into "unfair and unbalanced" trade practices with the U.S., with a deadline of April 1st for specific policy recommendations. Why wait? On February 1st, the President announced a universal 25% tariff on Canada and Mexico, as well as a 10% tariff on China. In what may become a trademark of this administration, eleventh-hour negotiations permitted a 30-day delay in implementation. The same was not true for China, where tariffs came into effect February 1st, with a retaliatory response leaning equally towards export controls on critical minerals and tariffs on U.S. imports. On February 10th, the President then announced 25% tariffs on all countries shipping steel and aluminum. That April 1st deadline seems nebulous at this point.

How to forecast in this environment?! This is where assumption-based scenario analysis is best applied, making them susceptible to more frequent reviews. Here’s our opening baseline assumptions on the U.S.:

• President Trump implements further tariffs on China, the European Union and other major trading partners by early-April. 
• The U.S. effective tariff rate is assumed to rise from today's level of 3% to a peak of 7.5% by Q3.  
• The tariffs are assumed to remain in play for the remainder of this year, before being largely phased out by mid-2026. 
• Some retaliation from trading partners is incorporated. 
• International governments will lean into supporting businesses and households.

From a global scale, the impact is small. Growth is held back by only 0.1 percentage point. China is one of those economies where we expect government stimulus measures to offset some of the drag. Special borrowing to the tune of roughly 2% of GDP is already underway, and authorities will likely step that up to sustain economic momentum near the 5% mark. In Europe, some fiscal offset could come from Germany, depending on the result of upcoming elections. Its economy is one of the most exposed to international trade and tolerance for further economic stagnation will be limited after several years already (see report). In contrast, the U.K. and France have limited fiscal space, making it challenging to buffer the economy from tariffs. 

From Canada’s standpoint, provincial and federal government levels are united on fiscal supports and tariff-retaliation. However, we’ve assumed that whether tariffs proceed or not, persistent and unstructured threats from the President will create a sufficient cloud of uncertainty to weaken business investment and reduce trade. As a result, we have downgraded the Canadian outlook to track a meagre 1.3% quarterly pace starting in the spring of 2025 though year end. That is a significant drop from the 2.1% quarterly average we penned from Q4 2024 to Q1 2025 (for more details on Canada's trade relationship with the U.S. see our recent report). 

As for the U.S., economic momentum will be pinched by 0.2-0.3 percentage points in 2025, as further tariff announcements lead to some tightening in financial conditions, while the passthrough to inflation results in a modest erosion in consumer purchasing power. 

Returning to the concept of scenario analysis, we review what could happen if Canada and Mexico fail to head-off the 25% economy-wide tariffs set to come into place on March 4th. We do this on a “time lapse” basis, if full tariffs remain in effect for 6-months, 1-year and 2-years (see Table 1). We chose 6-months as the initial starting point to run the scenarios because that’s when the Canadian economy would tip into recession with an unemployment rate peaking at 7.7% by the end of the year. The passage of time serves to worsen the outcomes. The scenarios also include Canada's outcomes with and without fiscal supports. Additional government spending amounting to 2% of GDP in the worst-case scenario provides some offset for the economy. This would also have an inflationary impact. In terms of the labour market, the impact of fiscal supports will depend on the type of measures the government elects to implement. For example, resurrecting wage subsidy programs from the pandemic period would reduce the impact on the unemployment rate. For the U.S., annual average growth is reduced by an additional 0.2 percentage points in the 6-month scenario, while the unemployment rate would peak at 4.6% in the fourth quarter, before improving once tariffs are removed. 

Q2.  How would central bankers react to trade war scenarios? 

Trade wars introduce huge uncertainty for central bankers. How the Federal Reserve and Bank of Canada respond depends on how they weigh the importance of the negative economic growth shock versus the permanence of higher inflation. 

Central bankers should (in theory) look through the immediate inflation increase, as it would be a supply-side shock that can't be addressed with higher interest rates. This would mean that the downside risk to growth should be the focus. However, life is rarely that simple. Even a temporary inflation boost can lift longer-term inflation expectations, particularly when households are already displaying high price-sensitivity. In this case, sitting on the sidelines may not be an option. The pandemic offers insight into this thinking. Central bankers initially looked through the rise in inflation as "transitory" due to one-time pandemic re-opening effects. But eventually had to aggressively raise rates to re-anchor inflation expectations. This is why some Federal Reserve speakers have already noted that they can't ignore a tariff-induced inflation shock. In our baseline assumption, we expect the Fed to remain on pause in the near-term. This presumes the summer will bring greater clarity on tariffs that will be absent “blanket” approaches. Likewise, this would help anchor inflation (and expectations) and allow the Fed to resume modest rate cuts. We expect the policy rate to end the year at 4.0% (Chart 1). 

Q3. How have markets reacted so far to tariff threats? 

So far, financial market reaction has been controlled and relatively benign to tariff developments. However, this is more a by-product of timing than outright indifference. With the exception of steel and aluminum, President Trump has made large-scale, official tariff announcements over the weekend, when most asset markets are closed. In addition, the significant policy measures were subsequently suspended in short order via negotiations with the targeted countries. This means limited active trading hours for financial participants to react.

Market reactions were strongest between the February 1st executive order on fentanyl, which threatened tariffs on Canada, Mexico and China, and the February 4th implementation date. At this time, markets began to price in the risks of an aggressive trade war. The Canadian dollar and Mexican peso fell sharply, roughly 2-3% against the U.S. dollar in the early hours of Monday, and U.S. equity markets tumbling by a similar amount. Oil prices also trended higher by almost 3% as markets expected the tariffs to filter through the continent's integrated market. However, the timeline was short. By 10am, movements were already reversing as Mexican President Sheinbaum announced a one-month tariff suspension for its country. Similar news was announced by Canadian Prime Minister Trudeau later in the afternoon. North American markets fully reversed the post-announcement moves over the following week, even though the 10% additional tariffs levied against China went into effect as announced.  

The Canadian dollar is currently fluctuating near its year-to-date high, undeterred by tariff risks, but still weighed down by monetary policy differentials (Chart 2). We expect the Canadian dollar to remain below 70 U.S. cents through the year due to historically wide policy rate differentials, and presuming tariff risks don’t fully leave the landscape. Should President Trump's economy-wide 25% tariff threat be imposed, brace for the CAD move to the mid-60 U.S. cent level, and possibly lower.

Financial markets have since returned their attention to company earnings reports and macroeconomic developments, but with multiple tariff threats still on the horizon, this respite may prove to be short-lived. 

Q4. Executive Orders are flying, how will they get captured in the U.S. outlook?   

President Trump has wasted no time signing over 70 executive orders (EOs) in the last few weeks. The actions have been far reaching, touching on everything from national security, climate & energy, immigration, the economy, and cost cutting controls within the Federal government. 

From an outlook perspective, we applied judgement on tariffs (see question 1), assumed Congress will maintain TCJA tax cuts, imposed a significant scaling back in immigration and labor force flows, and applied a positive growth-impulse from deregulation. But beyond this, it's too early and too complex to run impact assessments on the full suite of outcomes, particularly given that many policy changes remain in flux and many have long lags in impacting economic momentum. For instance, government restructuring fits both these bills.

One thing is for certain – the U.S. economy is starting the year on a solid footing. Economic growth expanded by a healthy 2.3% annualized in Q4, with all the strength coming from domestic drivers, including consumer spending, residential investment, and government. Further evidence of the ongoing momentum was underscored in the January employment figures. Annual revisions showed an even stronger pace of hiring to end 2024 and in January 2025 (Chart 3). With monthly employment gains still averaging north of 200k, it's no wonder consumer spending remains resilient. Even as tariffs bite, the consumer is likely to remain a key driver of growth in 2025 (see question 5). 

Business investment is also likely to get a lift from rising animal spirits. Several large tech companies, including OpenAI, Meta, and Alphabet, have announced big investment commitments to further expand AI infrastructure over the coming years. Investments in data centers have increased three-fold since 2021, while construction spending on semiconductor facilities has increased over 16-fold during that same time. Investments across these two industries accounted for over 20% of CRE construction spending by the end of last year. This speaks to a broader theme in 2025. Capital investments across the tech space should remain robust, as the U.S. tries to maintain its global position in AI advancements. Meanwhile, the manufacturing sector could see many projects put on hold and production interrupted until there's stability on the new administration's imposition of tariffs on trading partners. For instance, following the 25% tariff announcement on steel and aluminum, the United Steelworkers of America called for efforts to contain global overcapacity by targeting bad actors, like China, while distinguishing trusted trade partners, like Canada.

The combination of executive orders incorporated within the baseline forecast described above nets out to shaving only a few tenths from GDP in 2025. From an inflation perspective, near-term trends are likely to drift higher by Q2, as producers pass on some of the tariff costs. This will keep the Fed on hold for longer than previously expected, which means less reprieve in longer-term yields. 

This puts in jeopardy our view that the housing sector may finally turn the corner in the second half of this year (see question 6). It's still too early to throw in the towel on that call, but the risks will shift to the downside with the passage of time of ongoing tariff uncertainty. For now, the economy is predicted to expand by 2.4% this year. The theme of U.S. exceptionalism is still alive and well, although this pace is a stepdown from recent years that averaged 2.8%.  

Q5. American consumers bolted out of the gate, will this be another expectation-beating year? 

Despite massive policy uncertainty, the one thing going for the U.S. outlook is its consistent ability to surprise on the upside. Once again, consumers were off to the races last year. Spending growth accelerated from an annualized rate of 1.9% in Q1 to a blow-out 4.2% in Q4. Spending growth outpaced disposable income in ten of twelve months, a remarkable performance given  high interest rates and an easing in wage growth. 

Given the strong momentum from last year, as well as some lingering replacement demand for goods due to the wildfires in Los Angeles and hurricanes in various parts of the country, we have upgraded our outlook for consumer spending in 2025 by 50 basis points to 2.4%. However, there could be further room for gains, particularly if the labor market remains resilient and Congress delivers on an array of lower taxes for households that boosts disposable income. One of the biggest of these would be eliminating taxes on social security. 

Another source of upside risk to consumer spending stems from the continued strength of household balance sheets since the pandemic. Household net worth has increased by 44% over the last five years, with nearly every cohort benefiting from stronger gains relative to the five years prior (Chart 4). Higher levels of wealth could be one reason why the personal savings rate in December at 3.8% was lower than prior to the pandemic, when it averaged near 7% in the two years prior. Given its already low level, it is hard to see the savings rate declining much further. Outside of the pandemic, this last occurred during the housing market frenzy prior to the subprime crisis. 

While the backdrop for consumers holds solid, the risks around the forecast are considered balanced. The potential inflationary boost from tariffs is a downside risk. And the restart of student debt repayments in October of last year also presents a source of downside risk to consumer spending as time extends. 

Q6. Yields are stubbornly high, can U.S. real estate stage a lasting revival?

Lower mortgage rates in the spring and summer of last year delivered a late-year boost to residential investment. However, the backup in bond yields is likely to slow the sector's momentum in the near term. Pending home sales and weekly mortgage purchase applications have started to pull back. Thirty-year mortgage rates are hovering around 7%, 80 basis points higher than when the Fed first cut the funds rate in September. Meanwhile, existing home prices have not let up, with the median price up 6% y/y in December. At these levels, the typical mortgage payment for an existing single-family home is close to $2200 – more than double the pre-pandemic average. Over the same period, median family incomes have risen 23%. This would normally be a great result, but in the current environment, it still reflects badly stretched housing affordability (Chart 5).

The outlook for inflation and interest rates has higher than usual uncertainty due to policy shifts in Washington (see question 1). However, we anticipate lower borrowing rates in the second half of this year will help transaction to an upward trend in activity. But a lasting revival requires homebuilding to move the needle on affordability. The hope is that an improvement in homebuilding trends – aided by a lower interest rate environment and perhaps reduced regulation – can suppress home price growth and allow incomes to catch up. However, this will likely be a long-term process. For the near-to-medium term, other risks dominate, including import tariffs on lumber and other inputs combined with immigration restrictions that can create labor shortages.

Table 1: Economic and Financial Forecast Scenarios

Forecasts for interest rates and exchange rates are end-of-period (EOP).
Source: TD Economics.

	Baseline Forecast (Annual Average)		Duration of Trade War
			6-Months		1-Year		2-Year
	2025	2026	2025	2026	2025	2026	2025	2026
Real GDP (% Change)
U.S.	2.4	2.1	2.2	2.1	2.1	2.0	2.1	1.6
Canada	1.8	1.6	1.1	1.6	1.0	1.2	1.0	0.3
Canada with Fiscal	1.8	1.7	1.2	1.8	1.2	1.7	1.2	0.8
CPI Inflation (% Change)
U.S.	3.0	2.4	3.7	2.0	3.7	2.3	3.7	3.0
Canada	2.2	2.1	2.9	1.8	3.0	2.1	3.0	2.9
Canada with Fiscal	2.4	2.2	3.0	1.9	3.0	2.2	3.0	3.0
Unemployment Rate (%)
U.S.	4.1	4.1	4.3	4.2	4.3	4.5	4.3	4.6
Canada	6.5	6.1	7.2	6.7	7.3	7.2	7.3	8.0
Policy Rate (%, EOP)
U.S.	4.00	3.00	4.25	3.00	4.50	3.25	4.50	3.50
Canada	2.25	2.25	2.25	2.25	2.00	1.75	2.00	1.50
10-Year Yields (%, EOP)
U.S.	4.10	3.75	4.25	3.75	4.35	3.90	4.35	4.00
Canada	3.00	3.00	3.00	3.00	2.90	2.75	2.90	2.65
USD per CAD (EOP)	0.71	0.74	0.68	0.71	0.62	0.67	0.62	0.65
WTI (USD/BBL, EOP)	72	78	65	75	63	71	63	60