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Briefing highlights

  • What all-out war could look like
  • Stocks, loonie at a glance
  • Canada creates 32,000 jobs in June
  • Unemployment creeps up to 6 per cent
  • U.S. creates 213,000 jobs
  • Canada’s trade deficit widens
  • U.S. trade gap narrows
  • Montreal home sales on winning streak

It is a milestone in the trade war but a very well-telegraphed one

— Elsa Lignos, global head of foreign exchange strategy, Royal Bank of Canada

What if ...

Analysts are suddenly painting uglier scenarios of a no-holds-barred global trade war.

Observers have calculated, speculated and posited for months, but there’s a new urgency as President Donald Trump’s threats grow louder and the U.S. hits China with import tariffs today.

Many observers say Mr. Trump is bluffing, using tariff threats as a negotiating ploy, and that what is now a low-level trade war will be short-lived and won’t escalate. For some, their base case scenario is that logic will win out, calmer heads will prevail, and that the Trump administration could bow to business and political pressure.

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But others aren’t so sure, issuing dire warnings of the severe consequences for economies and markets should the trade battle escalate and the U.S. slap tariffs on auto imports.

“We no longer doubt that the U.S. administration’s proposals signal the direction of trade policy,” said Morgan Stanley strategist Michael Zezas.

“An escalatory cycle of protectionist actions, not just rhetoric, has begun and will continue,” he added in a report that warned of the potential fallout.

This comes after U.S. tariffs on steel and aluminum, and as levies on Chinese products kicked in today, with Beijing firing back. How U.S. responds, will, of course, be critical.

President Donald Trump speaks during a rally in support of Rep. Greg Gianforte, R-Mont., and GOP Senate candidate Matt Rosendale at the Four Seasons Arena at Montana ExpoPark, Thursday, July 5, 2018, in Great Falls, Mont.

Carolyn Kaster/The Associated Press

“In our view, there are only two events that could bring this trade war to an end,” said Raoul Leering, head of international trade analysis at ING, the first being the acquiescence of U.S. trade partners such as Canada, the second being “internal resistance” at home, particularly among Trump supporters.

“Right now, there is little reason to be optimistic about any of this happening soon,” Mr. Leering said.

Here, then, is a look at what could happen if the worst did happen. The precise impact may differ among analysts, but that’s only a matter of magnitude.

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“This is what a vicious cycle looks like,” said Morgan Stanley’s Mr. Zesas, citing what has played out so far.

“Given present market conditions, we think this dynamic exerts pressure on risk assets,” he added.

“The duration of these conflicts should now be measured in quarters, not weeks. Benign, negotiated outcomes may still be the endgame, but an extended cycle of escalation will give fundamental impacts time to play out in company financial statements and economic data.”

As ING’s Mr. Leering noted, the situation threatens to spiral.

Where China is concerned, the U.S. is punishing US$34-billion in goods, and had warned of tariffs on US$200-billion more on its goods if it does so. Mr. Trump’s latest figure would bring to US$550-billion the total of products hit.

Mr. Leering has three scenarios:

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In scenario one, the actions to date - including today’s U.S. tariffs and the tit-for-tat levies - will have a muted impact, hitting global economic growth by just 0.03 of a percentage point, and world trade by 0.35.

Scenario two would see the Trump administration hit China with more and punish European auto imports, and the two regions retaliate. That would be worth 0.1 of a percentage point on the global growth side, and 0.67 per cent on trade.

Scenario three, the one you don’t want to envision, would include tariffs on oil imports, with retaliatory measures. Take 0.82 of a point off growth, and 2.6 off trade.

“The most worrying aspect within this dispute is that Trump views his trade-restricting measures as necessary to level the playing field for trade, and he considers a response to retaliatory measures as unavoidable,” Mr. Leering said.

“This could mean a trade war escalates quickly.”

Then there are other countries.

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“While the U.S. does have a point about Chinese steel dumping, the scattergun effect of his trade sanctions will also serve to penalize the U.S.’s historical partners and allies, with Canada being hit the hardest,” said CMC Markets chief analyst Michael Hewson.

Consumers, of course, are the collateral damage in such a battle as the costs of imported goods rise. We’ve already seen some of this play out in Canada when Ottawa hit back against the steel tariffs, though so far the impact has been modest.

Markets have already been roiled, moving up and down with threats, barbs and, on any given day, seemingly calmer outlooks.

“We see many ways to position for escalation,” said Mr. Zezas, adding that Morgan Stanley’s equities team sees the U.S. technology sector as vulnerable.

“We also see Asia [emerging markets] entering a bear market, with the Hang Seng particularly vulnerable,” he added.

“In U.S. fixed income, we like duration over credit. Trade risk is one reason why we think the 10-year year Treasury has seen its high in yields.”

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Currencies, too, such as the Canadian dollar, have been affected, and could be further hit.

“The dollar and yen are likely to be the main winners, while those countries most sensitive to the Chinese economy will see their currencies weaken,” Kit Juckes of Société Générale said of the widening conflict.

“And given that the Chinese trade-weighted [foreign exchange] basket gives a significant weighting to the currencies of countries vulnerable to slower global trade growth, the biggest question of all is how much China lets the yuan weaken,” Mr. Juckes added.

“Weakening would in turn probably undermine the AUD, CAD and NZD, as well as the EUR in due course,” he said, referring to the Australian, Canadian and New Zealand dollars, and the euro.


The threat of a 25-per-cent tariff on vehicles is particularly ominous for Canada and Ontario’s industrial heart, given the importance of the auto and parts sectors.

Stressing again that many analysts don’t expect this to happen, if it did, the outcome would be harsh.

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“In what we still view as an unlikely event that the U.S. imposes auto tariffs and the rest of the world responds, a trade war would quickly unfold that would push Canada into recession in the second half of 2019 and into 2020,” Bank of Nova Scotia economists said in a global outlook.

Such a recession would be “about half as deep” as the 2008-2009 slump, they added, while unemployment would spike to 9 per cent.

“Sustained imposition of the mooted auto tariffs could force entire parts of the industry to be moved offshore given the intense integration of vehicle and parts production across Canada, the U.S. and Mexico,” Scotiabank said.

“Global tariffs on U.S. auto imports would invite such a wide-ranging trade war that our baseline remains that these duties will not be imposed.”

The impact on Canada could vary, said Royce Mendes of CIBC World Markets, depending on whether the Trump administration were to hit everyone, or just their friends and neighbours.

“If all foreign-made cars faced a tariff, Americans would have a tougher time finding alternatives,” Mr. Mendes said.

“However, if Canada were singled out, it wouldn’t be too difficult for consumers to just avoid buying vehicles assembled north of the border,” he added.

“In other words, the elasticity of demand for Canadian-made autos in the latter case is higher.”

A hit to all foreign vehicle imports would shrink Canadian auto production by more than 400,000 units a year, Mr. Mendes projected. If only Canada were to be hit, make that almost 900,000.

“After also accounting for a 10-per-cent U.S. tariff on parts, and the fact that reduced Canadian production would require fewer foreign inputs, we estimate the direct drag on GDP to be 0.5 per cent and 1 per cent, respectively, for each scenario,” he added.

“That doesn’t take into account a resultant weaker Canadian dollar, which would work to soften the blow, but a hit to confidence which could potentially seriously worsen the situation.”

What a way to welcome Ontario Premier Doug Ford and his new Conservative government.

“Of course, the vast majority of any decline would be concentrated in Ontario,” Mr. Mendes said.

“Such a shock would likely throw the province into a mild recession, and depending on the speed at which production tails off, risk one at the national level, as well.”

Observers have suggested Mr. Trump is playing an age-old negotiating tactic, in part ramping up the pressure on the stalled talks to remake the North American free-trade agreement.

But they haven’t ruled out the consequences of Mr. Trump actually moving ahead with auto tariffs, either.

Indeed, the Fitch Ratings agency noted that the cumulative impact of measures to date, additional tariffs on China, an auto tariff and the death of NAFTA would affect almost US$2-trillion in world trade flows.

And here’s Royal Bank of Canada senior economist Nathan Janzen, who also doesn’t see it happening: “If imposed, the U.S. tariffs would have a dramatic impact on the Canadian auto sector – and on Ontario, the centre of Canadian auto production – potentially lowering overall GDP in Canada by some 0.5 per cent.”

The bottom line here is that analysts believe all of these scenarios would be so devastating to global trade that Mr. Trump would never do it.

Hold that thought. Here’s Morgan Stanley’s Mr. Zezas: “We now must focus on the cumulative and interacting impacts of the next few rounds. Hence we’ve argued that investors should expect both the auto tariffs and the second round of China tariffs to go forward.”

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Markets at a glance

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Canada churns out jobs

Canada’s labour market is picking up after a couple of flattish months, with 32,000 jobs created in June.

But unemployment crept up 0.2 of a percentage point to 6 per cent as more people went hunting for work, Statistics Canada said today.

Full-time employment rose by about 9,000, while part-time positions climbed by 22,700, the federal agency said.

Over the past year, employment in Canada is now up by 1.2 per cent, or by 215,000 jobs, and all of them full time.

Ontario led the way, with a gain of 35,000 jobs, bringing its total to 157,000 over the past 12 months. As more people went looking for jobs, though, unemployment rose to 5.9 per cent from 5.7 per cent.

“A higher unemployment rate coinciding with a strong jobs gain in June is the best of possible worlds for Canada, with more of us working, but perhaps a bit more room for that to continue without triggering an inflation spike,” said CIBC World Markets chief economist Avery Shenfeld.

“If you give credibility to these one-month numbers, job gains were all in the public sector and self-employed, as private sector jobs were essentially flat. Moreover, part-time gains overwhelmed an only modest 9,000 rise in full-time work,” he added.

“Wages were up 3.5 per cent from a year ago, cooling from 3.9 per cent in May (that was exaggerated by a weak year ago figure that month). Overall, not great in the details, but good enough for the Bank of Canada to hike rates in July.”

The U.S., meanwhile, released a strong labour report, with 213,000 jobs created in June and unemployment rising to 4 per cent as, like in Canada, more people went looking.

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Trade deficit widens

Canada’s trade deficit is widening, now at $2.8-billion with Statistics Canada’s May reading.

Not a good sign as exports slipped 0.1 per cent and imports gained by 1.7 per cent, though the latter were driven by aircraft and other transportation-related goods, which skewed the numbers.

Exports to the U.S. slipped 0.2 per cent, while American imports climbed 1 per cent.

Separately, there may be some solace for Mr. Trump as the U.S. trade gap narrowed to US$43.1-billion, the best showing since October, 2016.

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