TLDR
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The economic pessimism that permeated the early part of the year has been tempered, with Canada’s currency and economy faring better than anticipated
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That is largely due to the USMCA, which shielded Canada from some of the harshest tariff measures—ultimately making it the least affected U.S. trade partner rather than one of the most, as was originally feared
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Though the economic and currency forecasts have improved, the situation remains changeable and volatile
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The end of the 90-day tariff pause, and the recently announced 30-day timeline for Canada to make a deal with the U.S., are set to expire in early July
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Geopolitical instability in the Middle East and beyond threatens further destabilization of a market already on edge
Canada’s economic outlook has gotten considerably more optimistic in a relatively short period of time, though the situation remains volatile.
In the opening days of the year, a surprisingly harsh tariff threat sent the Canadian dollar to a 22-year low, prompting the Bank of Canada to cut interest rates in an effort to boost what was expected to be a sluggish economy.
Since that time, however, Canada’s economy has proven more resilient, the trade war has proven less damaging, and interest rate slashing has been more reserved.
As the year has progressed, RBC has revised its economic growth forecast from lows of 1% in 2025 and 0.9% in 2026, to a more optimistic 1.6% this year followed by 1.3% next year. An expected rate cut to 2.25% was similarly revised to suggest the Bank will maintain its current posture at 2.75%, while the Canadian dollar is expected to strengthen modestly, rather than weaken, in the short and medium-term.
“The story has really turned upside-down,” explains George Davis, RBC’s Managing Director of Fixed Income, Currencies & Commodities in Capital Markets. “So far the tariff hit on Canada hasn’t been as bad as we thought, nor has the hit to growth.”
How the USMCA saved the day
That plot-twist is largely thanks to the United States-Mexico-Canada Agreement (USMCA), which Davis says blunted much of the potential damage, recasting Canada as one of America’s least hard-hit trade partners, instead of the most.
“Last year the net effective tariff rate that was applied to Canadian exports was around 2.5%,” he says. “When we went through the first wave of tariffs, that went up to 3.5%, and it’s now sitting around 4.6% because of the recent increase in steel and aluminum tariffs.”
Davis says that figure represents the total amount of duties placed on all U.S.-bound goods leaving Canada, which currently exempts those items that fall under the existing free-trade agreement.
Though a 4.6% tariff rate isn’t ideal, it’s far less damaging than the broad-based 25% tariff that was threatened earlier in the year, or the 10% baseline tariff applied to most other trading partners in April, and its effects have been far less damaging than originally anticipated.
“That’s a lot more positive than the initial risk, and we actually have a bit of a competitive advantage,” Davis says. “At 4.6% we actually have the lowest average effective tariff rate of any trading partner with the U.S.”
Just a few months ago there was an assumption that, as one of America’s largest trading partners and as a primary target of the President’s rhetoric on trade at the time, Canada would be one of the hardest hit countries. Instead, Canada has remained one of the least, forcing a near total reversal of the country’s economic outlook.
Where Canada’s economy, and the dollar, goes from here
Canada’s economy isn’t out of the proverbial woods just yet.
Though the country has remained relatively unscathed by tariffs thus far, the situation remains far from stable. Firstly, the USMCA is up for renegotiation in 2026.
Furthermore, the status quo remains tenuous as the country heads into July, at which point President Trump’s original 90-day pause on global tariffs expires, and the Canadian government continues to negotiate the terms of a new trade deal with the United States.
“This time, as opposed to being very broadly based as we saw in early April, we might see a little bit more activity on a country-by-country basis,” Davis says of the next round of tariffs.
At this point the United States has only signed one formal trade agreement, inking a deal with the United Kingdom in mid-June. That agreement could ultimately shield the U.K. from further tariffs, and Davis is hopeful that a similar deal could be struck with Canada in the coming weeks.
“They may decide to extend the deadline again for countries that they’re in active negotiations with,” Davis says. “For others, they might say it’s not happening fast enough, and we could see those tariffs ramp up.”
Instability extends beyond the financial markets
The prospect of tariffs, however, are now just one piece of an increasingly complex puzzle that also includes other aspects of geopolitics.
In recent days, the escalation of hostilities in the Middle East prompted a short-lived rally in the American currency, highlighting one of the most significant risks for investors during this period of volatility.
Whether it’s the threat of engaging in a direct conflict in the Middle East, pulling out of NATO, or pulling back support for Ukraine, the current administration’s break from geopolitical norms regularly threatens to move the market in dramatic ways.
“All of that uncertainty has caused people to question the validity of being overweight in U.S. assets,” Davis says. “We’ve seen some investors pull back on their U.S. exposure, and that’s caused the U.S. dollar to weaken across the board.”
In a different economic context Davis says headlines about geopolital instability may not have as great an impact on the markets.
“The U.S. is becoming a lot more isolationist—they’re backing away from trade relationships and military relationships they had with their allies in the past—and that uncertainty has really changed people’s perception of U.S. assets and the U.S. dollar,” he says. “When bad news flares up, people are a lot quicker to get out of those U.S. holdings, and that’s made us more optimistic in our view of the Canadian dollar.”
What it means for Canadian businesses and investors
The recent changes to economic, interest rate and currency outlooks will force some Canadians to change their plans. Many Canadians have revised their plans to visit the States in reaction to both political tensions and declining currency values, both of which appear to be easing.
“For those that are planning to travel into the U.S. it certainly suggests cheaper vacation costs, because the Canadian dollar has been a lot stronger,” Davis says. “Similarly, for companies that are purchasing goods and services in the U.S., the dollar’s direction has been a pleasant surprise.”
As for investors, Davis says the recent optimism is by no means an invitation to lower their guard.
“On the investment front, the current climate calls for a lot more caution,” he says. “A lot of Canadian investors have decent exposure to the United States, and I think the broader movement towards isolationism requires more vigilance, because the market has gotten a lot more sensitive to those issues.”
Canadians can explore RBC’s thought leadership page to stay on top of new developments, reach out to their banking advisors to discuss risk exposure, or connect with RBC’s Global Fixed Income & Currencies Team to learn more about the currency’s trajectory and its implications.
