Lindsay Patrick
Welcome to Strategic Alternatives, a podcast series from RBC Capital Markets. I'm Lindsay Patrick, Chief Strategy and Innovation Officer, and today we're delivering our Canadian economic outlook, exploring what's next as we look ahead to 2026. This past year has brought its share of curve balls for Canada's economy, from shifting global supply chains to evolving trade and policy dynamics. We've also seen the first signs of AI related impacts and productivity shifts, marking a real turning point for both business and labor markets. At the same time, the policy landscape is shifting, impacting both business and investor sentiment, and together, we think these forces are creating both uncertainty and opportunity, and they demand that we think strategically about how Canada can stay competitive, resilient and innovative, that forward-looking perspective, connecting macro trends to client strategy and innovation is central to how we navigate change and position for what's next, and it's why this conversation is such an important one for us at RBC, but also For all of you our clients joining me to unpack it all is our chief economist, Frances Donald. We'll discuss key drivers shaping Canada's outlook, how global trends intersect with our domestic priorities, and what the road ahead may hold for both businesses and investors. Frances, welcome to the podcast.
Frances Donald
Thanks for having me. I'm excited to get into it.
Lindsay Patrick
So before we jump in, Frances, I wanted to take a moment to congratulate you and the entire RBC economics team on your number one ranking in Canadian economics and taking the top spot in the 2025 Extel All-Canadian Research survey.
Frances Donald
Thanks Lindsay, the team and I are extraordinarily proud to have provided this research in such a complicated year, and so happy that it's been well received, as the team will tell you, it has been a grind of a year, but it has been absolutely worth it.
Lindsay Patrick
What a year it's been. We've had a historic trade shock, a change in federal leadership, rate cuts from the Bank of Canada, coupled with ongoing issues in affordability and productivity. Before we start talking about 2026 let's level set 2025. What is the state of the Canadian economy right now?
Frances Donald
That's such a good place to start, Lindsay, and I could tell you, one of the joys of this job over the past year is how many client conversations and rooms that I've had the opportunity to be in. And they range from retail advisors in rooms in Calgary to institutional investors on Bay Street. And in the past few months, I always start with the same question, whether it's a giant conference with 500 people in the room, or just three portfolio managers. In front of me as I tend to ask, what is their perception of Canada? How many folks believe that Canada is in a recession? You'll see about a third of the hands in the room go up. How many of you believe that Canada will be going into a recession? About another third will go up. And then how many of you believe that Canada has evaded this entirely, and so the last third will go up. It has been, the first time in my career when I've seen such a dissonance and maybe confusion about what the state of Canada is. Now what I tend to tell that group is, actually there's no wrong answer to that question, and we'll talk a little bit about why some areas in Canada are very much in recession. Some are not. But technically speaking, Canada is going to avoid a recession this year, and the closer we look to the data, particularly in the last month and heading into 2026, the more we're actually seeing an economy that's improving. 2026, that's going to look better than 2025. I'm reminded of February 1. Lindsay might not remember February 1. It was a big day for economists, for a lot of folks, it was just another Saturday. That was the day when President Trump announced there would be 25% across-the-board tariffs in Canada, and we spent that whole weekend as a team really trying to come up with what this would mean for the country, what it would mean for governments, what it would mean for global trade and that relationship. And it was very, very difficult. At that time, we ran a range of scenarios. We came up about eight scenarios that ranged from assumptions we were making about currencies to how governments respond, some of them were really serious. Some of them were scenarios that could plausibly have meant three-year-long recession with 10% unemployment rate. I mean really something that resembled or was worse than the great financial crisis. And maybe the best of those bad scenarios was an economy that was hit off course, worse than no trade war, but stabilizing within a year. And I can tell you right now, as we head into 2026 perhaps the most surprising and positive news, I could tell you, is that we are traversing in Canada the best of all of those bad paths on aggregate. So we spent a lot of time thinking, why is that? One of them is actually the the trade hit has been far less than maybe a lot of the general consensus believes. I mean, I think it's becoming increasingly well known. But a few months ago, not many Canadians would recognize that 90% of US imports of Canadian goods are tariff free and covered by Kuzma, so the bulk of trade is still really well protected by free trade and not being substantially impacted. And then, of course, there was another date, April 2. This one most folks around the world will know. This was Liberation Day when President Trump stood up in the Rose Garden with a long list of 186 trading partners and all of the tariffs that will be applied to them. And what I think has been missed in the Canada story is that Canada was not on that billboard that day, and in one single day, Canada went from being the largest victim of American trade policy to its least impacted, and Canada continues to have the lowest average effective tariff of all of American trade partners. And that's so critical to our global trading partners. It's so critical to Americans, as they see prices rise for them around the world, with all partners, they're looking to where if price has gone up the least. And I see this in my travels around the world. I see investors in countries that are saying, well, if there's a place to try hide from America's trade war, where is it? Canada comes up regularly on that. So what we're actually seeing now is a big surprise, which is that we're seeing a stability in trade exposed sectors. Canada currently has more manufacturing jobs now than it did a year ago, a complete shocker out of the realm of what we expected to happen in this given year that's supported a little bit by government money, which has come in and injected some stability there. It's also a story of expectations having been really negative. But on top of that, we've seen stabilization heading into 2026 across a range of other factors. That labor market, it's a little bit weaker. The unemployment rate has been rising, but not because of layoffs. Layoffs have been extraordinarily low in Canada. It's because we're not hiring, and that's disproportionately hurting young people. Mortgage renewal pressures are starting to ease. Household balance sheets are rising, even business confidence is starting to improve. And to be clear, there are still pockets of this economy that are really struggling, and we're still worse off than we would have been absent a trade war. But just as I don't want to downplay the negatives for the country of which there are many. I also think we should be cautious about downplaying the positives that are increasingly evolving.
Lindsay Patrick
It's such a positive story. And I too, think back to that moment in time when we were all preparing for the worst-case scenario, and to hear that we're veering on the most positive case, I think, is encouraging going into 2026. I do want to spend a little bit of time though, understanding more about the 10% of trade that is not currently tariff free. Tell us a little bit more about how those impacts are changing the economy, and what the impacts from that trade shock are,
Frances Donald
So indeed, our sectors, the steel sector, the aluminum sector, many segments within autos are still being substantially tariffed, and lest we not forget softwood lumber, which has been tariffed since Trump's first term and just saw a pretty sizable tariff increase again in October of this year. On top of that, well, we spend an enormous amount of time talking about us tariffs. Canada is also suffering under the weight of Chinese tariffs. China has imposed tariffs on Canadian canola, which is frankly hurting the prairies more than the US tariffs and aquatic products, think lobster, which is impacting our friends and colleagues in the Atlantic far more than US tariffs themselves. And so there's a complexity to this discussion that maybe when you read a headline that says the economy is improving, might get lost. And this 10% of trade is predominantly focused in southwestern Ontario, so that steel, autos and aluminum, those are the sectors that have been substantially exposed. And so as much as the unemployment rate is peaking around the country, and there are areas of the country –
Quebec City, Thunder Bay, Victoria BC – that have very low unemployment rates. If you head down to Windsor, Ontario right now, they have an unemployment rate that's ranging around nine to 11% it's been floating around there. So you might remember when we talked about the worst possible case scenario for the country as a whole, it was something that looks very much like what is happening in areas of southwestern Ontario. But as we head into 2026 I suspect that that regionalization is going to become even more acute, and for policy makers, it is a very difficult situation, because cross country applications of any types of policies is going to be very difficult. There parts of this country that require significant amount of assistance, and there are those that don't require any at all. And that's going to be extraordinarily important for investors on a go forward basis, as they begin to realize the trade shock was ultimately a regional shock, and may persist.
Lindsay Patrick
Indeed, and this fragmentation of regions does echo a theme that you've raised before about the K-shaped economy and the impacts that income diversion have on overall economic growth. Do you see that k shaped economy theme, still being that dynamic, still being relevant, going into 2026?
Frances Donald
I'm so happy you asked about this. I can't remember exactly, but I think last year, when we were recording this podcast, I’d newly started at RBC, we defined what the K-shaped economy means. But in the past, you know, when high income folks were doing better, low-income folks were doing better, and vice versa. So you could have one economic outlook that more or less applied to almost all segments of the economy, and sort of all households. In 2023 we really began to see a big divergence, that sort of E-shaped economy, where everyone's running in parallel, morphed into the K. And this isn't just that this age-old idea, the rich are getting richer and the poor are getting poorer. It's that those groups are now operating in very different economic cycles. They're being impacted by interest rate very differently. The top part of the K has accumulated such an extraordinary level of wealth that to your question, is this dynamic going to remain relevant? We actually believe that the K-shaped economy will be a semi-permanent theme in that it's very difficult to see how that K could end up closing again. And this is super relevant for those who are thinking about Canadian businesses. We have to apply different economic outlooks and different types of analysis if we're thinking about for example of the customer group that may go to $1 store might look very different than one that's going to a very ultra-high end retailer. There's a lot of focus on this in the United States, and in our US outlook, we talk a lot about the K shape. We've been doing a lot more research there being able to quantify how large it is. Canada doesn't have the same level of data, but I don't know that we fully encapsulated how disruptive This is to the way that we measure an economy, because one of the challenges that we're experiencing is a lot of this consumer confidence data. It's base bottom. It looks as bad as it has during recessions and crises and the pandemic and the great financial crisis, and yet it hasn't been matched by regular spending. I mean, I have this one chart that shows you Canadian consumer confidence just continuing to move lower and lower and lower. My most favorite data point in the whole country is an RBC data point. It aggregates debit and credit card data, and we can see at the top, in real time, how Canadians are spending and they look like totally different series. This is the K shape. So what we're witnessing in Canada is similar to the United States, which we know that the top are propelling spending based off of wealth accumulation, and the bottom part of the case still experiencing the drags from the affordability hit, still experiencing sort of setbacks from the higher end of the K through wealth accumulation. And I think that's going to be an ongoing theme, and we have to be very mindful of it as we're thinking about everything from investments to being business owners. Where are we investing on that K and how are we going to think differently about it versus thinking about the economy as one moving single entity.
Lindsay Patrick
Francis, this is so fascinating. You have different consumer outlooks depending on which segment you're in. You have different regional outlooks across the country depending on where you reside. But yet, we have one central bank, the Bank of Canada, and they are a commonly used tool in the toolbox for economic policy, and one that Canadians, frankly, perhaps, have grown a little accustomed to depending on. What does this mean for the Bank of Canada and their outlook for the year ahead?
Frances Donald
Well, that's certainly true, and in the past, it's made sense. If you want to limit inflation, you raise interest rates, you maybe take a little bit money out of the economy, you make it a little bit more expensive to borrow, and then inflation comes down. And this has been a very effective system for several decades now. But the problem is, what happens when a, your economy starts to become much more fragmented, and b, what happens when the inflation in the system becomes less tied to whether everyone has a job and whether they want to go out to dinner on a Saturday night. On the first point, I mean, this is really the biggest challenge facing the Bank of Canada. If there was a Bank of Canada of Windsor, Ontario, they probably would have held inter meeting emergency rate decision and cut to 0%. And if there was a central bank of Victoria BC, one might even say they should be raising interest rates as an example. So what we've been hearing from the Bank of Canada has been that they are not the right tool for a trade shock, that monetary policy is not the right medicine for an economy that is becoming fragmented to this extent, in part, because the challenges facing Canada right now are different. Lower interest rates are not going to do much to help those who are really suffering from the trade war. And a line that I really like from Carolyn Rogers, who's the senior deputy governor at the Bank of Canada, in their November meeting, she said, We don't want to add an inflation problem to a trade problem. And in my mind, that translated to, the only thing worse than not having a job is not having a job, and prices are going up at the same time, so it's complicated. Now I think if we started to see the economy weaken if, for example, our base case doesn't pan out, if we saw the unemployment rate rise up because of layoffs and more broad based and we started to see the demand side of the economy falter, of course, the Bank of Canada would step in, but they're being very mindful right now about explaining to Canadians, who, as you've noted, have become extraordinarily dependent on the Bank of Canada stepping in at any moment when things go wrong. I think about it a little bit like a helicopter parent. The fact that there's a little fight at school, someone shows up at the door to try to rectify it. That's a little bit our dependence on the Bank of Canada. And I think we're going to go through a moment here when we realize we need fiscal policy to come in. We need policy that can come in and inject into the cracks of the foundation, not broad-based policy that impacts everybody at the same time. But certainly a complicated scenario for central banks. And I'll just put an asterisk on this. This is not just a Canada story. This is also a US story. The US has a K-shaped, a very fragmented economy. European central banks have been wrestling with same sort of factors. What do you do when inflation becomes increasingly supply-side generated? They can cut or raise interest rates all they want. It's not going to make it rain in Brazil and solve droughts. It's not going to end wars that have gummied up supply chains. It's not going to change tariff policy. So it's a new era for central banks, and we just have to adjust the way that we think about them and the way that Canadians get used to using them, I think.
Lindsay Patrick
It's also a new era for governments, and if we're looking more towards fiscal policy, there's a lot to read into that from the new federal budget. Tell me a little bit about your engagement with clients on the federal budget, and then your own analysis around Canada's increase in fiscal spending, what its impact will be, and how that is driving your near- and medium-term outlook,
Frances Donald
It would be very difficult to rectify all of the challenges in Canada in one document, in part because, of course, this government got a lot of criticism for having $78 billion deficit. To fix all of the challenges, probably required an even larger one. But there are things happening right now that are interesting and different than what we've seen from the past 10 years, and we've sort of isolated three strategic ideas. The first one is that in the prior Liberal government, we were used to governments focusing on consumption. So, for example, you might remember that period there were some tax-free Christmas gifts for a while. Now that had the benefit of immediately goosing growth statistics. So the next week, we saw data fly upwards, but it didn't really do much. This Carney government is moving away from consumption-driven to investment-led, type of government spending. That's a new era. The advantage is it's stickier and lasts longer. But the disadvantage is it takes a lot longer for it to play out. I'll walk you through some of those timelines in a moment, we're also seeing a different sort of strategy, which is that most of us grew up with the idea that the bigger the government is, the bigger it sort of crowds out private sector private spending. You've probably heard that line before, but this government is maybe trying to replicate a little bit about what the US did in that it's trying to crowd in private sector investment, and so we talked to clients a lot about how to help them prepare for that baton pass between public to private, but again, probably a couple years away. And the last, of course, very front of mind for Canadians and Canadian investors, much more of a resource focused major projects. And that's positive. Because it's a more organic way to diversify exports and boost productivity. But Lindsay, you've taught me something in my past year here, and I think about it all the time. You have taught me that execution eats strategy for lunch, and this is a strategy that has been put together, but we have not seen and do not know what the execution will look like, and in the meantime, it's probably a long path towards seeing that. In the next 12 to 18 months, in our forecast, the elements of this budget that we will see impacting us now, are the tariff relief we're already seeing some of that in manufacturing, and the middle-class tax cuts. Many Canadians forget that we were given middle class tax cuts in the middle of last year. When we think out longer horizon, the defense spending, the major projects, the resources. Well, it takes time for these things to pass, to get as economists call it, shovels in the ground. That's probably a three-year horizon and AI initiatives and productivity focuses, those take many years, five years, to get going. Now my hope, and I think many Canadians’ hope, any political hope, is that 10 years from now, we look back and we say, this was the starting of the turn of the tanker ship. What I hope to see going forward, for this to really be effective is a stage two. And we've seen budgets before, like the 1994 budget was followed up with the very transformative 1995 budget. There's a tracks and b tracks on records. There's first acts and second acts. The second act that has to come here is really on the deregulation side and maybe some more tax focus, because until then, a lot of these ideas to try to get the private sector moving. I'm a little bit worried. It's like pushing on a string. So there's a gap here. And when we think about forecasts and some of the investment implications we've had, sort of the Bank of Canada that has said we're not going to be cutting interest rates very much anymore. Most of the street no longer sees that, and we have a government that says we're going to try to take over, but there's an air pocket, and how long that air pocket lasts? It's a bit of a risk for the Canadian story. And one that we spend a lot of time thinking about is, are we going to go through a bumpy transition from monetary policy to fiscal policy? But all in all, we would say that this budget bears monitoring, and maybe I'll put a little asterisk on this. A lot of interesting things happen from fiscal policy outside of budgets, and I wouldn't say that this is a fiscal plan that we should look at once a year. It's one that will be continuous. And of course, RBC economics will be commenting on it regularly, so you can sign up or follow us on LinkedIn, too, and we'll make sure that we're front and center on every new development that comes through.
Lindsay Patrick
Francis, this has been a terrific discussion. We've gone from consumer outlooks to investment outlooks, from trade policy, fiscal policy and monetary policy. But you have such a broad view of the Canadian and the US economy. What's one thing that we're missing from our dialog today?
Frances Donald
There is one thing that we think about a lot, and it's sort of a background issue, but I think it may turn out to be more impactful than most realize. After a remarkable surge in population growth between 2022 and 2024 we are now reversing course, so population growth is probably going to decline to sub 1% or even to 0%. I'll very quickly say on this, Canada was actually renowned between 2010 and 2020 for having a brilliant immigration policy. It's one of the reasons right now that we have a much smaller share of those over the age of 65 in the US economy and are not facing the demographic crisis the United States is. And over that time, those who came to Canada were economic superpowers. They had very high rates of employment, very high productivity levels, and they tended to buy homes in five years. In 2022 the mistake for Canada was not in nearly quadrupling the amount of folks coming in. It was that we radically changed the type of folks coming in towards students and non-permanent residents, and those folks, by definition, are not working. They don't buy homes, they didn't have the same productivity levels, and they weren't supposed to. They had student visas, right? And so, the economic nature of immigration changed really radically. We were witnessing the economy grow, but the economy per person getting smaller. That's going to turn around now. So as the population starts to shrink, we're going to see an environment where both the size of the pie grows, but then the pie per person is going to get even bigger. That's kind of a good thing. It also means that we're going to have to create far fewer jobs. For a long time. We believed that we needed to add well over 100,000 jobs per month in the United States in order to keep the unemployment rate stable, or that there were 100,000 people per month that would need a job. In the United States, that number has dropped to 40, but that number has also dropped significantly in Canada. We now believe that the Canadian economy will only need to produce zero to 5,000 jobs per month and into 2027 we could actually see job growth go negative and still not see the unemployment rate rise. That's going to be an odd time for Canadians. They're going to see headlines that say Canada created zero jobs, and think this is a bad thing. But as we head into 2026, 2027 The question isn't going to become, can you get a job if you want one, it's going to be, can you hire someone if you want to. That's going to be a shift in the Canadian story that not just was an issue for us in 2022 to 2024 but hasn't really been a Canadian story for decades. So I think it's important for us to just be aware of this underlying structural dynamic at the same time as we monitor this improvement in cyclical growth.
Lindsay Patrick
That's a great point Frances, and I think it will also feel very different for individual Canadians. We started this podcast with a view on why 2025 and going into 2026 is better than expected. And I think this last point on rising per capita GDP is also a nice positive point to end on. Thank you very much, Francis for the discussion today,
Frances Donald
Well, thank you for having me.
Lindsay Patrick
And to our listeners, thank you for joining the strategic alternatives podcast from RBC Capital Markets. This episode was recorded on November 21, 2025. Listen and subscribe to strategic alternatives on Apple, Spotify, or wherever you get your podcasts. And if you'd like to learn more or continue the conversation, please visit RBCCM.com/strategicalternatives or connect with your RBC representative. Frances and I will see you next time.