08:35 AM EST, 12/02/2024 (MT Newswires) -- Last week United States President-elect Donald Trump surprised markets and analysts with the threat of a 25% across-the-board tariff on Canadian and Mexican-made goods, which would be implemented as soon as the incoming administration takes office in January, noted TD.

The clearest impact from this announcement was seen on the Canadian dollar (CAD or loonie), which dropped about 1 cento, or about 1.5%, on the news, before regaining some of that lost ground over the week, said the bank. Equities declined and bond yields continued their descent, although the relatively muted response suggests that markets have yet to fully embrace the potential downsides from a Canada/US trade skirmish.

This threat isn't to be taken lightly in TD's view. In a prior report, the bank analyzed a scenario where a 10% US tariff was slapped on all Canadian exports, with in-kind retaliation by Canada. It found that Canada's economic growth would slow to a crawl, inflation would see a boost, and the loonie would tumble under 70 cents US.

A tariff rate more than double the one used in the analysis would exacerbate these already severe outcomes, pointed out TD. All Canadian provinces would take a hit through weaker exports, although some -- like Alberta, New Brunswick, and Ontario -- would likely feel it more than others given their tight trade linkages with nearby states. Others, like Prince Edward Island and Saskatchewan, could see a larger inflation boost through Canadian tariff retaliation, given their relatively high concentration of US content.

"Fortunately," there's at least one reason to be hopeful that this is a negotiating tactic, according to TD. Namely, US economic growth would suffer, given the deep interconnectedness of industries such as energy and autos between the US and Canada. A trade clash between the two countries would deliver not only economic damage but political pain for the US. This backdrop would also be negative for stock markets, which Trump has shown a sensitivity to in the past.

The bank has yet to incorporate these threats into its baseline view, but it will be watching. So will the Bank of Canada, which stands ready to incorporate whatever policies eventually do flow from the incoming US administration, according to Deputy Governor Rhys Mendes last week. In the here and now, Canada's central bank has an interest rate decision on Dec. 11 and will be using the hard economic data to guide its actions, stated TD.

Since the BoC's October decision, the bank has seen a steady flow of hawkish data -- like the recent backup in core inflation and a retail sales report that showed solid spending momentum heading into Q4 of the year.

Friday's Q3 GDP report was another important piece of the puzzle before the December decision, and the data offered mixed messages, added TD. On the one hand, overall GDP growth was modest, and soft monthly showings in September and October will make the BoC's call for a Q4 growth acceleration to 2% more difficult to achieve.

On the other hand, domestic demand was solid, fueled by healthy gains in both goods and services consumption. Given this, a 25bps cut versus a larger 50bps move seems the more likely outcome next month, it concluded.