Trump 2.0’s aggressive trade and foreign policies have sent nations scrambling to adjust. Canada has been one of the US administration’s top targets. Many world leaders, hoping America’s new approach would be temporary, have sought to appease POTUS47. However, Prime Minister Mark Carney understood quickly a New World Order was replacing the post-WWII system.

Borrowing from Thucydides’ description of powerful Athens’ treatment of its rival during the Peloponnesian War, Carney warned that in the new regime “strong countries do what they can, and the weak suffer what they must”. Earlier this year in Davos, the Prime Minister sounded a clarion call for mid-sized nations to work together rather than to accept this fate.

To be sure, Canada is especially vulnerable to America’s new strategy. Canada is a very open economy. Foreign trade represents 67% of GDP compared to 27% for the USA. Likewise, foreign direct investment (inflows+outflows) account for 170% of GDP compared to 40% for the United States. And, Canada is heavily reliant on its southern neighbour: 72% of Canadian exports are to the USA, and 50% of FDI inflows emanate from the United States (Chart above).

In this blog, we will consider the impact of US trade policy on Canada’s near-term outlook. Also, we will highlight the early success of the Prime Minister’s tireless efforts to reduce Canada’s dependence on its now less reliable partner. In addition, we will identify numerous important domestic policy options Canada has at its disposal to adjust to the New Order.

Economy Stuttering, Not Stalling….Yet

First of all, it’s hard to understand POTUS’s problem with America’s second largest trading partner. Indeed, Canada runs a small worldwide current account deficit, and only a small trade surplus with the USA. And, Canada’s export/import ratio is higher than the US global average — suggesting US exporters do not confront any particular impediment to accessing the Canadian market.

To be sure, US trade policy has taken a toll on the Canada. Indeed, GDP grew only 1-2% during the first half of 2026 — below the economy’s long-term trend. In particular, capital spending advanced only 1%, reflecting overall business uncertainty.

Nevertheless, it’s fair to say, Canada has been more resilient than expected. Perhaps most surprisingly, exports have increased nearly 15% during H1 2026. Of course, much of the gain reflects higher prices and demand for Canadian energy sales abroad. In addition, despite escalating trade tensions with the USA, the effective US tariff on Canadian goods has not risen much so far (Chart above), as most of Canadian exports are exempt under the CUSMA (USMCA south of the border).

Most importantly, Mr. Carney’s efforts have succeeded in diversifying the destination of Canadian exports. Indeed, sales to Europe and China are up 70% and 35% respectively (Chart above). Even the USA has maintained a healthy appetite for Canadian energy products.

Unfortunately, the outlook may get tougher in the period ahead. Indeed, US tariffs will increase further in coming months. To be sure, as a net energy exporter, Canada benefits from higher oil prices. And, while consumer spending has remained resilient (expanding 2% in H1 2026), continued high prices will take a toll. In addition, rising Canadian bond yields may limit both household spending and business investment, as debt levels are high in both sectors relative to other countries (Chart below).

Domestic Reform: Unleash the Beast

In addition to diversifying its trading partners, Canada has other options to offset the impact of Trump 2.0 trade policies. The following Chart highlights that since Covid Canadian GDP per capita growth has lagged behind virtually all OECD rivals, particularly the USA. Of particular concern, capital spending growth has trailed far behind many of its competitors.

As a result, Canadian productivity growth continued to underperform its rivals — a unenviable pattern which has has persisted for over two decades (next Chart). Of particular concern, the efficiency gap with the USA has widened to 30% during the past 25 years. Canada’s loss of competitiveness is reflected in relatively weak export growth compared to other nations during the post-pandemic recovery (Chart above).

To be sure, this is a well-known problem. On the one hand, Canada is an open, liberal, free-trading country. Domestically, however, the economy is far less integrated, reflecting the nation’s federal structure. Regulatory and administrative impediments have hampered domestic trade, prevented the exploitation of economies of scale, and harmed competitiveness.

The IMF estimates successfully integrating Canada’s domestic market could boost GDP by a whopping 7% (Chart above). As I estimate US tariffs could subtract roughly 2% from Canadian GDP, the need for domestic reforms is clear. Indeed, the benefits of internal integration would swamp the impact of Trump 2.0. Mr. Carney is the right person to take on this challenge.

Macro-Policy: Many Levers to Pull

In addition, Canada has several macro-economic policy options to deploy to offset the impact of tariffs. First of all, the inflationary impact of the Iran War has been relatively limited so far, especially compared to the USA. Indeed, core inflation has risen little this year, reflecting minimal pass-through of higher oil prices. As a result, the Bank of Canada has not raised interest rates yet, and monetary conditions remain more relaxed than in the USA and elsewhere (Chart above). I expect the BOC to support the domestic economy, and to continue to proceed more cautiously than the US Federal Reserve in the period ahead.

In most cases, nations suffering the imposition of higher tariffs would allow their currency to depreciate to offset the loss of competitiveness. To be sure, the Canadian dollar appears a bit undervalued, but the inflation-adjusted C$ has moved little since the US trade war began (Chart above). Therefore, if the domestic economy falters or the trade war escalates further, I would expect Canada to allow the C$ to decline.

Furthermore, Canada’s fiscal position is far healthier than other G7 nations — enjoying lower debt and smaller deficits (Chart above). On the one hand, therefore, Canada could support domestic spending if needed in the period ahead. Likewise, if global bond markets become more concerned about unsustainable public finances worldwide, Canada would fare better than others, especially the USA. Therefore, lower inflation risk, easier monetary conditions, and better government finances point to continued outperformance of Canadian bonds relative to the USA.

Equities to Outperform?

To be sure, Canadian equities are not cheap, especially considering the economic risks the nation confronts (Chart above). However, given the government’s macro-economic policy options and the significant potential boost from domestic reforms, the economy is likely to continue to exceed expectations. If so, Canadian equities should outperform the US market.