Canada's Economy is Plummeting and Unemployment is Climbing | Robert Embree and Jimmy Connor

Key Concepts

• Structural vs. Cyclical Economic Problems: Canada faces both long-term declining growth rates (structural) and short-term economic downturns (cyclical).
• Productivity Growth: A key driver of structural economic weakness in Canada, linked to low R&D and capital formation.
• Uncertainty and Tariffs: Major contributors to the current cyclical downturn, impacting Canadian businesses and investment.
• Low Oil Prices: A significant factor affecting Canada's commodity-dependent economy.
• Labor Force Growth vs. Job Creation: When job creation doesn't keep pace with labor force expansion, unemployment rises.
• Defensive Corporate Behavior: Companies are pulling back on hiring due to uncertainty, rather than resorting to layoffs.
• Youth Unemployment: A leading indicator of labor market weakness, as young people are more vulnerable to hiring freezes.
• Foreign Direct Investment (FDI): The flow of investment into Canada from foreign entities.
• Commodity Exports: A significant portion of Canada's exports, which are not currently benefiting from the US economic boom.
• Inflation: The persistent rise in prices, which remains above the Bank of Canada's target.
• Disinflationary Trend: A slowing down of inflation, expected to become more pronounced in the coming years.
• Mortgage Renewal Cliff: The upcoming period where a large number of mortgages will need to be renewed at potentially higher interest rates.
• Tax Base: The total value of assets and income on which taxes can be levied.
• TSX (Toronto Stock Exchange): The Canadian stock market index, which has shown strength despite a weakening economy.
• USMCA (United States-Mexico-Canada Agreement) Renegotiation: A critical factor for Canada's economic future, particularly regarding tariffs.
• Derisking Investment: Reducing exposure to riskier assets like stocks and shifting towards safer assets like bonds.

Canadian Economic Challenges: Structural Weakness and Cyclical Downturn

The Canadian economy is currently grappling with a dual set of problems: structural issues characterized by declining growth rates over several years, and cyclical issues exacerbated by current economic conditions. Robert Rosenberg highlights that Canada's average growth rates have been falling due to low productivity growth, insufficient R&D investment, and limited capital formation. This means that even in favorable economic times, Canada's economy struggles to grow robustly.

Adding to this, the current year's performance is significantly below the expected potential growth rate. This is attributed to a combination of factors, including widespread uncertainty, the impact of tariffs, and the persistent effect of low oil prices. The confluence of these issues has resulted in an economy that is not growing fast enough to absorb the expanding labor force, leading to a noticeable increase in unemployment.

Unemployment Figures and Trends

• National Unemployment Rate: Currently at 7%.
• Ontario Unemployment Rate: 7.9%.
• Toronto Unemployment Rate: A concerning 9.9%.
• National Unemployment Increase: Approximately 0.4 percentage points.
• Toronto Unemployment Increase: Closer to 1 to 1.5 percentage points.

Rosenberg notes that the unemployment rate has been ticking upwards, with young workers and those in more vulnerable sectors of the labor market experiencing the effects most acutely.

Structural Growth Rate vs. Current Performance

• Potential Growth Rate for Canada (Long-Term Average): Approximately 1.8%.
• Annualized GDP Growth Rate (Current Year): Around 0.7%.

This stark difference indicates that the Canadian economy is performing significantly below its already modest long-term potential.

The Impact of Corporate Defensive Behavior on Hiring

A key observation regarding the current economic climate is the defensive posture adopted by employers. Instead of engaging in widespread layoffs, which is a more traditional indicator of economic downturn, companies are significantly pulling back on hiring. This strategy is driven by uncertainty about the future; businesses are hesitant to hire new employees only to face the costly prospect of laying them off later.

This pullback in hiring has a direct impact on individuals entering the job market. New graduates and immigrants are finding fewer available positions. Since individuals do not have jobs to quit, this hiring freeze disproportionately affects those trying to establish themselves on the career ladder, making youth unemployment a critical "canary in the coal mine" for this defensive corporate behavior.

Youth Unemployment Rate

• Current Youth Unemployment Rate: 14.7%.
• Historical Context: This rate has not been this high since the 1990s.

This figure underscores the difficulty young Canadians are facing in securing employment.

Challenges in the Southern Ontario Auto Sector

The auto industry in Southern Ontario, a significant employer, is facing considerable headwinds. This sector, which directly employs around 45,000 people and supports an entire supply chain of 150,000 to 160,000 individuals, is experiencing plant closures and job losses.

Specific Case Studies:

• Stellantis: Announced the closure of an assembly plant in Brampton, Ontario, relocating operations to Illinois, USA. This move will result in the loss of 3,000 jobs in Ontario, while creating 5,000 jobs in Illinois with a $13 billion investment over four years.
• General Motors: Is shutting down a plant in Ingersoll, Ontario, that manufactured EV vans. The demand for these vans, intended for companies like UPS, FedEx, and Amazon, has not materialized, leading to the closure and the loss of 1,300 jobs.

Concerns for the Auto Sector's Future:

The fear is not just about isolated job losses but the potential for a cascading effect, similar to what happened in Australia's auto sector, where a series of closures led to the near-complete shrinkage of the industry. The viability of Canada's auto sector is further complicated by ongoing US auto tariffs, which show no signs of disappearing.

While the auto sector is regionally concentrated and represents a relatively small portion of Canada's overall economy, its localized impact can be devastating. The broader slowdown in Canada is seen as a consequence of economy-wide trends rather than solely being driven by the auto and steel industries.

Foreign Direct Investment (FDI) and Policy Concerns

There are concerns that foreign companies are hesitant to invest in Canada due to policies enacted by the Liberal government over the past decade, leading to a perception that Canada is "uninvestable."

Understanding FDI:

Foreign Direct Investment refers to investments made by foreign entities into Canadian businesses or the establishment of new operations in Canada. Conversely, Canadian companies also invest abroad.

Current FDI Trends:

While there hasn't been a significant reduction in inbound FDI yet, there are indications of potential slowdowns. The data available up to the second quarter of 2025 does not fully reflect the impact of recent uncertainties. However, Rosenberg anticipates a meaningful slowdown in FDI into Canada in the third and fourth quarters of 2025 and the first quarter of 2026.

Canada's Economic Disconnect from US Growth

Despite sharing a border with the robust US economy, which is experiencing GDP growth of 2.5-3% and low unemployment (around 4%), Canada is not fully benefiting from this proximity. The US stock markets (S&P and NASDAQ) are consistently reaching new highs.

Reasons for the Disconnect:

• Narrow US Growth Drivers: Much of the US economic growth is concentrated in AI-related capital expenditures, particularly in semiconductors and chips.
• Canada's Export Composition: Canada's export basket is heavily weighted towards commodities (like energy, which is currently depressed) and auto/steel products subject to tariffs. Canada is not a significant exporter of the high-growth technology components driving the US boom.
• Structural Weaknesses in Canada: As previously discussed, Canada's lower productivity growth and capital formation limit its ability to capitalize on external growth opportunities.

Persistent Inflation Despite Economic Slowdown

A perplexing aspect of the current economic situation is the persistence of inflation, particularly for essential goods like food, even as the economy slows down. The cost of groceries has significantly increased, with specific items like beef tenderloin seeing dramatic price hikes.

Inflationary Dynamics:

• Food Prices: While volatile and a smaller component of the overall inflation basket, food prices have seen substantial increases.
• Persistent Inflation: Inflation has remained above the Bank of Canada's 2% target since late 2021.
• Disinflationary Trend: Despite the persistence, there is a clear disinflationary trend, albeit volatile and slower than anticipated.

Connection to Labor Market Slack:

The high unemployment rate (7.1%, well above the neutral rate) indicates significant slack in the labor market. This slack is expected to reduce wage growth, which will, in turn, eventually lead to a decrease in service sector inflation. This effect typically manifests with a 6-12 month lag.

Shelter Costs:

Falling rents and house prices are also contributing to disinflationary pressures, with predictable impacts expected to be seen in the data starting in 2026.

Bank of Canada's Stance:

The Bank of Canada is closely monitoring these trends. With markets pricing in a high probability of an interest rate cut, the central bank recognizes that inflation is unlikely to rise and is more likely to decline due to the weak labor market.

Mortgage Renewals and Real Estate Market Concerns

The upcoming "mortgage renewal cliff," where a large number of mortgages are set to renew in 2025 and 2026, presents a significant challenge. Homeowners who purchased properties in 2020-2021 may face substantial increases in their mortgage payments due to higher interest rates.

Bank of Canada's Awareness:

The Bank of Canada is aware of this issue and considers it among many factors in its monetary policy decisions. However, Rosenberg suggests that the rate-cutting cycle is primarily driven by the balance between sticky inflation and labor market weakness, rather than solely by the mortgage renewal cliff.

Toronto Real Estate and Property Taxes:

• Property Tax Increase: Toronto saw a 6.9% increase in property taxes for 2025, representing a 25% rise over the last five years.
• City Councilor Raises: Coinciding with the property tax hike, city councilors voted themselves a 24% raise, increasing their annual salaries from $137,000 to $170,000.
• Declining Tax Base: Property tax increases are partly a response to declining residential property values in some parts of Toronto, forcing the city to raise taxes on a shrinking base to maintain revenue.
• Condo Market Correction: A significant price correction is anticipated in the condo market.

The impact of plant closures, like the GM plant, on local tax bases is also a concern, as these industries can represent a substantial portion of a municipality's revenue.

Divergence Between the TSX and the Canadian Economy

A notable disconnect exists between the strong performance of the Toronto Stock Exchange (TSX) and the weakening Canadian economy. The TSX is trading at or near all-time highs, and Canadian banks are also performing well.

Reasons for the TSX Strength:

1. International Composition of the TSX: The TSX is heavily influenced by global companies and sectors, not solely by the performance of the Canadian economy. Some Canadian companies listed on the TSX are benefiting from the US economic boom, even if the broader Canadian economy is not.
2. Corporate Profits vs. GDP: Canadian corporate profits have held up better than GDP. Companies are managing to maintain profits by holding off on hiring, which can support profitability in the short term.
3. Bank of Canada's Easing Cycle: As the Bank of Canada and other global central banks cut interest rates, the discount rate for equities decreases, which tends to support stock valuations.
4. Soaring Gold Prices: The uncertainty in the global environment has driven up the price of gold, and gold stocks represent a significant portion of the TSX's index, contributing to its strong performance.

Rosenberg emphasizes that the TSX's performance does not necessarily reflect the health of the Canadian economy.

Recession Outlook and Worst-Case Scenarios

Canada is currently "flirting with recession," with the possibility of entering a recession in Q4 or Q1 of the following year, especially if trade war uncertainties persist.

Base Case Scenario (Avoiding Recession):

• USMCA Renegotiation: Successful renegotiation of the USMCA is crucial.
• Federal Stimulus: An additional $10-15 billion in federal spending and business subsidies in the upcoming budget.
• Bank of Canada Rate Cuts: One or two more interest rate cuts.
• Oil Prices: Stabilization of oil prices in the high $60s.

In this scenario, Canada would narrowly avoid a recession, but growth would remain slow (around 1%), and unemployment would likely continue to increase as it wouldn't keep pace with labor force needs.

Worst-Case Scenario (Recession Unavoidable):

• Failure to Renegotiate USMCA: If the USMCA is not renegotiated, Canada's effective tariff rate could rise to 15-20%, similar to other countries.
• Deep, Cross-Sector Structural Recession: This would lead to an unavoidable recession.
• Unemployment: Unemployment could easily reach 8.5% or higher.
• Asset Price Declines: Significant declines in housing prices and stock market values are expected.

Rosenberg warns that if Donald Trump imposes massive tariffs on the Canadian economy, a recession similar to the early 1990s could occur, with double-digit unemployment and substantial asset price corrections.

Investment Advice and Risk Mitigation

Given the current rich valuation of the TSX and the potential for worst-case economic scenarios, Rosenberg advises investors to:

• Take Risk Off the Table: Reduce exposure to stocks.
• Shift to Bonds: Increase allocation to bonds.
• Diversify Equities: Consider investing in Asian and emerging market equities outside of Canadian stocks.

Conclusion and Future Outlook

The Canadian economy faces significant challenges stemming from both long-term structural weaknesses and immediate cyclical pressures. While the TSX is performing well due to international factors and monetary policy, the underlying economic reality points to a slowdown and a heightened risk of recession. The outcome of USMCA renegotiation and federal fiscal policy will be critical in determining whether Canada can narrowly avoid a recession or face a more severe downturn.

For those interested in further analysis, Rosenberg Research offers comprehensive research and market commentary at rosenbergresearch.com.