With contributions from Josh Nye, Vivien Lee, Ana Ardila and Aaron Ma

Economic webcast

Our latest monthly economic webcast, recorded on July 2, is now available here: Declining fear versus lagged damage.

Tariff deadline extended

A 90-day reciprocal tariff pause that was set to expire on July 9 has been extended to August 1. To maintain negotiating pressure, the White House is sending letters to trading partners detailing new tariff rates that will take effect next month. So far, letters have gone out to 14 countries including Japan and South Korea. Tariff rates range from 25% to 40% and are close to or below reciprocal rates that were originally announced on April 2. The average effective tariff rate announced thus far is in line with what was previously proposed.

More letters will be sent out in the coming days, potentially covering the nearly 60 countries that were included in the April 2 reciprocal tariff announcement. There are some reports that the European Union (EU) will not receive a letter and is close to reaching a preliminary trade deal. Treasury Secretary Bessent has suggested that about 100 countries can expect to continue paying a 10% baseline tariff once the process is complete.

These blanket tariffs are separate from the sectoral tariffs discussed below. The letters warn that any retaliatory tariffs will be met like-for-like, and goods that are transshipped to avoid higher tariff rates in other countries will pay those higher rates.

[A] short turnaround to August 1, combined with the ongoing challenge of negotiating with many trading partners simultaneously, has markets on edge.

If newly proposed tariff rates remain close to the original reciprocal rates, this amounts to little more than a three-week extension of the July 9 deadline, giving trading partners more time to negotiate. President Trump indicated that “a couple” other tariff framework deals are expected to be announced in the coming days, while Bessent indicated it would be a “flurry” of deals.

But a short turnaround to August 1, combined with the ongoing challenge of negotiating with many trading partners simultaneously, has markets on edge. We have speculated for some time the White House might feel emboldened to double-down on its tariff agenda now that the stock market is again strong and economic optimism has partially recovered.

Fully imposing retaliatory tariffs would result in a higher effective tariff rate than we’ve been assuming. But it is encouraging that Vietnam, which was assigned one of the highest reciprocal tariff rates on April 2, was able to negotiate its tariff rate down to 20%. That suggests scope for other countries to substantially reduce these new tariff rates as well. That this marks the latest in a series of tariff deadline extensions also raises the prospect of further delays.

President Trump has also threatened an additional 10% tariff on countries that align themselves with “the anti-American policies of BRICS.” The BRICS group previously consisted of Brazil, Russia, India, China, and South Africa but has expanded to include 5 additional member states and another 10 “partner” states. There were no details on which of the bloc’s policies are considered anti-American, but President Trump has previously threatened the group with 100% tariffs if they create a common currency or back another currency to replace the U.S. dollar as the world’s reserve currency.

Vietnam deal

On July 2, Vietnam struck a trade deal with the U.S. The country’s products will be charged a blanket 20% tariff when imported into the U.S., while U.S. products will enter Vietnam barrier free. Products that are deemed to have been transhipped through Vietnam on their way to the U.S. will face a higher 40% rate.

There are several things to say about this deal.

1. First, it is quite an important deal. Vietnam is a big exporter to the U.S., ranking sixth after Mexico, China, Canada, Germany and Japan. It is also a big deal for Vietnam, as nearly 30% of Vietnam’s economic output is consumed by Americans. That’s a huge exposure and the highest of any country in the world – above even Mexico and Canada.

2. It is only the second framework deal that has been struck, after the UK. It therefore significantly informs what other countries might expect to secure. We think the UK provides a reasonable template for developed-world countries, while this is probably a more realistic template for countries with enormous trade surpluses and significantly lower manufacturing costs, such as many Southeast and East Asian nations. China’s present interim arrangement with the U.S. expires in August, and parts of this could be a template for any future deal for China (though the issues are broader with China, spanning access to critical minerals and computer chips, dumping accusations, government subsidies and asymmetric corporate access to markets).

3. Vietnam struck a deal with a worse tariff rate than they were previously paying (the 10% baseline rate). On the surface that is curious. But clearly they expected the full reciprocal tariff rate of 46% that was assigned to them in early April to apply as of July 9, and so opted for an outcome not as bad as that. Their competitive advantage over the U.S. in low-value manufacturing is likely still sufficient to maintain a major presence in the U.S. market even after the tariff. If other similarly positioned countries in Asia fail to strike their own deals, Vietnam could even pick up market share.

Canadian scuttlebutt

Canada continues to articulate its expectation that it will secure a trade deal with the U.S. within a 30-day window expiring on July 21. One would hope that this confidence is backed by internal evidence that a deal is forthcoming.

Canada has definitely made important progress in addressing U.S. complaints:

• Canada is among the NATO members that have committed their military spending to rise to 5% of gross domestic product (GDP). It could commit to fulfilling that target with additional procurement from the U.S., and/or participating in the U.S. Golden Dome missile defense plan.

• Canada recently cancelled its digital services tax over U.S. objections just as the tax was about to collect its first round of money – an outcome we had long predicted.

• Canada has adjusted its trade rules to block the dumping of steel and aluminum from third-party countries – another White House priority.

• Canada is increasing its border security.

• Canada is tightening its immigration policies as per the Strong Borders Act, with certain components explicitly linked to U.S. concerns.

A potential sticking point could be Canada’s supply management industries, which have repeatedly raised the ire of the White House, and which will be difficult for Canada to alter given the passage of recent legislation that bars making trade concessions in those sectors.

While the hope is that Canada can continue to avoid a blanket U.S. tariff, it appears less likely that the country will avoid tariffs altogether. The government reportedly asked the leaders of various economic sectors what level of tariff they could endure, so some form of sector tariffs remains likely. Steel tariffs are thought to be least likely to come down (or to come down the least), while aluminum tariffs may be most malleable.

[I]t is possible that Canada is part of the take-it-or-leave-it deals now being offered, motivating faster negotiations.

We had briefly thought that Canada might be on the cusp of a sweetheart deal with the U.S., as why would Canada rush into a deal when it is not currently paying a baseline rate and the previous July 9 deadline is meaningless to a country without a reciprocal tariff? The answer would seem to be that the deal is quite good.

But it is possible that Canada is part of the take-it-or-leave-it deals now being offered, motivating faster negotiations. Also, one should not underestimate the pain felt in the auto, steel and aluminum sectors by the sector-oriented tariffs currently in place, nor underestimate the economic damage being done to Canada by tariff uncertainty. Indeed, it is among the countries with the most visible economic damage so far.

As a result, the jury remains out on what a Canadian deal might look like. We continue to assume the average tariff rate remains in the 5-10% range, but there are other possibilities.

Sector tariff variability

Sector-oriented tariffs have been a key component of the Trump tariff plan and remain an attractive option for future actions given that they have encountered fewer legal challenges. The U.S. has forewarned that it intends to implement tariffs on pharmaceutical products, computer chips, forestry products, critical minerals and copper, in addition to the existing tariffs on steel, aluminum and autos.

One substantial oddity related to sector tariffs is that they seem to be either really high or non-existent, but nowhere in between. To illustrate, the default steel and aluminum tariff rate is 50% – higher even than the broad tariff rate against China – but the UK (and potentially others to come) managed to negotiate that down to 0% for their own steel and aluminum exports to the U.S.

It is a similar situation with several of the sectors for which sector-based tariffs have been threatened but not yet implemented. The reciprocal tariffs cover the vast majority of U.S. imports, but explicitly exclude other strategic sectors that the U.S. purports to have a particular interest in protecting: copper, lumber, pharmaceuticals, computer chips and critical minerals.

Granted, the idea is that these sectors will later be hit with sector-specific tariffs. But the fact remains that the strategic sectors have either extra high or non-existent tariffs, and nothing in the middle. And it is particularly curious that the U.S. is willing to strike deals that open up these strategic sectors to foreign competition such as from the UK, as that undermines their goal of being self-sufficient in those areas.

Other critical U.S. policy developments

While tariffs remain a key consideration for markets, the focus has broadened out in recent weeks to a wider range of U.S. public policy considerations. There are strong parallels to the late 2024 environment, when the potential economic drag from tariffs and from diminished immigration was being weighed against the potential benefit from tax cuts, deregulation and rising animal spirits.

Those tax cuts are now being delivered, there remains hope for deregulation in a variety of sectors including financial services, and animal spirits have significantly revived. Our rough calculus still points to a net negative effect on the economy when the full suite of policy initiatives is considered together, but it is less profoundly negative than when tariffs are evaluated alone. That still leaves a soft growth trajectory over the remainder of 2025, but with scope for a notable revival in 2026 as tax cuts take effect.

The Big Beautiful Bill

President Trump signed into law the Big Beautiful Bill on July 4 – a major fiscal undertaking that should increase the country’s cumulative deficit by between US$2.8 trillion to $4.0 trillion over the next decade.

The bill barely squeaked through the Senate and the House of Representatives, and polling shows it to be unpopular with the public due presumably to the way tax cuts disproportionately benefit the wealthy and spending cuts to Medicaid and food stamps disproportionately hurt the poor. If perceptions don’t change, this could weigh on Republican support in the lead up to midterm elections next year.

Key details include:

• Tax cuts from the first Trump term that were scheduled to expire on December 31 will instead be extended into the future.

• Some new tax cuts were implemented, including a larger standard deduction for tax filers and the elimination of taxes on tips and overtime income.

• The accelerated depreciation of capital will be both extended and expanded, potentially unlocking significant capital expenditures.

• More money is allocated to border security and the military.

• Spending is reduced on green initiatives, food stamps and Medicaid. For the latter, many Medicaid recipients will now need to work to maintain their eligibility, and funding to states has been reduced. The Congressional Budget Office is projecting the loss of health insurance for 11 million people by the year 2034. On green initiatives, a key provision in the final bill is that wind and solar projects undertaken over the next 12 months will be grandfathered into the expiring tax credits – this could unleash a temporary flurry of activity before it all dries up.

Fiscal implications

From a fiscal standpoint, the budget is concerning as it builds upon an already-large U.S. deficit. Our fiscal health index indicates that the U.S. was already in the most challenging fiscal position among the world’s major nations before this latest undertaking (see next chart).

RBC GAM fiscal health scorecard

2024 data for all indicators except interest payments (2023) and GDP growth. International Monetary Fund (IMF) forecast for 2030 used as a proxy for ‘normal.’ Fiscal adjustment refers to the necessary reduction in fiscal deficit to stabilize debt-to-GDP ratio. Sources: IMF, Macrobond, RBC GAM

It must be conceded that a sizeable chunk of the additional deficit created by this bill should be offset by anticipated tariff revenue. As such, the deficit shouldn’t actually increase by several trillion dollars over the 10-year time horizon. But that still leaves a problematic deficit starting point, and a public debt level that is already fairly burdensome from a debt-servicing perspective.

Debt ceiling avoided / liquidity drain upcoming

The U.S. debt ceiling was lifted by a large $5 trillion, meaning that the government no longer flirts with technical default over the summer. Indeed, the government can now halt the special measures it has been taking for several months to avoid breaching the existing threshold. In turn, the Treasury will issue new debt to rebuild the Treasury General Account’s traditional buffer. It should be noted that this may temporarily affect the economy: liquidity was pumped into the economy over the last several months as the Treasury drained its General Account, and that liquidity will now be drained back out as the Treasury rebuilds its war chest. U.S. economic growth may be slightly slower than otherwise over the next few months as an equilibrium is sought.

Economic implications

From an economic standpoint, the main thrust of the budget bill – tax cuts – should permit the U.S. economy to grow somewhat more quickly in 2026, and then be larger than otherwise in subsequent years (though not growing any more quickly). But do not look for an enormous amount of extra growth, as much of the bill represents the extension of expiring policies. This avoids an economic deceleration rather than enabling an acceleration.

Foreign withholding tax increase avoided

Global investors were quite concerned when early versions of the bill included Section 899: a provision that would sharply increase the withholding tax on U.S. interest and dividend income, effectively reducing the after-tax return for foreign investors and foreign businesses with U.S. subsidiaries.

Fortunately, the final bill excludes that section after other countries indicated that they would not levy a key component of the global minimum tax framework on U.S. companies – the original source of U.S. ire. For its part, Canada also removed its digital services tax under U.S. pressure. Curiously, not all countries have been forced to eliminate theirs. The U.K. trade deal seemingly leaves the country’s digital services tax in place.

Executive power increases

A recent U.S. court ruling on June 27 has greatly increased the short-term power of the Presidency. In the case Trump v. CASA, the Supreme Court decreed that lower federal courts should not be able to block executive orders via quick nationwide injunctions before a case’s merits have been fully evaluated.

Opponents to President Trump’s policies had been doing precisely this. They’ve been getting injunctions against various White House executive orders that temporarily halted them until a more comprehensive legal judgement could be delivered. Whether such laws stand or not over the medium and long run will still depend on whether they can hold up in court, but the default stance is now that such executive orders are enacted until that happens, which can take several quarters to multiple years.

There is an exception: courts can still temporarily block an executive order for the specific plaintiffs in a case – just not for the entire country. As such, class action lawsuits might still be able to halt executive orders, but the threshold for successfully implementing a class-action lawsuit is considerably higher than an ordinary claim – in terms of the time required and ensuring sufficient commonality of the claim across all parties, making it impractical to do in many cases.

Some examples of Trump initiatives that were blocked and are now theoretically re-activated, at least until such a time as a class action lawsuit is implemented or a formal court ruling is delivered:

• The end of birthright citizenship for those born in the U.S. to non-American parents

• The suspension of asylum eligibility at the southern U.S. border.

To give a sense for the nuanced implications in some cases, the injunction blocking the revocation of visas for Harvard’s international students still stands, but the injunction would no longer apply to universities outside of Massachusetts.

Conversely, the recent Supreme Court ruling does not change the implications for IEEPA-based tariffs (under the International Emergency Economic Powers) – the tariffs applied at a blanket level against nations under the guise of national security. This is because the judgement only applies to Federal District Courts, where the bulk of executive order-related legal judgements are rendered. It does not apply to the Court of International Trade, where tariff disputes are resolved.

[T]he two rulings over the past 13 months have the combined effect of increasing presidential power in the short run and decreasing it over the long run.

The main takeaway is that President Trump is now much less encumbered in getting his agenda delivered – over the short run. This could allow fairly substantial policy shifts, depending on what the White House wants to do. But, over the medium and long run, executive orders will still be vetted and eventually rejected if contrary to law by court decisions.

As a reminder, just over a year ago, the Supreme Court overturned the Chevron ruling, with the implication that government agencies can no longer make their own best judgements when laws are unclear. Instead, this power was handed to the courts, which will have the final say, instead of having to accept government agency interpretations. To the extent that government agencies are directed by the executive branch, this has the effect of somewhat diminishing executive power.

Taken together, the two rulings over the past 13 months have the combined effect of increasing presidential power in the short run and decreasing it over the long run.

Spheres of influence: U.S. and China

More than two decades of rapid globalization and an even longer period of U.S. hegemony are giving way to an increasingly multipolar world. At the centre of that shift are growing trade and geopolitical tensions between the U.S. and China, the world’s two largest economies that combine for one-third of global output.

The U.S.’s emerging isolationism and protectionism is causing even its traditional allies to re-evaluate their economic and security ties. Meanwhile, concerns about national security and unfair trade practices are keeping some from fully embracing China as an alternative.

Third-party countries are facing pressure to take sides. The U.S. wants its trading partners to diversify their supply chains away from China and limit Chinese investment in exchange for preferential access to the U.S. market. President Trumped recently threatened an additional 10% tariff against countries that align themselves with “anti-American policies” of the BRICS.

China is looking to fill the void left by a more isolationist U.S., seeking deeper integration with countries outside its traditional sphere of influence. Its position as a dominant supplier of critical inputs has reminded some trading partners that decoupling is not without risks. China’s infrastructure investments into much of the developing world over the past decade as part of the country’s Belt and Road Initiative have also strengthened ties.

Balancing complex relationships with the two superpowers will be challenging. To gauge the relative strength of linkages between third-party countries and the U.S. and China, we looked at bilateral trade, investment, people, and diplomacy connections, focusing on the top 50 economies for which sufficient data was available.

Some of the key findings:

• On average, the rest of the world is roughly equally exposed to the U.S. and China, though there is great variation at the country-by-country level, and across four areas of focus.

• On average, countries tend to be more dependent on China for trade and the U.S. for investment. Our “people” measure tilts toward the U.S., while “diplomacy” is almost evenly split.

• Many countries are clearly in the U.S. or China sphere, but a handful of Southeast Asian economies are highly dependent on both. Few countries would have an easy time de-coupling from either superpower.

• On average, relationships have shifted slightly in China’s favour over the past decade. That trend could continue amid rising U.S. trade and investment barriers, slower immigration, shrinking security commitments and less favourable views of the U.S.

The big picture

We examined 15 indicators grouped into four categories: trade, investment, people and diplomacy. For each indicator, countries’ relative exposures to the U.S. and China were ranked on a 1-5 scale (higher = greater exposure or closer ties). Those indicators were weighted to come up with averages for each of the four sub-categories and an overall exposure indicator, also on a 1-5 scale.

The bubble chart below shows the overall picture that emerges. Each country’s bubble size represents its share of global GDP. The x-axis shows its relationship with the U.S. (further right = more exposure) and the y-axis its relationship with China (higher up = more exposure).

Spheres of Influence: Overall score

As at 07/04/2025. Source: RBC GAM

There is clearly a regional skew with North American economies tilting more toward the U.S. and many South and Southeast Asian countries aligning more with China. But some, like South Korea and Singapore, have strong ties with both the U.S. and China, and have a particularly fine line to walk in managing relationships with the two superpowers.

Looking at the four sub-components, bilateral trade relationships tend to tilt in China’s favour, with Canada, Mexico and the UK notable exceptions. It’s the opposite case for investment, where the U.S. tends to dominate. The “people” component also leans toward the U.S., while diplomacy is more bifurcated (see next chart).

Spheres of influence scorecard

As at 07/04/2025. Scored 1-5 where higher = greater exposure. Source: RBC GAM

Trade

On trade, the U.S. does relatively more bilateral services trade with every major country (for which admittedly limited data is available) than China does. The dominance of large U.S. multinational companies in sectors like tech and finance, and significant foreign direct investment which facilitates services trade, helps the U.S. run a notable surplus in services.

But that’s where the U.S. trade advantage ends. The more export-oriented Chinese economy conducts more bilateral goods trade with third-party countries, particularly those outside of North America and Europe. More of China’s exports also make their way into other countries’ supply chains – there tends to be more Chinese than U.S. content in other countries’ exports (which we measure as supply chain integration).

Even more significantly, China has come to dominate trade in certain strategic sectors like agrifood, chemicals, health, steel, defense and aerospace, transport and electronics. Looking at products for which imports are highly concentrated and few domestic or foreign alternatives are available, third countries are “dependent” on China for 67 strategic products, on average, compared with just 9 from the U.S.

This dependence has been highlighted recently with China restricting exports of rare earth metals and magnets that are essential components in foreign supply chains, causing automakers in North America and Europe to warn of potential factory shutdowns.

Neither the U.S. nor China has a distinct advantage in terms of shipping costs to and from third-party countries, although China has a slight edge in its connectivity to global liner shipping networks, helping to facilitate greater goods trade with other countries.

Spheres of influence: Trade

As at 07/04/2025. Source: RBC GAM

Investment

Most third-party countries have stronger investment ties with the U.S. than with China. The U.S. is both the largest source of and destination for foreign direct investment (FDI) globally. Bilateral FDI with the U.S. is the equivalent of about 13% of other countries’ GDP, on average, compared with 7% with China. Aside from a handful of Asian economies and major recipients of Belt and Road Initiative funds (e.g., Indonesia, Kazakhstan) most countries are in the U.S.’s investment sphere.

The U.S. also attracts more portfolio investment (bonds and equities) from investors in other countries. Its Treasury market is the deepest and most liquid in the world, even if concerns about fiscal sustainability and a broader Sell America trend have seen investors recently demand a higher term premium for holding U.S. debt.

In equities, the U.S. has attracted significantly more foreign capital. Its stock market has consistently outperformed major foreign indices and offers investors unique exposure to some of the world’s most dynamic and innovative companies. China’s capital controls hold it back in this regard, as does its relatively less developed corporate governance and a sometimes-complicated relationship between the state and major firms.

Spheres of influence: Investment

As at 07/04/2025. Source: RBC GAM

People

China’s relatively closed immigration system causes it to lag in bilateral migration flows, particularly outside of Asia. Immigration can help facilitate trade and investment, and other financial flows as well. U.S. residents remitted $93B to foreign countries in 2023, compared with $20B from China.

Foreigners also tend to have more favourable views of the U.S. than China. That has started to shift, though, with the U.S.’s favourability ratings dropping significantly year-over-year in 15 of 24 countries surveyed by PEW, including a 20-point decline in Canada and 32-point drop in Mexico.

China does have a slight advantage when it comes to cultural connections – defined here as the correlation across six cultural dimensions between third-party countries and the U.S. or China. Stronger cultural ties can help build trust and facilitate negotiations. Among the 12 countries with which China has the strongest cultural correlation, it has preferential trade agreements with 11.

Spheres of influence: People

As at 07/04/2025. Source: RBC GAM

Diplomacy

Among our 50-country sample, China has preferential trade agreements with 17 countries while the U.S. has 10. When factoring in the enforceability and depth of those agreements – for example, whether they cover policy areas like investment, environmental and labour market regulations, and competition policy – China’s advantage narrows somewhat but remains sizeable.

To gauge security relationships, we looked at third-party countries’ bilateral arms trade (mostly imports) with the U.S. and China. This tilts heavily in the U.S.’s favour, except for a handful of countries including Russia, Bangladesh and Pakistan – and Hong Kong, which we hard coded to a maximum score of 5 to reflect its unique security relationship with China.

When it comes to policy alignment – proxied by UN voting records over the past 10 years – China’s voting history tends to align much more with other countries than the U.S. In fact, the U.S. votes with the majority less than any other country. This year alone, it has been the lone voice of dissent in four UN votes.

The U.S. and China are members of various international organizations such as the World Trade Organization, the G7 and the BRICS group. When we evaluate whether third-party countries are more aligned in their own memberships with the U.S. or China, there is a nearly even split – with a slight edge for the U.S.

Spheres of influence: Diplomacy

As at 07/04/2025. Source: RBC GAM

Shifting patterns

Comparing the current scorecard with a decade ago shows a modest drift toward China: the U.S. advantage shrinks by 0.13 points.

Of our 50-country sample, 26 have moved toward China since 2015, including Mexico and several South American countries that traditionally gravitated more toward the U.S. Most countries that were already in China’s sphere of influence have moved even further in that direction, though South Korea and Vietnam have drifted slightly toward the U.S.

The U.S. has deepened its advantage in services trade but most other aspects of trade, including supply chain integration and import dependence, have tilted more toward China, which has deepened its connections via preferential trade agreements. The U.S. investment advantage has also narrowed amid a steady flow of Belt and Road Initiative investment by China.

Navigating a multipolar world

Unsurprisingly, many countries have strong trade and financial ties with both economic superpowers. The ideal scenario for the vast majority of nations is that they maintain access to both the U.S. and China.

But this appears set to become increasingly hard to achieve as the frictions between the two superpowers mount, and as the U.S. in particular imposes restrictions on the degree to which countries can interact with China if they wish to maintain access to the U.S. 

It is critical to understand that we are now firmly in a multipolar world, with the implication that the U.S. is no longer a hegemonic entity, that the balance of power is actively shifting toward China.

Looking forward, based on the assumption that the U.S. remains more inward looking than in the past, that the Chinese economy outgrows the U.S., and that China incrementally opens its markets to the rest of the world, there is a good chance that China continues to make inroads with many countries, much as it has incrementally strengthened its hand over the past decade.

It is critical to understand that we are now firmly in a multipolar world, with the implication that the U.S. is no longer a hegemonic entity, that the balance of power is actively shifting toward China, and that third-party nations under one sphere of influence may increasingly encounter frictions when attempting to engage with countries under the other sphere of influence. This fracture may incrementally slow global growth and add to inflation over the long run.

But China is unlikely to successfully woo all nations given concerns about national security and unfair trade practices, and their desire to avoid being too reliant on any one country.

–JN

Update on Middle East conflict

The level of conflict in the Middle East escalated profoundly higher on June 13 when Israel launched a sequence of strikes against Iranian military and nuclear infrastructure. The U.S. later participated with a targeted strike on several of Iran’s most heavily fortified nuclear facilities that Israeli munitions were incapable of penetrating.

But, since then, the situation has broadly tracked our best-case scenario, with only a small symbolic response from Iran against a U.S. base in Qatar – with no casualties – and a subsequent cease-fire that appears to be holding.

In turn, the price of oil has made a nearly completely round-trip back to pre-conflict levels (see next chart).

Crude oil prices returning to pre-conflict levels

As of 07/02/2025. Sources: Macrobond, RBC GAM

Oil prices are materially lower than a year ago, and even more substantially down from a few years ago. These lower prices constitute something of an anti-tariff. This is to say, they boost global growth and reduce global inflation – the opposite of what tariffs threaten to do. To be sure, the effect of the decline over the past year is not large enough to fully neutralize tariff damage, but it helps.

Looking forward, Iran’s nuclear prospects are certainly diminished, but with considerable uncertainty around the extent. The White House initially insisted that Iran’s nuclear sites have been categorically “obliterated.” But the Pentagon indicates Iran’s progress has only been set back by a few years, and some experts say Iran has only lost a few months of time. The latter two opinions appear to be most realistic.

Key uncertainties are the extent to which bunker buster bombs damaged underground infrastructure and whether Iran managed to relocate enriched uranium and centrifuges before the strikes. Overall, it would appear that Iran’s nuclear plans have suffered a setback but are not dead.

Perhaps reflecting Israeli concerns about the potential for a nuclear-armed foe in the Middle East, Polymarket assigns a 42% chance that Israel will again attack Iran before the end of the year. In turn, the betting market assigns a 17% chance that Iran closes the Strait of Hormuz at some point this year – an upside risk for the price of oil.

It is concerning, if unsurprising, that Iran has now halted its cooperation with the International Atomic Energy Agency, meaning that it will be more difficult to monitor Iran’s nuclear capabilities in the future. One remedy would be a new U.S.-Iran nuclear deal, which Polymarket prices at a 42% chance by the end of 2025.

At this juncture, it does not appear that the Israeli attack will result in Iranian regime change, though it is too early to say with absolute certainty until political machinations have run their course. Polymarket assigns a 29% chance that Supreme Leader Khamenei will be ousted in 2025 and a lower 15% chance that the Iranian regime falls this year.

Current oil prices in the mid-sixty-dollar range for West Texas Intermediate seem roughly appropriate. While one would normally expect somewhat higher prices given the current state of the economy, OPEC continues to sit on a large amount of idled capacity, and its strategy appears to have shifted from maintaining high prices to capturing previously lost market share.

“Dangerous world” department

In the “it’s a dangerous world” department, NATO members have responded to White House pressure by radically increasing their military commitments. Whereas the struggle had long been to persuade many members simply to reach a relatively moderate military spending commitment equal to 2% of GDP, the stakes and norms have both changed in recent months.

Countries recognize that the world is indeed becoming more dangerous as superpowers such as Russia, the U.S. and China flex their muscles, given war in Eastern Europe and conflict in the Middle East. Warfare itself appears to be in flux with new technologies such as drones and cyberattacks increasingly taking center stage.

President Trump has also put explicit pressure on other countries, demanding that they increase their military spending up to a huge 5% of GDP. Emphasizing the point, he has simultaneously reduced American support for Ukraine and equivocated over the support the U.S. might provide to NATO partners in the future.

The deadline for lifting military spending to 5% of GDP is only 2035, so it will be a gradual process.

In turn, NATO members have now committed to spending a large 5% of GDP on defense. But let us be clear that an expansive definition is being used. It is actually a 3.5% of GDP commitment on classically defined military spending (personnel, weapons, ammunition, operations), and another 1.5% of GDP on adjacent pursuits (cybersecurity, critical infrastructure resilience, supply chains, logistics, defense innovation). Conveniently, current U.S. conventional military spending is 3.4% of GDP, so this is essentially asking that other countries match the U.S. on core military spending.

The deadline for lifting military spending to 5% of GDP is only 2035, so it will be a gradual process.

Still, the commitments are quite large. These figures are as a share of GDP, not as a share of government spending. For the average NATO nation, allocating 5% of GDP to the military is the equivalent of about a quarter of government spending (government spending averages 20% of GDP).

If a country is increasing its spending from 2% of GDP, there are a few options. Taxes can rise, but they would have to increase government revenue by about 15% – quite an enormous tax hike. Alternately, government spending can be reallocated: 15% of the government budget would have to be cut and that money reallocated toward the military – another huge adjustment. Finally, the deficit can rise – but it would rise by 3 percentage points of GDP, which is hard to manage for the many developed-world countries already running hefty deficits of 3% to 8% of GDP.

The point isn’t that it will be impossible for countries to achieve their target, but that it will require difficult political decisions. Yes, the additional spending – if it manifests via a larger deficit, as seems most likely – will provide something of an economist boost. But one would expect military spending to generate less of a positive economic impulse than many other types of spending. Of course, national security has value of its own, if in a more counterfactual sense (avoiding domestic war and destruction).

U.S. economic data stabilizes?

A quick comment on the latest trajectory of U.S. economic data. The general trend over the past few months has been that of a tentative softening in economic activity, seemingly motivated by the damage of high uncertainty and of tariffs themselves.

However, at least for a moment, the high-frequency data has actually bounced slightly higher over the past week or two. Weekly initial jobless claims have declined marginally after an earlier upward trajectory (see next chart). The Dallas Fed’s weekly economic indicator has also ticked slightly higher after a prior persistent decline (see subsequent chart).

U.S. jobless claims ticked higher before declining slightly

As of the week ending 06/28/2025. Sources: U.S. Department of Labor, Macrobond, RBC GAM

Federal Reserve Bank of Dallas Weekly Economic Index improved after a stretch of weakness in the spring

As of the week ended 06/28/2025. The Weekly Economic Index is an index of 10 indicators of real economic activity, scaled to align with the four-quarter GDP growth rate. Sources: Federal Reserve Bank of Dallas, Macrobond, RBC GAM

We continue to believe U.S. economic growth will be distinctly subdued over the second half of 2025, but it is undeniable that the recent data has been a bit better. Let us see if that persists.

Canadian insights

Canadian data point to ongoing softness

Relative to other major trading partners, Canada has received a lighter touch from the Trump administration in recent months. Spared from a 10% baseline tariff, its exports to the U.S. faced one of the lowest effective tariff rates in May. As discussed above, Canada hopes to strike an interim trade deal with the U.S. in the coming weeks.

But it appears tariffs and trade policy uncertainty continue to weigh on Canada’s economy. Economic data have deteriorated and generally came in short of expectations since late-May.

Canadian economic data are surprising to the downside

As of 07/04/2025. Sources: Citi, Macrobond, RBC GAM

GDP declined by 0.1% in both April and May, the first back-to-back negative readings since 2022. At this stage, it looks like Canada’s economy contracted slightly in Q2. This follows a healthy 2.2% annualized GDP gain in Q1, although that was largely due to an increase in exports and inventory investment ahead of threatened tariffs.

Canada’s unemployment rate rose to 7.0% in May, up from 6.3% a year earlier. Job losses have been concentrated in the manufacturing sector, and to a lesser extent transportation and warehousing, suggesting trade-exposed industries are bearing the brunt of economic damage. According to the latest Purchasing Managers’ Index (PMI) surveys, sentiment in the services sector remains subdued but employment continues to rise, albeit modestly.

Consumer sentiment has rebounded somewhat but has yet to fully recover from its swoon in earlier months. Consumer-facing sectors reported modest growth in April, but early indications point to a pullback in retail sales in May. Housing markets are showing some signs of stabilization, but activity remains subdued.

Disappointing economic data leaves the door open to the Bank of Canada (BoC) resuming modest rate cuts in the second half of the year, so long as inflation cooperates. After some disappointingly firm readings earlier this year, the Canadian Consumer Price Index (CPI) was more quiescent in May. Another soft print for June could result in a more active discussion around a cut at the BoC’s late-July meeting.

Downgrading Canadian employment

Canada’s population is estimated to have increased by just 20K in Q1 – a rounding error for a country of 41.5 million people. Outside of border closures during the pandemic, that represents the slowest quarterly increase (on a percentage basis) in the post-war period.

The slowdown reflects the government’s more restrictive approach to immigration announced last fall. It lowered its permanent resident targets to 395k in 2025 and 380k in 2026, down from 500k previously. It also plans to reduce the share of temporary residents to 5% of the population by the end of 2026 from a peak of 7.4% last year. It said those targets would result in modest (-0.2%) declines in the overall population in 2025 and 2026.

Q1 saw developments on both fronts. The number of non-permanent residents fell by 61k in Q1 to 7.1% of the overall population. Permanent immigrants increased by 104k in the quarter, only slightly ahead of the government’s planned pace on an annualized basis. Canada’s natural population growth was slightly negative.

Temporary foreign workers and foreign students in Canada have declined significantly

As of March 2025. Temporary residents include Temporary Foreign Worker Program (TFWP) and International Mobility Program (IMP) work permit holders, and study permit holders who are in Canada in the observed calendar year. Sources: IROC, Open Canada, RBC GAM

Population growth is a key factor in labour input, which along with productivity growth contributes to the economy’s sustainable or potential GDP growth rate. With limited growth in labour supply, the “speed limit” for Canada’s economy will depend largely on productivity gains, which have been sluggish for several years but recently showed signs of improvement.

In the context of a nearly flat population, average monthly job gains of +12k year-to-date through May don’t look so bad. However, that likely overstates the true pace of employment growth. The Labour Force Survey (LFS) – which StatCan acknowledges is “not optimized or designed to monitor changes in the size of the population” – accounts for changes in non-permanent residents using a 12-month average based on the most recent demographic estimates.

So, turning points in the non-permanent resident population – as we’re seeing now – will only gradually be incorporated into LFS population estimates, causing employment growth to be temporarily overstated.

A separate payroll survey suggests 47k jobs were lost in Q1, compared with the LFS’s 45k increase. That payroll data comes out with a lag, so it gets less attention than the timelier LFS. But in our estimation, LFS employment growth in Q1 without population smoothing would be much closer to the payroll figure.

Other LFS measures like the unemployment rate and employment-to-population ratio should still paint an accurate picture of the labour market. Canada’s unemployment rate has increased by 0.3 ppts year-to-date to a cycle high of 7%, indicating a softening jobs backdrop. We expect the BoC will have limited tolerance for any further increase in the jobless rate, even if it’s accompanied by reportedly positive job growth.

–JN

Canadian policy developments

With a new government installed, Canadian public policy is now being altered. Despite a minority government and no formal coalition, this is being achieved in a few ways.

First, given the apparently universal appeal of tax relief for Canadians, all parties supported a ways and means motion that fast-tracked the tax cuts from the Liberal campaign platform for implementation on July 1. They are now in effect.

The tax cuts include a reduction in the bottom personal income tax bracket rate from 15% to 14%, the removal of GST for first-time homebuyers on new home purchases valued up to C$1 million, and the elimination of the consumer portion of the carbon tax.

Those changes still need to be fully formalized into law, and so will be debated and passed as part of a traditional bill later.  Tweaks can even be made as part of later debates, but not to the core elements of the tax changes.

The tax cuts include a reduction in the bottom personal income tax bracket rate from 15% to 14%, the removal of GST for first-time homebuyers on new home purchases valued up to C$1 million, and the elimination of the consumer portion of the carbon tax (which had already functionally happened in April but needed to be formalized via this motion).

For the vast majority of us not schooled in the minutiae of the Westminster parliamentary system, it can be a baffling system.

In the case of the carbon tax, a prime ministerial directive first removed the consumer carbon tax on April 1, this ways and means motion now makes its removal more formal, but a bill still needs to be passed to make the change truly permanent.

Last year brought a different procedural twist. The 2024 federal budget proposed a capital gains tax hike. This was implemented by the Canada Revenue Agency before the tax increase was ever passed into law (or even passed via a ways and means motion) because it was deemed likely to be formally implemented at a later date. When the tax increase was later abandoned, it created myriad headaches for tax filers and the government alike as all parties had to unwind previously collected taxes.

As a more general comment, the new Liberal government has been surprisingly effective at implementing its agenda despite the aforementioned minority status.

A second important Canadian policy change occurred on June 26. Bill C-5 was passed into law with the support of the opposition Conservative Party which had planned a similar initiative if elected.

The law removes federal barriers to interprovincial trade (though many barriers remain at the provincial level, for the moment), and creates a framework for what amounts to speeding up major resource and infrastructure projects deemed to be in the national interest. This has been controversial, but should increase such investments, boosting the resource industry and potentially accelerating Canadian productivity over time.

As a more general comment, the new Liberal government has been surprisingly effective at implementing its agenda despite the aforementioned minority status. Recall that, in addition to the tax cuts and infrastructure/resource streamlining, the party’s commitment to more military spending also seems on track. There are also efforts underway to streamline federal services and make government processes more efficient, and to further tighten immigration rules. 

Written by Eric Lascelles, except where otherwise indicated.