A renewed escalation in the Middle East conflict between the U.S. and Iran has pushed oil prices sharply higher (with key benchmarks near or above $100 a barrel) and has caused concern for potential disruptions in global energy. Meanwhile, Canada's retaliatory tariffs took effect on September 8th as the Canadian government continues to stand firm against what's been labelled as an attack on our country's economic independence and sovereignty. While these risks feel familiar to us (and we should continue to expect these forces in the near term), the economic outlook remains relatively favourable.

In this economic update, we examine the impacts of the latest Middle East tensions and attacks, the strategy behind the Canadian counter-tariffs, and why there is cause of pragmatic optimism looking forward.

Economic Update

The Big Picture: Crosscurrents

As summer comes to an end, the global economy remains on relatively firm footing.  Business activity surveys continue to point to expansion, with momentum evident across both manufacturing and services.  In the U.S., economic growth appears poised to accelerate meaningfully in the third quarter, with annualized real GDP growth potentially exceeding 3%, following a more modest pace of 1.5% in the previous quarter.  While this resilience provides a constructive foundation for financial markets, we remain attentive to some risks that could drive intermittent bouts of volatility.

The most immediate concern is the renewed escalation in Middle East tensions, which have pushed oil prices sharply higher, with key benchmarks near or above $100 a barrel.  As attacks on energy infrastructure and shipping in the region have intensified, this has raised concerns about the potential for broader disruptions to global energy supplies.  A prolonged period of elevated oil prices would in turn feed into higher near-term inflation, potentially putting pressure on central banks to raise interest rates.  Financial markets have already begun to reflect some of this uncertainty, with government bond yields generally moving higher this year across major markets and maturities.

Higher bond yields are not necessarily a negative in isolation.  They are partly a reflection of an economy that has proven more resilient to a variety of macro shocks than many anticipated in recent years.  And at current levels, bond yields also appear broadly consistent with the pace of economic growth.  Nevertheless, higher borrowing costs represent a possible headwind that we are monitoring, as they can potentially restrain equity valuations and dampen growth momentum, especially in economies with elevated debt burdens.

Canada: A Calculated Tariff Response

Canada’s retaliatory, dollar-for-dollar tariffs took effect on September 8th, marking another step up in the ongoing trade clash with the U.S.  As discussed in our previous economic update, the longer the Canada-U.S. tariff dispute persists, the greater the risk they pose to consumer spending, business investment, and hiring decisions.  Importantly, Canada’s response has been carefully structured and strategic rather than indiscriminate.

Most notably, the latest round of counter tariffs is expected to disproportionately affect politically sensitive U.S. states—including Ohio, Pennsylvania, Michigan, and Wisconsin—that are likely to play an outsized role in determining control of U.S. Congress in the upcoming November midterm elections.  By concentrating tariffs on industries and products within more vulnerable Republican districts, Canada appears to be applying targeted political pressure aimed at bringing the Trump administration back to the negotiating table.

The U.S. has since responded with additional tariff threats, creating more jarring headlines, but RBC Economics continues to expect the broader economic impact to remain relatively contained.  Canada’s federal government has also introduced several financial support packages for businesses and workers affected by tariffs, which should help mitigate the impact on the most exposed industries.

Given recent escalations, however, we acknowledge that the path forward remains fraught with uncertainty.  We expect continued posturing and volatile headlines in the months ahead, but the depth of integration between the two economies suggests to us that a return to the negotiating table remains, in our view, the more likely outcome - even as near-term escalation risk stays elevated.

Takeaway: Pragmatic Optimism

The outlook remains relatively favourable. Economic activity is holding up well, with most indicators pointing to a pace of expansion capable of supporting solid corporate profit growth.  At the same time, we believe two risks stand out as potential “speed bumps” for markets.

Renewed Middle East aggressions have nudged oil prices higher, adding to inflation uncertainty that is complicating the task for central banks as they balance price stability against the risk that higher borrowing costs could slow growth. Antagonistic policies from the Trump administration also remain a risk that markets may struggle to price efficiently.

Against this backdrop, we remain focused on disciplined portfolio that is focused on long-term value creation.

As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.