Canadian Highlights
Canada’s Q2 GDP contracted 1.6% (annualized), laying bare the economics of a trade war.
Net trade carved a hefty slice out of growth, while business investment also weakened. In contrast, other components of domestic demand held firm, with consumption surprising to the upside.
Further rate relief from the Bank of Canada cannot be ruled out. We expect two more cuts by year-end, bringing the policy rate closer to lower bound of the Bank’s neutral range.
U.S. Highlights
President Trump is attempting to remove FOMC member Lisa Cook, sparking further concerns of Fed independence.
Real GDP growth for the second quarter was revised higher to 3.3%, with most of the upward revision stemming from stronger business investment.
Real consumer spending rose 0.3% m/m in July, thanks to a strong gain in motor vehicle sales & parts. Meanwhile, annual core PCE inflation hit a five-month high of 2.9%.
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Canada – Trade War Economics Laid Bare
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Chart 1 shows the annualized quarter-on-quarter percent change in Canada’s real GDP. Q2 2025 GDP contracted by 1.6%, broadly in line with the Bank of Canada and TD Economics forecasts. Looking ahead, TD Economics projects 0.6% growth in Q3, slightly lower than the Bank of Canada’s forecast of 1%.
As summer winds down, this week’s economic calendar heated up. The headline release was Q2 GDP, offering the first hard look at how Canada’s economy coped under the weight of tariffs. The economy contracted 1.6% (q/q, annualized) — in line with both our own tracking and the Bank of Canada’s July scenario, but weaker than consensus expectations for a modest 0.7% decline (Chart 1). Markets took the news in stride: equities gained nearly 1%, 10-year yields slipped, and the Canadian dollar inched up toward US$0.73, even as the greenback strengthened elsewhere.
The numbers laid bare the economics of a trade war. Exports plunged by a whopping 27% in Q2, with autos, machinery, and travel services hit especially hard. Imports also fell, but by less than exports, leaving net trade to carve a hefty eight percentage points off growth. Thursday’s international balance of payments release foreshadowed this outcome, reporting a record-low current account deficit of $21.2 billion (Chart 2).
Business investment provided no relief. Machinery and equipment spending dropped sharply, driving the 10% quarterly decline, though structures spending rebounded thanks to a one-off import tied to an offshore oil project in Newfoundland and Labrador. A brighter spot came from residential investment, which regained some ground after its steep Q1 fall, helped by the recent surge in new home construction.
Chart 2 shows Canada’s quarterly current account balance in billions of Canadian dollars, from Q1 1981 to Q2 2025. Current account deficit widened to $21.2 billion in Q2 2025 – the largest on record.
There were more positive signals elsewhere. Inventory accumulation and government spending both contributed positively to domestic demand, which excludes net exports and rose solidly in the second quarter of 2025, following a decline in the first quarter. The real surprise came from households. Personal consumption jumped: durable goods rebounded from their Q1 slump, semi-durables and non-durables posted more modest gains, and services spending recorded its strongest gain since early 2024. Some of this reflected tariff-related front-running, but it also showed consumers’ willingness to spend despite a softening job market. Whether this resilience can hold is doubtful: early retail data for July point to cooling momentum, and slower wage growth will weigh on spending in the second half of 2025 (see our Q&A).
Taken together, the data show an economy caught between trade-driven weakness and surprisingly sturdy domestic demand. The former makes the case for further monetary easing, while the latter could temper how quickly the Bank of Canada moves. With Canada’s retaliatory tariffs now lifted and trade talks resuming, uncertainty may begin to ease for businesses. Still, as Governor Macklem reminded in his remarks this week, monetary policy cannot “offset the hit to efficiency from higher tariffs and the reconfiguration of trade.” What it can do is cushion the blow. With the the current policy rate still sitting at the midpoint of the Bank’s estimated neutral range, the Q2 contraction only strengthens the case for more cuts this year. Markets are now pricing a 55% chance of a cut in September.
Maria Solovieva, CFA, Economist | 416-983-8806
U.S. – President Trumps Applies Further Pressure on Fed
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Chart 1 shows the 30-to-2-year spread on U.S. Treasuries. This week, the spread widened to 1.3% or the highest level since January 2022. The data is sourced from the Federal Reserve.
President Trump continued to pressure Federal Reserve officials this week, this time attempting to fire Governor Lisa Cook for alleged mortgage fraud. The situation remains influx, as Cook is contesting the President’s actions in court. But the mere threat of her removal has sparked further concerns of central bank independence, sending shorter-term yields lower. The yield curve steepened on the week, with the 30-to-2-year spread widening to its highest level since early-2022 (Chart 1). Meanwhile, equity markets largely shook off the news, as investors’ attention remained squarely focused on this week’s earnings reports, including Nvidia and several large retailers. The S&P 500 briefly hit another all-time on Thursday, but retraced on Friday and looks to end the week slightly in the red.
Turning to the economic data calendar, the Bureau of Economic Analysis released its second estimate of Q2 real GDP. Relative to the first release, economic growth was revised higher by 0.3 percentage points to 3.3%. While net trade remained a major source of growth, a good chunk of the upward revision came from stronger business investment, specifically in categories that are likely tied to AI investments. In fact, spending on ‘computers & other peripheral equipment’ and ‘software’ accounted for all the growth in business investment through the first half of 2025.
Chart 2 shows final sales to private domestic purchasers. Through the first half of this year, it grew by 1.9%, a notable slowdown from H2-2024 where it grew by +3%. Data is sourced from the Bureau of Economic Analysis.
Final sales to private domestic purchasers – the best gauge of underlying domestic demand – was raised from 1.2% to 1.9% and is now on-par with Q1’s rate of expansion. While this marks a deceleration from H2-2024 (Chart 2), it suggests the narrative of ongoing economic resilience hasn’t completely fizzled out amid ongoing trade uncertainty.
This point was further underscored in the Gross Domestic Income (GDI) figures, which accompany the second estimate of GDP and serve as an alternative measure of economic output. Real GDI rose a healthy 4.8% in Q2 – up from a flat reading in Q1. Corporate profits rose 7% annualized, despite elevated cost pressures from tariffs, while household income also continued to expand at a +5% clip.
Despite the healthy gains in income, households have become increasingly selective in their spending. Real PCE rose 0.3% month/month in July, with most of the gains coming from an increase in durable goods. Vehicle sales had a heavy hand in the uptick, as consumers appear to be pulling forward purchases to get ahead of tariff price increases which will likely materialize later this year once OEMs roll over to 2026 models. But it’s the discretionary services spending that remains weak, a theme that has played out through most of this year and something that’s unlikely to change until households have more certainty about the economic outlook.
With inflationary pressures heating up, this is unlikely to come anytime soon. Core PCE inflation rose 0.3% m/m, pushing the year-ago measures to 2.9% – a five-month high. Hotter services inflation was the major driver in last month’s uptick, something that is likely to further embolden Fed hawks. This puts next week’s employment report sharply in focus. Consensus currently expects payrolls to add 75k jobs in August. A stronger reading could push back on the odds for a September rate cut, which is currently 90% priced in.
