The Bank of Canada published reports showing that tariffs and related uncertainties are impacting business projections. The Q2 Business Outlook Survey noted the direct tariff impact was less than in Q1, with fewer export-focused businesses expecting worst-case tariff scenarios.
Survey findings suggest most firms plan to keep staffing levels stable and limit investments to upkeep. Expectations for inflation above 3% remained at 23%, while 43% foresee lower labour costs over 12 months, with 9% anticipating higher costs.
Consumer Expectations Of Recession
Consumer expectations indicate a recession, with 64.5% anticipating it in the next year, a slight decline from 66.5% in Q1. Sales performance shows 24% of firms reported a sales decline in the past year, reduced from 28% in Q1.
Regarding inflation, consumer 5-year expectations increased to 3.45%. The surveys reveal that 28% of firms predict Canada will experience a recession in the next year, dropping from 32% in the previous quarter.
Despite improvements, many Canadian consumers still expect recessionary conditions within the coming year. The balance of opinion on future sales indicators dropped dramatically from +22 in Q1 to -6.
Economic Uncertainty Ahead
We view the conflicting data between business and consumer sentiment as a clear signal for higher market volatility. The dramatic plunge in the future sales indicator from +22 to -6, despite other modest improvements, suggests significant economic uncertainty ahead. This environment makes buying options to play on price swings more attractive than placing simple directional bets.
Given that nearly two-thirds of consumers anticipate a recession, we believe a bearish bias is prudent. The Bank of Canada already initiated a rate cut in June to 4.75%, its first in four years, acknowledging slowing economic momentum. We see value in purchasing put options on broad market ETFs, like the iShares S&P/TSX 60 Index ETF (XIU), to protect against potential downturns.
The gap between consumer five-year inflation expectations of 3.45% and the actual annual inflation rate, which slowed to 2.7% in May, creates a key uncertainty for interest rates. This divergence suggests the path for future rate cuts is not guaranteed, making derivatives tied to the Canadian Dollar Offered Rate (CDOR) or bond futures useful tools. We can use these to speculate on the pace of the central bank’s policy changes.
Firms planning to limit investment and anticipating lower labour costs align with a cooling economy. This is reinforced by the latest Statistics Canada report showing the national unemployment rate rose to 6.2%. Such data supports strategies that profit from limited upside, such as selling out-of-the-money call option spreads on major Canadian sectors like financials or energy.
This policy divergence with the United States, where the Federal Reserve is holding rates firm, puts downward pressure on the Canadian dollar. If Canada continues cutting rates to support its economy, the currency is likely to weaken further against the US dollar. Consequently, we are looking at buying call options on the USD/CAD currency pair.
