North American outlook: Uncertain political environment adds to business, consumer fatigue

After enduring months of high inflation and astronomical borrowing costs in recent memory, North Americans are beginning to feel a sense of relief as price increases slow and central banks begin easing their interest rate policies.

But the relief won’t translate into an immediate rush of consumption adrenaline because businesses and consumers are exhausted from punishing inflation and interest rate headwinds during the tightening cycles of various central banks.

As their balance sheets begin to normalize, the descent from the height of monetary policy cycle is fraught with a polarized political environment that could cause the economies to stumble. Policy misstep resulting from the Mexican election in June and looming elections in Canada and the United States, present slippery slopes for the North American economies.

Across North America, inflation is down and continues to fall, although with some bumps along the way, and an economic downturn that seemed to be looming hasn’t materialized. Hiring has slowed, but wage gains remain above inflation, and it’s helping consumers keep their heads above water.

In North America, we aren’t impervious to events beyond our hemisphere. What happens geopolitically usually washes up on our shores. War in Ukraine and the Middle East conflict are far away, but we’ve seen their impact through higher prices. With the conflicts intensifying, inflation could worsen and hit real wages and the purchasing power of households on this continent.

Despite this, the international picture is brightening. Global inflation is receding from recent highs, allowing North American central banks to cut interest rates. Several major central banks—including the Federal Reserve (Fed), Bank of Canada, Bank of England and the European Central Bank—have already cut interest rates. As the cost of borrowing starts to fall, it’ll gradually support demand for goods and services.

Some problems are common across North America, like housing prices, which have skyrocketed, putting homeownership out of reach for many, and steep rent prices eating up consumer budgets. High interest rates have suppressed new home construction, while an uptick in immigration has increased overall demand—putting upward pressure on housing and rental prices. Until the supply gap is plugged, housing will continue to eat into household budgets and limit discretionary spending.

But there are signs of improvement: All North American governments are trying to improve the housing situation. Mexico’s president-elect has promised to build one million homes, while the U.S. government is leveraging existing federal programs, as well as working with municipalities to boost housing supply. In Canada, where lack of affordability is more acute, the federal government has announced billions of dollars in funding to boost housing supply, and provincial governments have started to address regulatory restrictions.

That’s the general picture. When we look at North America’s three nations more closely, we can see differences, but overall, the likelihood of a recession is remote.

The U.S. economy surprised on the upside in the first half of this year as inflation continued to ease and economic activities remained solid while the doom-and-gloom recession dominated the news cycle.

Inflation slowed to 3.2% in the first half of 2024, while overall real gross domestic product (GDP) expanded by 3%, allowing employers to increase their payroll head count by 207,000 a month—more than the 183,000 monthly average of the last 10 years preceding the pandemic. The strong economic performance over the same period has led to an upward forecast revision that will see U.S. growth outpacing other developed markets.

Economic activities have, however, begun to slow in the second half of 2024. The labour market is softening. Job gains and unemployment rates averaged 116,000 and 4.3%, respectively in July and August, while the value of construction activities and net exports contracted in July. In our forecast, we expect the pace of expansion of economic activities to slow to 2.1% in the second half of the year. But it still leaves the U.S. in a class of its own among advanced economies: In our most recent Global Economic Outlook, GDP is forecast to advance by 2.5% in 2024 and 1.8% in 2025.

While inflationary pressure is ebbing, easing to 2.5% in August compared to a year ago, certain consumer needs such as vehicle insurance and housing remain costly. With the headline inflation now closer to the Fed’s target of 2% and the labour market cooling, the Fed reduced policy rate by 50 basis points on Sept. 18. It’ll likely continue to ease the policy rate into next year—albeit at a slower pace—since the core rate, which excludes the volatile items of food and energy cost, is still above the Fed’s 1% to 3% target range. 
 

Because the Fed’s downward policy adjustment will be gradual and the credits of some consumers overextended, the U.S. economy won’t feel the full benefit of the interest rate cut for a while. Consumers who are carrying high debt loads won’t be inclined to splurge. They’re likely to be more focused on repairing their household finances after two years of dipping into their savings.

Housing remains another pain point for consumers, as persistently high borrowing costs and elevated prices underscore their reluctance to purchase in the near term. Once borrowing costs ease into a more manageable rate next year, the pent-up demand will be released and both home building and buying activities should pick up. That, in turn, will support other housing-related spending.

On the business side, surveys indicate that financing conditions are generally positive for companies. Business spending is expected to remain steady into next year as incentive packages made available through recent legislations help support businesses to renew their aging capital assets while expanding and building new plants.

While the overall outlook is positive for the U.S. economy, the outcome of the Nov. 5 election and its impact on policy changes remain uncertain. That has raised concern among businesses. Trade policy has become a major campaign issue in this election, helping to lift the trade policy uncertainty index to the highest level since 2021. While the overall level of the index isn’t anywhere close to where it was during Donald Trump’s presidency, the slight upward movement underscores the unease among business leaders and the likely impact on business decisions. 

The Canadian economy has struggled to get good traction since last year. Real GDP slowed to 1.2% in 2023 and has underwhelmed the first half of this year as well, expanding by a paltry 0.7%. The steady stream of warnings about a looming recession has made many Canadians worry about the bottom dropping out of the economy, especially when consumers are heavily loaded with debt. High interest rates haven’t helped. Since the Bank of Canda started raising its key policy interest rate in spring 2022, home purchases have slumped while rental costs have skyrocketed. Households have less room for discretionary spending and big-ticket items, leading to a sharply weakened domestic demand for goods and services.

The good news is that inflation that brought on the high interest rate has finally been wrestled down to where the Bank of Canada wants it to be. Inflation rose 2% year-over-year in August, which is the Bank of Canada’s desired target. Going forward, while there might be bumps along the way on the inflation dynamics, Bank of Canada’s attention is now focused on cutting the borrowing costs to stimulate the economy to help reduce the jobless rate. It’s expected to cut rates further for the balance of this year and into next year to stimulate domestic demand and job growth.

While households are making decent wages, most are focused on paying down debt, while the top income bracket continues to build their savings buffers. In fact, the bottom 60% of the income ladder have always been under water in their savings. Credit card balances are now through the roof and pushing borrowers to file for credit proposals, which could limit future credit facilities. Aggravating this uneasy situation is the cooling labour market. Unemployment rates soared to 6.6% in August as the labour pool swelled beyond what the economy could absorb.

Close to three million people—almost equally split between permanent and non-permanent residents—have been added to the Canadian population since 2021. With the economy not growing fast enough to create jobs to absorb the rising labour force, the unemployment rate is likely to rise further by the end of the year.

On the business side, the near-term outlook isn’t very positive for capital investment as optimism among purchasing managers is low. The good news is that cost pressures are moderating and financing conditions are beginning to improve. EDC’s Trade Confidence Index (TCI) in June showed that exporters are seeing global economic conditions and business opportunities improving. This will eventually lead to an increase in business investment next year.

The auto sector has been a drag on Canadian exports so far this year as companies adjust plants to produce electric vehicles (EVs), but we expect it to fade out next year. And with this year’s good harvest, agri-food should sustain Canadian export into the first half of 2025. 

Government spending, which has been a key support for the economy since the pandemic, has wound down as all levels of governments are focused on returning to a balanced budget. This will likely remove growth momentum from the economy, which wasn’t great in 2023, and is forecast to only advance 1.1% in 2024 and 1.6% in 2025.

In the interim, weak Canadian growth means that investors will be drawn to the U.S. This will likely keep the Canadian dollar to an average of US$0.73 this year, continuing the downward trend of the last two years. But the loonie is expected to rise to an average of US$0.74 in 2025 once the economic prospect improves and the Fed continue to catch up on rate cuts.

Mexico’s June 2 election is reverberating throughout the country’s economy as financial markets reacted negatively to the election results. Equity markets dropped more than 4,200 points and the peso lost 18% of its value against the United States dollar between May 31 and Sept. 10. A landslide victory for the country’s first female president, Claudia Sheinbaum, and her coalition’s super majority in the new Congress have allowed them to pass a controversial judicial bill and sign it into law even before she took office on Oct. 1. The perception that the judicial bill will degrade governance and the rule of law, which are key to attracting business investments, has unsettled investors.

While financial markets are yet to fully recover from the negative reaction to the election and the ensuing judicial reform, investors are now in a wait-and-see mode to assess the policy direction of the new administration. Foreign direct investment (FDI) in new projects has been on a downward trend since former president Andrés Manuel López Obrador hinted about constitutional changes in 2022, and it reached its lowest point in second quarter of 2024 when it became evident that the constitutional reform could become reality.

The new judicial law could scuttle investment into the country. Tesla’s July announcement that it’s halting its proposed US$5-billion factory at Santa Catarina in Nuevo León, underscores the ramification of the constitutional reform on the country’s economic potential. 

Economic activities were weak in the first half of this year. The pre-election-related spending by the government wasn’t enough to boost the economy as economic activities almost grounded to a halt in the first half of this year. The super peso constrained exports, while inflation snuffed out private consumption. After growing double digits each year over 2021-2023, private investment is expected to take a breather to see where the wind of policy change from the incoming government blows. That means slower jobs gains, and with inflation expected to remain hotter than normal, private consumption will take a hit next year.

On the inflation front, progress has been slow, as well as bumpy, and the march towards the Central Bank of Mexico (Banxico) inflation goal is likely to be sluggish. Banxico is being careful with its policy adjustment as inflation remains a threat. It’s reduced its policy rate twice this year by 25 basis points each time and it’s expected to continue this path into the first half of 2025 to ensure inflation doesn’t reignite.

With the domestic economy flagging, Mexico can count on a solid U.S. demand to sustain its economy. Mexico has overtaken China as the leading exporter of merchandise to the United States, as geopolitical tension between the two largest economies is reorienting U.S. buyers to de-risk their supply chains from China and looking to their southern neighbour to fill their orders. 

EDC Economics has downgraded Mexico’s outlook for the medium term because economic activities underwhelmed in the first half of this year, while a cloud of uncertainty hangs over the Claudia Sheinbaum administration. Real GDP is forecast to advance by 1% in 2024 and 1.4% next year. This is a 0.9-points and 0.6-points reduction, respectively for 2024 and 2025, compared to our 2024 summer forecast. 

Export Development Canada (EDC) offers several solutions, including market intelligence and business connections, to support Canadian companies in their global expansion. Our sector-focused teams have a range of knowledge and expertise.

“We have local knowledge of how to do business in different markets, but we also have the right people who have the connections, and we can leverage that benefit to Canadian exporters,” says Jorge Rave, EDC’s regional vice-president for Latin America and the Caribbean.

“We have a significant and strong Team Canada, including the Trade Commissioner Service, as well as our guides on local culture and doing business as a Canadian exporter.”

• Accessing the U.S. market should start with learning how to navigate and leverage the Canada-United States-Mexico-Agreement (CUSMA) and understand how the U.S. Buy America policy can impact business.
• EDC’s Export Help Hub covers the globe and can connect you with EDC trade advisors who can answer your questions, help you understand your challenges and help you find solutions for them. They specialize in markets and strategies and customs and regulation requirements.
• EDC offers the Business Connections Program, which promotes Canadian export capabilities to international buyers.

For Canadian exporters who need to mitigate risk, EDC offers financial and risk management solutions and tools.