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Welcome to our latest video #MacroMemo. As always, lots to cover off. We'll talk about the U.S. government shutdown, which is ongoing at least as we record these words. We'll give you a little tariff update, a number of interesting developments, including some new tariffs. We'll talk a bit about CapEx (capital expenditures) in the U.S. context and specifically in an artificial intelligence (AI) context, and the extent to which that is supporting economic growth.

Then we will pivot to Canada and talk about Canadian recession concerns and also what the upcoming USMCA (United States-Mexica-Canada Agreement) negotiations may yield. And so let's get going here.

We'll start on the U.S. government shutdown front. And so it continues. It is now two weeks old as I record these words. Betting markets believe that it is likely to be resolved in less than a month, though there is a rising chance of it dragging on.

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Betting markets initially had thought it might be tightly resolved in just a few weeks. And of course, it hasn't been so far, so this drags on. Neither party appears to be in a great rush to resolve things. From an economic standpoint, as we try to map through the implications of a shutdown, we would figure loosely that the U.S. economy is about a percentage point, maybe a percentage point and a quarter smaller than it would otherwise be during the period of the shutdown.

That's not a statement of the economy is a percentage point smaller in 2025. It certainly isn't unless it was somehow a 12-month shutdown. So divide by 12 or divide by 24 if it ends up only being a few weeks. Nevertheless, there is real visible damage happening during the period of the shutdown, and we're doing our best to track that.

Equally, it is fair to acknowledge that it is inherently temporary, and when other shutdowns have ended, of course the economy bounces back to where it would normally have been. And actually usually you play a little bit of catch up too, in terms of recovering a portion, at least, of the output that had been lost before. And in theory, at least – I should say it's legislated, so likely in more than theory –

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the workers who are currently furloughed, about three quarters of a million of them, will be paid after the fact. They won't have worked, but they will be paid. And so I suppose you could say that buffers a bit of the blow to the extent the financial flow continues to government workers.

We are missing economic data as well. This is something perhaps only economists worry about. But the economic data isn't being released. And in particular, the payrolls numbers for the month of September were not released. We've been leaning on alternative estimates that would tell you that likely job creation was quite soft – if it happened at all.

It might have been slight job destruction in the month of September. But on the aggregate, I can say that it looks as though that economy is running a little bit softer than would be ideal.

Similarly, the inflation numbers will not be released this week, at least as I record things, but they have pulled back in some workers, and they will aspire to release it before the end of October.

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And that's important because the U.S. Federal Reserve has a decision to make at the very end of October, and we think it probably can still cut rates. But of course, the inflation data will be very helpful in determining whether that's the correct move or not.

Let's move from there into tariffs. And so a couple of tariffs thoughts.

One would simply be that just in recent days there has been some additional friction, some heat between the U.S. and China specifically. And the U.S. is now charging Chinese ships when they alight in U.S. ports. And China is now retaliating with the U.S. ships that reach Chinese ports. I believe there are far fewer of those.

However, China is also seemingly slowing the rate at which its rare earths flow to the U.S. as well, which has been a sticking point in the past. In response, the White House has threatened a 100% additional tariff on China.

And so financial markets were down for a period of time on concerns that there would be just this intensification of trade frictions between the world's two largest economies. I will say, since then, President Trump has suggested that they will find a deal. He has seemingly de-escalated to some extent, but there is still a level of anxiety on that front.

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And at a minimum, you would say it's not clear that China and the U.S. are coming closer to a big deal of the sort that, in theory, they've been trying to work to for a number of months.

Continuing on the tariff front, new tariffs will start. October 14th, which is the date I'm recording this, has brought some new tariffs, specifically forestry related tariffs.

And so there is now a 10% tariff on softwood lumber and timber going into the U.S. There is a 25% tariff on some specific timber-adjacent products on kitchen cabinets, on bathroom vanities, on upholstered furniture. There are also heavy-duty truck tariffs on their way. Those were meant originally to have been applied on October 1st. Those have been delayed until November 1st at a 25% rate.

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And then pharmaceutical tariffs, in theory they were meant to come on October 1st. In practice, there has not been the sort of executive order required to do that. I would say it also looks like there are a lot of loopholes in this as well. And so by that, I mean, if you are bringing in generic products, you are exempt. And of course, a significant fraction of drugs entering the U.S. are generic.

Similarly, if you are a pharmaceutical drug maker, and you're building a facility in the U.S., you're exempt. And broadly speaking, a lot of those companies are now building facilities in the U.S. It’s not clear that a lot of countries and companies will be affected by those pharmaceutical tariffs.

And then one other tariff thought here, just on the subject of margins: where is the tariff burden being felt? We've said a number of times now we see some burden sharing. We can see very much higher consumer prices in products that are heavily imported. So the consumer is paying some of the costs – arguably a bit less though than theory would suggest, though it is, of course, early and often more of the pain accrues to the consumer over time.

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So we'll see where it ends up. But so far, consumers are certainly not the only recipient of that pain. Foreign producers, foreign manufacturers have absorbed some – significantly so when we're talking toys and games and steel and aluminum. We're talking sort of half plus, in many cases, of the cost increase being absorbed before it really hits U.S. shores.

And then I should also acknowledge American firms – and we're talking mostly retailers and wholesalers and so on, but it does extend a bit beyond that – they are also being hit. And so we can see retail and wholesale margins within the U.S. falling to some extent.

\When we look at the NFIB (National Federation of Independent Business), the small business survey, we can see that the survey indicates that their margins are falling. They are expecting to absorb some of the tariff blow themselves. And some regional Federal Reserve (Fed) surveys are similarly showing intentions for businesses not to pass the entire cost to consumers, to absorb some of the cost themselves.

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And so, of course, that's good for consumers, bad for businesses. Not great for investors as well, who, of course, are faced with something of a declining profit margin.

All right, on to the next subject. Let's talk CapEx. So this is U.S.-focused as well. And so really the point here is that artificial intelligence and related spending has been buffering some of the tariff damage in 2025, with the point that the economy has been holding up better than had initially been feared.

And so let me be clear. When we're talking about AI, the main aspiration is that AI increases productivity and innovation and financial well-being. That's the long-term goal. We're maybe getting the smallest bits and pieces of that now, but still, I think, mostly waiting to see that manifest.

In the meantime, though, there is an arms race, and big companies and technology firms in particular are investing huge sums of money in capital expenditures.

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And that is actually elevating the economy itself. That's money that's flowing through the economy and making it stronger in the short term, just as this build-out is occurring.

And so to share with you a couple of stats, really focused in on The Magnificent Seven (Mag7), those big American tech giants who are in many cases really going after the AI approach.

Mag7 CapEx is up 58%, at least tracking that for 2025 versus 2024. So massive growth. Mag7 CapEx is now about 30% of overall S&P 500 CapEx. So that is to say, the other 493 companies are only spending twice as much or a bit more than twice as much cumulatively as those seven companies are.

I can say when we look at CapEx within the S&P, 500, 96% of the growth this year was from those seven companies. The Mag7 is now spending in the realm of $365 billion U.S. on CapEx just this year in that AI space. So it's huge sums of money. That's over 1% of GDP.

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So it does move the needle. To give you a sense, housing is maybe 4% of GDP. And so it's not on the scale of housing, but neither is it an order of magnitude different. It is big. It is important, as well. It's been, we think, a driver of growth over the past year. Conservatively and very, very loosely, you might say an extra half percentage point of U.S. economic growth on the basis of this.

I've seen estimates much bigger than that, by the way, as well. But we would say conservatively half a percentage point.

Looking forward then the question is: can this trick be replicated in 2026 and 2027 and beyond? The answer is we do think the CapEx will be very high in those years. We think it'll be higher, in fact. Analysts are forecasting 21% further growth in Mag7 CapEx in 2026, another 8% growth in 2027.

So it’s getting bigger and bigger and representing ever more sums of money being spent within the context of GDP, but equally slowing growth. We talked about 58% growth in 2025, then 21, then eight. We'll see what actually happens.

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There's obviously lots of uncertainty here. But the rate of growth may be slowing. And so it might not drive economic growth quite as much in future years, even though it may be a bigger share of GDP, if that makes sense.

I should acknowledge estimates vary. The Nvidia founder, maybe not surprisingly, is very optimistic, thinks exponential growth is still likely in the years ahead.

So perhaps there's some upside risk here. But it may more likely be that the rate of growth slows and it's not quite as magical a source of economic growth as it was in 2025. Then again, 2026 may not need quite as much help to the extent that perhaps some of the tariff burden starts to fade in that year.

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By that we mean not that tariffs go away, but simply that the tariff growth rate isn't quite as intense in 2026 as in 2025. And then just a reminder as well, of course, the main point again of AI is to increase productivity. That's the big thing we are optimists over the next few decades thinking we will see something of that.

That could be a very important and sustained economic driver. But it's hard to say what exact day of the week or what year of the decade that will show up in a big way.

Let's pivot. Let's talk about Canada. Two elements here. First of all, just economic concerns, recession concerns. It's undeniable the Canadian economy has been struggling under tariffs, and fear about more tariffs and uncertainty and so on.

The job market has been particularly soft, especially in areas oriented towards U.S. demand. So here we are with an unemployment rate that is about a half percentage point higher than it was at the start of the year, which is a substantial increase. It's about a percentage point higher than you'd like it to be in terms of a sustainable unemployment rate. And so there is certainly weakness.

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Do note that the September, the latest job number was actually quite positive and so was up substantially. But it's famously choppy. We think more useful is to recognize that on a trend basis, we are still seeing more negative than positive. So likely still some job destruction. And that's even after factoring in minimal population growth. That is pretty soft.

Canadian GDP in Q2 was down. That's not new news, that’s fairly stale news. But nevertheless, just to frame the conversation, it was down and so reflects of course weakness. I would say though maybe the GDP situation isn't quite as bad as it looks.

One thought would just be within Q2, GDP, domestic demand actually rose pretty nicely. Now, I guess that's not a surprise. Foreign demand was down due to tariffs. That's where you would have expected the weakness. But often you would see consumers retrenching and so on. And we didn't actually get that in Q2. So consumers kept spending, the domestic economy actually held together as much as foreign demand weakened.

The other maybe silver lining is just that Q3 GDP, which we're still tracking, is tracking positive.

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And so July had a nice monthly GDP increase. August was flat. That is just adding up to probably something of a gain. Nothing impressive, but something of a gain.

And I just mention that because of course, it means that Canada probably doesn't string together two consecutive quarters of declining output. That is common parlance for a technical recession or something like that. So not obviously on their way to that specifically.

And then maybe a third silver lining thought is just as much as tariffs are proving very painful and Canada is very oriented towards U.S. demand, the 7% average tariff rate Canada is facing is actually among the lowest in the world. So I guess it could be worse.

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As much as we are still budgeting for sluggish growth in Canada. But a lot of what determines where we go from here is this final subject. And so the USMCA, the big Canada, Mexico, U.S. trade deal, is up for renewal. You know, tariff uncertainty is down sharply for most countries versus the U.S. around the world, but not really for Canada and Mexico, because those USMCA negotiations are still pending.

2026 is likely to be the big year for that. It does sound as though it won't just be renegotiating that deal. It will also be bilateral deals on the side, separately, between the U.S. and Canada and the U.S. and Mexico. The U.S., pretty explicitly, are seeking to divide the two countries.

Some of that is because the issues are different. Presumably some of that is also because it gives the U.S. more clout in the individual negotiations.

Let's focus on Canada here. Canada has made significant concessions already: border security spending up, military spending up, digital services tax gone. Global minimum tax on the U.S. essentially not tweaked in a way that would have hurt the U.S. We think further concessions are likely, including likely more joint U.S.-Canada military initiatives. That Golden Dome will feature centrally.

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Prime Minister Carney committed to buying $1 trillion of additional U.S. goods, investing in the U.S. more, and so likely making commitments to that effect as well. And we'll see whether other concessions are made. Supply management figures centrally in that conversation.

So what might the USMCA include? Well, some of those things I'd just mentioned, likely, though, formalizes sector tariffs and probably quotas as well.

Again, we've already seen sectors targeted including autos, steel, aluminum, copper and lumber. And so the issue here is these tariffs might be formalized into the USMCA. There may be quotas put against them, perhaps at a lower tariff rate. Maybe if Canada's lucky, a no tariff rate for a certain amount of these goods to enter before the tariffs supply.

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The U.S. does seem particularly intent on carving Canada out of the auto assembly business. I don't think we can be especially optimistic for outcomes there. The USMCA might largely replicate tariffs currently in place, and not expecting big improvements.

I think the challenge here is really one in which what the USMCA does, as opposed to just mimicking what's already been done, is formalizing in legislation these tariffs, making it harder for future administrations to reverse.

And so we don't think the tariff rate necessarily goes up on Canada or down all that much with these negotiations. But it does formalize something, make it harder to unwind in 2029 and beyond.

Okay. I'll stop there and say I hope you found that interesting. I hope you found that useful. Thanks for tuning in. Please consider tuning in again next month.