Canada’s Shallow Recession Looms: Defensive Sectors Offer Safe Harbor

The Canadian economy is careening toward a shallow recession, driven by the confluence of monetary policy constraints, tariff-induced inflation, and sectoral imbalances. With the Bank of Canada’s room to cut rates dwindling and U.S. trade tensions distorting prices, defensive sectors like utilities and healthcare are emerging as critical safe havens for investors. Here’s why the risks are manageable—and where to position portfolios now.

Monetary Policy at a Crossroads

The Bank of Canada’s (BoC) policy rate has been steadily declining since its peak of 5.00% in July 2023, falling to 2.50% by April 2025 after a series of cautious cuts (see Figure 1). Yet further easing faces significant hurdles. While inflation has dipped to 2.3% in recent months, core measures—excluding volatile items like energy—remain stubbornly elevated at 2.7%, complicating the path to deeper rate reductions.

The BoC’s dilemma is clear: cutting rates risks reigniting inflation through higher demand, while inaction risks deepening economic softness. With unemployment rising to 6.9% in April 2025 and job losses concentrated in trade-sensitive sectors like manufacturing, the central bank’s policy tools are nearing their limits. This constrained environment bodes poorly for rate-sensitive assets like real estate and consumer discretionary stocks, but it creates a tailwind for defensive sectors insulated from cyclical downturns.

Tariffs and the Inflation Quagmire

The U.S. trade war’s ripple effects are reshaping Canada’s economic landscape. New tariffs on Canadian goods—from lumber to automotive parts—are squeezing business margins and distorting supply chains. The BoC’s April 2025 Monetary Policy Report starkly warned that prolonged trade conflicts could push inflation above 3% by 2026, even as headline figures dip due to falling energy prices.

The dual inflation dynamic—lower headline rates but persistent core pressures—creates a paradox for investors. While energy and commodity stocks may see short-term gains from lower oil prices, sectors exposed to shelter costs and services (e.g., housing, healthcare) face sustained pricing pressures. This divergence underscores the need to prioritize companies with pricing power and stable demand.

Defensive Sectors: Steady as She Goes

Amid this volatility, utilities and healthcare stand out as recession-resistant havens.

1. Utilities:
2. Regulated pricing and inelastic demand make utilities immune to economic swings. Canadian utility giants like Hydro One (HUN.TO) and Fortis (FTS.TO) have delivered annualized returns of 6–8% over the past five years, outperforming the S&P/TSX Composite by 300 basis points during periods of market stress.

4. With interest rates stabilizing, utilities’ dividend yields (currently 4.5–5.0%) offer a compelling hedge against bond market volatility.

5. Healthcare:

6. Essential services and pharmaceuticals are shielded from economic cycles. Bausch + Lomb (BLI.TO) and CannTrust (CNT.TO), for example, have seen steady demand for vision care and chronic disease therapies despite slowing GDP.
7. The sector’s low correlation with broader markets (beta <0.8) and defensive balance sheets make it a prime refuge.

Navigating the Loonie’s Decline

The Canadian dollar’s 10% slide against the U.S. dollar since mid-2024 has dual implications. While it boosts the competitiveness of Canadian exports, it also raises import costs—exacerbating inflation in sectors like food and automotive. This creates a sectoral divergence:
- Winners: Export-heavy firms (e.g., Loblaw (Loblaws) in groceries) gain pricing power.
- Losers: Companies reliant on imported inputs (e.g., Tim Hortons (THI.TO)) face margin squeezes.

Investors should prioritize firms with currency-hedged revenue streams or those that benefit from a weaker dollar without overexposure to inflation-sensitive costs.

Investment Strategy: Sectoral Rotation Now

The path forward is clear: rotate out of cyclical sectors (energy, financials, consumer discretionary) and into defensive plays. Consider:
1. Utilities: Target high-dividend names with regulated growth.
2. Healthcare: Focus on essential services and generics producers.
3. Cash and Bonds: Use short-term government bonds (e.g., XBB.TO) to hedge against market volatility.

Avoid sectors tied to housing (e.g., CMHC (CMHC.TO)) and cyclical manufacturing (e.g., Bombardier (BBD.B.TO)), which face headwinds from trade tariffs and weak demand.

Conclusion: Defend to Offend

Canada’s recession is likely to be shallow—GDP is projected to grow 0.8% in 2025—but the path to recovery will be uneven. With the BoC’s tools stretched and trade tensions unresolved, defensive sectors are the ultimate diversifiers. Investors who act now to rebalance into utilities and healthcare will position themselves to weather the storm and capitalize on the eventual rebound.

The writing is on the wall: defend your portfolio before the next chapter begins.