Executive Summary
- Desjardins now expects the Government of Canada federal deficit for the coming fiscal year to rise to C$74.5 billion, about C$6 billion higher than the Parliamentary Budget Officer (PBO) forecast.
- The increase is driven by higher spending (infrastructure, defence, transfers) plus revenue softness stemming from recent income-tax cuts and the elimination of certain counter-tariffs on U.S. goods. Advisor.ca
- While a deficit of this size is not unprecedented in crisis years, it signals growing fiscal headwinds, especially in an era of elevated interest rates, and underscores constraints for government-funded initiatives and credit metrics.
What Happened (Facts)
- According to Desjardins’ report, the fiscal imbalance will be “among the largest in recent memory outside of a recession or pandemic.”
- Specifically, Ottawa’s assumptions include extra outlays on defence and infrastructure, alongside tax-cuts passed over the summer and removal of counter-tariffs, which reduce revenue.
- The official Annual Financial Report for FY 2023-24 shows an operating deficit of C$61.9 billion for that year. Canada.ca
- Desjardins warns that despite these deficits, Canada’s strong credit rating should not be taken for granted given ongoing pressures.
How We Read It (Mechanism & Context)
- Debt servicing pressures rising: With elevated interest rates and growing debt stock, interest expense becomes a larger share of the budget.
- Fiscal anchor strain: The federal government has set “anchors” (e.g., deficit-to-GDP, debt-to-GDP) which now face greater stress given this deficit path. Desjardins had already been sceptical of meeting these anchors. Desjardins.com
- Policy trade-offs intensify: With fiscal space tightening, the government will face tougher decisions between new spending, tax cuts, or raising new revenues — each with economic/market implications.
- Macro linkages matter: Given the role of fiscal policy in growth and the interplay with monetary policy (rate path, inflation), large deficits in a higher-rate regime heighten risk for the overall macro outlook.
Investment Implications — Where We’d Look
1) Canadian sovereign credit & fixed income (0-24m)
- Thesis: The elevated deficit raises the probability of slower debt-to-GDP improvement, putting modest pressure on Canadian government bond yields and possibly credit spreads.
- Action: Monitor Can-bond curves and relative spread to other OECD peers; hedge interest-rate or duration exposure if policy tightening looks likely.
2) Infrastructure & public-private investment (12-48m)
- Thesis: With fiscal space constrained, Ottawa may rely more on P3/PPPs and private-capital-intensive infrastructure instead of pure public spending. Private-sector participants in Canadian infrastructure may benefit.
- Action: Screen for firms engaged in Canadian infrastructure concession models; evaluate regulatory/tax/flavour changes.
3) Canadian banks/financials with sovereign exposure
- Thesis: Banks with significant sovereign bond holdings face mark-to-market and reinvestment risk in a world of higher deficits and rates.
- Action: Re-assess bond portfolios, duration risk, and asset-liability mismatches within Canadian banks.
4) Tax-sensitive sectors & consumption (0-24m)
- Thesis: With tax cuts already implemented and fiscal pressures mounting, future tax increases or slower growth could weigh on consumer-facing stocks, particularly in Canada.
- Action: Look for early signs of tax policy drift (e.g., capital gains, corporate tax) and tilt sector allocations accordingly (e.g., defensive rather than tax-sensitive growth).
5) Canadian dollar / FX (0-12m)
- Thesis: A larger-than-expected fiscal deficit can add downward pressure on the CAD via higher yields or counter-cyclical risk; conversely if borrowing is well-funded and growth remains, the CAD may hold.
- Action: Monitor CAD vs. USD, carry from yield differentials, and incorporate hedge strategies if exposure to CAD; consider commodity-linked FX plays (e.g., CAD vs. AUD).
Catalysts & Timing
- Nov 4, 2025: Federal Budget rollout — key release for official numbers, updated forecasts, policy measures.
- Q4 2025-Q1 2026: Revised revenue forecasts, built-in spending commitments (e.g., defence/infrastructure), and bond issuance size could hint at funding stress.
- Bank of Canada & credit-rating agencies: Any change in tone regarding fiscal trajectories, debt servicing, or rating outlooks could affect yields/spreads.
Scenarios (12-24m)
- Base (~55%): Deficit remains large (~C$70-80 billion) with debt-to-GDP flat or slightly rising; bond yields modestly higher; Canadian financial markets adapt without major dislocation.
- Bull (~25%): Growth surprises, tax base expands, and the government modestly outperforms deficit expectations; yields stabilize or decline; CAD strengthens.
- Bear (~20%): Slower growth + tax revenue under‐performs + interest costs rise → deficit widens beyond C$80 billion, debt-to-GDP climbs, sovereign spreads widen, CAD weakens.
Key Risks & What Could Go Wrong
- Interest-rate shock: If global rates spike, Canada’s debt servicing cost could jump and push the fiscal position off course.
- Revenue shock: A downturn or commodity-price fall (Canada is resource-sensitive) could reduce tax receipts and widen the deficit.
- Political/tax policy reversal: If tax cuts are reversed or new taxes introduced unexpectedly, this could alter growth/sector outcomes.
- Rating agency action: If agencies flag deterioration in fiscal fundamentals, risk premia could rise in Canadian sovereign bonds.
What We’re Watching (KPIs)
- Year-over-year changes in federal program spending, public debt charges (both reported by Department of Finance).
- Revenue growth vs. forecasts (especially corporate tax, personal income tax).
- Canadian government bond yield curves and spread changes (10-yr vs. 2-yr, compared to U.S.).
- CAD foreign-exchange trends and commodity-revenue link strength.
- Budget 2025 fiscal projections (debt-to-GDP, deficits) and any announced tax or spending measures.
Sources
- “Tax cuts, dropping U.S. tariffs will hurt Ottawa’s fiscal position: Desjardins report” — The Canadian Press (via Advisor.ca) (Oct 22, 2025). Advisor.ca
- “Desjardins estimates federal deficit will be the highest in 30 years” — Yahoo Finance Canada (Oct 22, 2025). ca.finance.yahoo.com
- Government of Canada, Annual Financial Report 2023-24. Canada.ca
Bottom Line (How We’d Act)
We view Canada’s fiscal widening as a moderate structural tailwind for yield-sensitive assets and a caution flag for growth/leverage exposures in Canadian equities. We’d favour income/defensive strategies, keep duration/fundamental credit hedges active, and tilt away slightly from high-beta Canadian consumer names until the fiscal and growth picture stabilises.
