Federal deficit could top $100B by 2035, economist warns - ca.news.yahoo.com

Key projection: baseline federal deficit could reach $117 billion by 2035 if current policy holds. NATO-driven defence spending to 3.5% of core defence implies roughly $100 billion more (≈10% annual increases), elderly benefits are projected to rise ~50% (~$45 billion), and health transfers, equalization and debt interest will grow faster than revenues. Ottawa’s 2025-26 budget already forecasts deficits >$55 billion annually through 2029-30; balancing by 2035 without cuts would require GST to more than double to 12.5% per the analysis.

Analysis

A persistent structural widening of federal deficits will show up primarily as a higher term premium rather than an immediate spike in policy rates. Mechanistically, ongoing deficit financing increases sovereign issuance, which pushes real yields and swap spreads wider over the 1–5 year horizon as dealers and global allocators demand compensation for duration and liquidity; expect 10y Canada term premium to reprice meaningfully if issuance remains elevated.

Budget pressure drives resource re-allocation: defence and capital procurement create lumpy, multi-year demand for steel, specialized electronics and skilled labor, inflating input costs in specific supply chains and bidding away capacity from civilian projects. That creates a bifurcated alpha opportunity — industrial / defence suppliers can re-rate while broad domestic capex and municipal/infrastructure growth get squeezed, pressuring provincial finances and credit spreads.

Politically constrained tax options make spending composition the likeliest lever, not headline tax rate hikes; that implies targeted benefit-indexation changes and slower growth in social transfer flows, which will compress discretionary consumption growth among older cohorts and shift where inflation shows up (services linked to healthcare/elder care). Key catalysts to monitor: near-term election outcomes, rating-agency actions (18–36 months), and commodity-price cycles which could offset or exacerbate revenue shortfalls; a commodity upswing remains the fastest route to fiscal stabilization and a potential rapid unwind of risk premia.

Key Decisions for Investors

• Short iShares Canadian Universe Bond Index ETF (XBB) — horizon 6–18 months. Expresses CAD sovereign rate repricing; position size 3–6% NAV. Target: capture 4–8% downside if 10y CAD rises ~50–100bp. Stop: cover on rally that pushes 10y CAD below recent lows by 20bp.
• Long CAE Inc (CAE.TO) and selectively long US defense primes (Lockheed LMT) — horizon 12–36 months. Defence/aviation supply-chain beneficiaries with multi-year orderbooks; risk: procurement delays or offsets. Allocate 3–5% gross; expect asymmetric upside if procurement stays elevated, limited downside vs highly levered industrials.
• Short Canadian dollar vs USD (go long USDCAD) — horizon 3–18 months. Funding: short FXC or use forwards. Rationale: structural issuance and diverging fiscal trajectories create sustained downward pressure on CAD term-adjusted real returns. Risk: commodity price shock (oil/metal rally) quickly reverses; size accordingly (2–4% NAV).
• Pair trade — long large-cap Canadian banks (RY, TD) vs short Canadian REIT/RE mortgage-sensitive names (XRE or single-name REITs) — horizon 6–24 months. Banks often benefit from higher short-term rates and wider NIM while mortgage/REIT sector suffers from higher long rates and housing stress. Keep banking exposure hedged for credit shock; target 2–1 bank tilt with explicit stop if unemployment spikes.