When Constraints Return

For more than a decade, investors, businesses and households operated in an environment where economic constraints seemed to be fading. Inflation was low, interest rates remained structurally depressed, and central banks had considerable latitude to support the economy when growth weakened or markets came under pressure. Governments could borrow cheaply, globalization helped compress business costs, and falling discount rates provided a powerful tailwind to asset valuations. That environment has not disappeared entirely, but it is increasingly a poor description of the world we are in today.

Perhaps the defining feature of the current environment is the simultaneous return of constraints that had come to seem secondary. Energy has regained strategic importance as overlapping geopolitical tensions expose vulnerabilities in global supply. US protectionism has reintroduced frictions that decades of trade integration had reduced. Population aging is weighing on labour supply, business succession External link., and public finances. And already highly indebted governments must find the resources to fund defence, infrastructure, the energy transition and the fiscal costs of aging. Each of these challenges might be manageable in isolation. Taken together, they force trade-offs that the economic environment of the past decade and a half had largely allowed policymakers to avoid.

The shift is particularly visible in bond markets. For a long time, understanding long-term yields was largely an exercise in anticipating the path of policy rates. That is no longer enough. Investors must also decide how much compensation External link. they require to commit capital for ten, twenty or thirty years in a world where inflation is less predictable and governments are issuing considerably more debt. The return of a higher term premium is the financial-market expression of this change in regime.

The US provides the most striking illustration. In the early 2000s, official projections could still contemplate a gradual decline External link. in federal debt. Today, debt held by the public exceeds 100% of GDP and remains on an upward trajectory. It does not take a fiscal crisis for this to matter. When the supply of government bonds rises persistently, they need to find someone to hold them. If demand does not increase at the same pace, the market-clearing mechanism is a higher yield. Governments may still be able to postpone difficult fiscal choices, but doing so is becoming increasingly expensive.

This is happening just as the global economy is entering a phase that could require enormous amounts of capital. Artificial intelligence is perhaps the clearest example. Capital expenditures by major technology companies are expected to reach US$700 billion to US$800 billion this year, roughly twice their 2025 level, with a growing share of that investment financed through debt. This surge in private financing needs is therefore arriving alongside already substantial government borrowing requirements. AI may ultimately expand the productive capacity of the economy, but in the meantime it is intensifying competition for capital, electricity and infrastructure. And between the initial investment and the eventual productivity payoff lie adoption, organizational change and labour-market adjustment. Just as importantly, there is the question of which investments will ultimately prove productive and which will not.

Canada enters this environment from an ambiguous position. The trade conflict with the US represents a clear negative shock for an economy so deeply integrated with its largest trading partner. Tariffs and counter-tariffs External link. reduce trade, disrupt supply chains and weigh on profit margins and investment in the most exposed sectors. They also create an unusual challenge for the Bank of Canada: the same shock can weaken economic activity while raising some prices. When supply and demand are affected simultaneously, the appropriate monetary policy response becomes inherently less straightforward.

Yet this uncertainty does not necessarily make Canadian assets less attractive. Canada combines several characteristics that have become relatively scarce: public finances that remain stronger overall External link. than in many other advanced economies, a bond market that continues to attract foreign capital, and abundant natural resources and energy that are increasingly sought after in a more fragmented world with substantial investment needs. For investors, the relevant question is therefore not simply how quickly Canada is growing, but how Canada compares with the alternatives in the global environment now taking shape.

Trade diversification External link. should be viewed through a similar lens, although we need to be careful not to overstate what it can achieve. A decade ago, roughly one-quarter of Canadian exports went to markets outside the US; today, that share is approaching one-third. That is meaningful progress, but it remains a long way from economic independence. Geography, infrastructure and decades of industrial integration will continue to make the US Canada’s dominant trading partner. Diversification can therefore broaden Canada’s markets more quickly than it can reduce the economy’s vulnerability to the US.

More broadly, Canada’s experience illustrates why there is no necessary contradiction between an economy facing significant headwinds and assets External link. that may become more attractive to investors. Markets ultimately price relative risks, returns and constraints. An economy can grow slowly while still offering assets for which global demand is increasing. Conversely, a faster-growing economy can become less attractive if valuations, imbalances or financing requirements rise even more quickly. In a world of tighter constraints, relative starts to matter again.

For all its turbulence, the current environment does not necessarily point to a severe economic crisis. Rather, it marks the end of a period in which several economic objectives appeared achievable simultaneously without imposing particularly painful trade-offs. Governments could support demand without paying much attention to the cost of servicing their debt. Central banks could cut rates without immediately worrying about a resurgence of inflation. Businesses could optimize supply chains primarily for cost rather than security. And investors could rely on declining interest rates to provide a persistent tailwind to valuations.

That is changing. Increasing spending in one area now more often means giving something up elsewhere. Funding defence, infrastructure, the energy transition and aging populations all require capital. Reshoring supply chains can make them more resilient, but often at a higher cost. Preserving fiscal credibility limits the extent to which governments can repeatedly use their balance sheets as shock absorbers. And massive investment in AI may lay the groundwork for tomorrow’s productivity gains while increasing today’s competition for capital, electricity and infrastructure.

For financial markets, the challenge is precisely that no single scenario dominates all others. Several forces are operating simultaneously, sometimes in opposing directions, making selectivity increasingly important. In a world where capital is no longer close to free, not all debt is created equal, not all investments will generate adequate returns and not all jurisdictions will have the same room to manoeuvre. After a long period in which abundant liquidity often allowed economic constraints to be deferred or obscured, an older reality is reasserting itself: when resources become scarce, trade-offs become unavoidable.