Trusting his word is like forecasting the weather with a magic eight ball - you'll get an answer, but don't expect it to be the same tomorrow.
The past week underscored the noise and volatility surrounding U.S. trade policy, particularly under the Trump administration, and its far-reaching implications for markets and economic alliances. While the latest tariff decisions appear to have been negotiated to a 30-day pause at the last minute for Canada and Mexico, the imposition of higher tariffs on China signals a broader strategic shift in U.S. policy. Meanwhile, the U.S. labour market remains resilient, contrasting sharply with the deteriorating economic conditions in Europe. These dynamics create both risks and opportunities for investors navigating an uncertain global economic landscape.
Navigating U.S. trade policy: Deals or strategic posturing?
A key takeaway from the latest developments in U.S. trade policy is the administration's willingness to negotiate - provided counterparties offer political wins. Tariff threats against Canada, Mexico and Colombia were all reversed in last-minute deals, suggesting that trade friction with allied nations remains more about leverage than about a fundamental shift in economic relationships. However, the follow-through on tariffs against China indicates a more entrenched stance, driven by long-term geopolitical competition rather than short-term negotiating tactics.
Despite Donald Trump cutting deals with Mexico and Canada, we're not backtracking from our revised view that the U.S. Federal Reserve (Fed) will stay on the sidelines for the next six months. If U.S. tariffs end up close to our assumptions, we think the boost to inflation will prevent cuts later in 2025. Our expectation is that interest rates settle at 4.75% in the U.S. It has also bolstered our belief in a stronger dollar and renewed U.S. exceptionalism in equities.
The Bank of Canada's decision to cut its policy rate by 25 basis points (bp) on Jan. 29 was no surprise, but the outlook for future meetings has become increasingly unclear. While markets are pricing in a 40% chance of a hold at the Bank's next meeting in March, we still expect rates to be cut twice more in the coming months, down to a terminal rate of 2.50%. A 25% tariff on Canada would knock around 3% off gross domestic product (GDP) over the next year, but also prompt a sharp depreciation in the loonie, raising the cost of imports significantly. This would constrain the ability of the Bank to cut interest rates to support the economy, especially if a pick-up in capital outflows posed further downside for the loonie. If Canada manages to avoid a 25% tariff, we believe it'll still be caught up in a 10% U.S. universal tariff in the second quarter. In this case, we would expect a similar interest rate path but far less fiscal stimulus, given the smaller potential impact on GDP.
A key takeaway from the latest developments in U.S. trade policy is the administration's willingness to negotiate - provided counterparties offer political wins.
Market complacency and the risk of a re-escalation
A lingering risk is the assumption that trade-related threats will always be diluted before they materialize. This past week, investors appeared a bit sceptical that this was the start of a trade war. The peak-to-trough fall of nearly 2% in the S&P 500 wasn't dramatic and far from uncommon by past standards. It was much less deep at the start of the trade war in 2018.
Trump has a habit of using economic threats to reach unrelated objectives (e.g., with Colombia recently: Colombia agrees to take deported migrants after tariff showdown with Trump | CBC News), so market scepticism makes sense to me. I still expect the U.S. to impose tariffs on Mexico and Canada, but also a universal 10% tariff. Investors should remain attuned to key deadlines - March 5, when the 30-day tariff reprieve for Canada and Mexico expires, and April 1, when a broader review of U.S. trade relations is expected. These points could serve as catalysts for renewed volatility, particularly if the White House signals dissatisfaction with ongoing negotiations.
Before Trump's inauguration, we had assumed the Federal Open Market Committee (FOMC) would deliver two more 25bp cuts to its policy rate by the middle of 2025. However, we no longer expect any more cuts from the U.S. Federal Reserve. This change has prompted us to ratchet up our year-end forecast of 4.75% for the 10-year Treasury yield. The influence of near-term expectations for Fed policy on long-term U.S. government bond yields remains strong, reinforcing our updated outlook.
The labour market: U.S. resilience versus European struggles
Amid trade policy turbulence, the U.S. labour market remains a source of economic strength. January payrolls, though somewhat softer at 143,000 new jobs, were revised downward less than anticipated and wage growth continued at a solid pace. Unemployment declined to 4%, reinforcing the view that while the labour market is cooling slightly, it remains fundamentally strong. (1)
By contrast, European economic data tells a different story. German industrial production fell by more than 2% in December, bringing output back to levels seen at the height of the 2020 pandemic. The Eurozone's economic weakness is becoming increasingly entrenched, with the U.K.'s monetary policy committee divided on whether rate cuts should be larger. The fundamental challenge for European policymakers is to assess how much of this slowdown is cyclical versus structural. Given the persistence of high services inflation, monetary policy alone may not be sufficient to stimulate growth, leaving Europe vulnerable to prolonged stagnation.
The global economic fracturing: U.S.-China rivalry and the battle for influence
Beyond immediate trade disputes, recent developments have reinforced the broader trend of global economic fragmentation. The imposition of tariffs on China - but not on long-standing U.S. allies - illustrates the bifurcation of global trade into U.S.- and China-led economic blocs. While Washington still holds a relative advantage due to its extensive network of allied economies, an aggressive U.S. trade policy risks alienating neutral players, particularly in Southeast Asia, who seek to balance relations between the two superpowers.
Trump remains predictably unpredictable. His eleventh-hour decision to delay the 25% tariffs on Canada and Mexico underscores his deal-making nature but doesn't necessarily mean his broader tariff threats are bluffs. We continue to assume a 10% universal tariff is coming in the second quarter, alongside an increase in effective tariffs on Chinese imports. There's also a rising risk that additional tariffs will be applied to European Union imports. While the latest delays provide some breathing room, a rolling tariff threat could persist throughout the year, keeping markets on edge.
Investment implications: Positioning for a volatile trade and growth environment
Markets may be in a temporary holding pattern, but risks remain skewed toward further volatility. Investors should closely monitor upcoming trade deadlines as well as labour market dynamics, which will likely be crucial for Fed policy decisions. The contrast between U.S. resilience and European weakness suggests divergent monetary policy paths ahead, potentially widening the gap in equity and bond market performance between the two regions.
If history is any guide, Trump's tariffs could reinforce U.S. exceptionalism in the stock market. In 2018, mid- and large-cap U.S. equities significantly outperformed their global peers after the initial round of tariffs, a trend that could repeat if trade policies follow a similar trajectory. While enthusiasm for artificial intelligence remains a strong tailwind, investors should remain mindful of potential retaliatory measures, particularly from China that could undermine market sentiment.
Ultimately, while the past week's events reaffirmed that trade threats can often be negotiated down, the broader theme of economic fragmentation remains in place. The relentless cycle of tariff threats and policy shifts continues to inject noise into the markets, underscoring the importance of disciplined portfolio management, particularly in an environment where U.S. trade policy remains reliably unreliable.
Sincerely,
Vice President, Asset Allocation & Chief Investment Officer
Canada Life Investment Management