Two Scenarios, One Headache

Economic Data

After seven consecutive rate cuts, the Bank of Canada kept its key interest rate unchanged at 2.75% on Wednesday, saying officials need time to determine the final extent and severity of the tariffs imposed by the United States on Canada and other countries, as well as their impact on inflation. Governor Macklem said policymakers are working to digest the "dramatic" shift in global trade policy triggered by President Trump, which has disrupted financial markets, forced businesses to cancel or scale back spending and hiring plans, and led to rising inflation expectations among businesses and households. Citing high uncertainty, the BoC did not release its regular quarterly economic forecast. Instead, it provided two possible scenarios. In the first scenario, most tariffs are negotiated away and Canadian and global economic growth temporarily weakens. Canada's inflation rate drops to 1.5% within a year and then returns to the bank's 2% target. In the second scenario, tariffs trigger a prolonged global trade war. Canada's economy falls into a severe recession and the inflation rate soars above 3% in mid-2026 before returning to 2%. On the fiscal front, the Canadian government on Wednesday said it will allow automakers to import some US-made cars and trucks without tariffs as long as these companies continue to produce vehicles in Canada. This move will relieve companies such as General Motors and Stellantis, which have assembly plants in Ontario but still export a large number of vehicles from the US to Canada. The Canadian government also said it will provide a six-month tariff delay on products imported from the US for use in Canadian manufacturing, processing, food and beverage packaging, as well as certain items related to public health. Currently, Canada imposes a 25% retaliatory tariff on about C$60 billion worth of US products and additional tariffs on some US-made vehicles. 

In the US, retail sales in March rose by 1.4% month-on-month, marking the biggest increase in more than two years. Auto sales soared by 2.1%, reflecting consumers front-running purchases before the Trump administration imposes a 25% tariff on finished vehicles. The tariffs on both vehicles and auto parts will take effect no later than May 3, which is expected to raise vehicle prices by thousands of dollars. However, the Trump administration is considering a temporary exemption policy. Sales of goods other than automobiles also rose generally, with 11 of the 13 categories seeing increases. Sales of building materials, sporting goods and electronic products rose in tandem. The sales of the "control group", which serves as the benchmark for calculating goods spending in GDP, rose 0.4% in March, indicating strong consumer momentum at the end of the first quarter. However, behind the data lies a hidden concern – multiple consumer confidence surveys show that as the tariff policy advances, inflation expectations have soared, and Americans' evaluations of their own financial situations have hit rock bottom. The low-income group is already facing affordability issues, while the wealthy class has been hit by the recent stock market sell-off, casting a shadow over the consumption outlook and intensifying concerns about an economic recession. 

Global Market Reaction

Expectations that we are getting closer to tariff relief are increasing. Recent positive developments in tariff negotiations have significantly boosted global markets. Several countries, particularly in Asia, are actively pursuing swift resolutions to tariff issues. White House economic adviser Hassett emphasized that the US has made “enormous progress” in its tariff discussions with the European Union. Even China has signaled openness to talks—contingent upon the US showing respect. Constructive economic data globally have provided additional tailwinds. European stocks surged by about 3% in most cases. Equities in Asia-Pacific also experienced gains. Oil and cyclical metals outperformed. Yields dipped slightly, perhaps reflecting emerging expectations of reduced tariffs globally on US goods (the official reason for US reciprocal tariffs). Despite expectations of tariff relief, foreign investors have continued to show a declining appetite for US exceptionalism. The Greenback weakened against most currencies, while gold has continued its upward trajectory. The Canadian dollar also appreciated, albeit to a lesser extent than most currencies given its larger exposure to the US economy. 

Bond Market Reaction

Last week’s U.S. Treasury sell-off has eased, and yields across the curve have declined. Treasury Secretary Janet Yellen downplayed the recent market moves, explicitly denying speculation that foreign investors were divesting from U.S. Treasuries. She also stated that, if necessary, the U.S. could ramp up Treasury repurchases — a comment that supported bond prices and helped calm the market. In the short term, U.S. Treasury yields may remain elevated and volatile due to the uncertainty surrounding the tariff policy. In the medium to long term, assuming trade tensions ease, U.S. fundamentals stay stable, and the dollar retains its status as the global reserve currency, U.S. Treasuries are likely to strengthen. The overnight target for the Fed Funds rate is also expected to decline, following the significant rate hikes seen during the negotiation period and subsequent rate cuts. Reflecting the improvement in the treasury market, the new issue credit markets opened in the US and Canada. Amongst other new issues, GSIBs issued $28bln in USD.

Stock Market Reaction

Equity markets continued to be driven by tariff and trade news headlines. The technology sector started the week strong as tariff exemptions for consumer electronics like smartphones and laptops were announced over the weekend, temporarily lifting Apple's stock before settling lower for the week. Any positive sentiment was short lived, with Nvidia and AMD disclosing they are now subject to additional restrictions on chip exports to China. Additionally, comments from the Fed suggested they would not cut rates to support asset prices, sending tech stocks and the broader US market sharply lower and into the red for the week. Q1 earnings season kicked off, with management teams noting significant uncertainty in their forward guidance due to recent macroeconomic events. United Airlines even presented two earnings forecasts, with one scenario baking in the impact of a US recession. Canadian markets were up as the inflation rate came in lower than expected. Energy, materials, financials and real estate were amongst the better performing sectors. 

ETF Strategy - Tilts & Timing

Equity markets are currently facing significant volatility and uncertainty, as our Regime model continues to signal a “Sell” stance. However, several shorter-term indicators turned positive during last week’s sharp pullback. This ongoing drawdown is reflective of broader economic challenges, including persistent inflationary pressure and geopolitical tension surrounding tariffs.

Globally, value as a factor continues to outperform, underscoring concerns around global growth in the current economic environment. In the US, our machine learning model suggests a potential softening in the relative positioning of value versus growth in large-cap equities, while mid- and small-cap Value equities show continued signs of relative strength. Dividend-oriented equities reflect robust investor sentiment in the space and score positively across market capitalization. 

Looking ahead, the macroeconomic landscape suggests that volatility is likely to persist, driven by ongoing economic adjustments and potential shifts in monetary policy. As we progress through 2025, it is essential for investors to remain vigilant and responsive to evolving market dynamics. A key focus remains on the US 10-year yield, which has rallied sharply from around 4% to over 4.5%. This level is unsustainable for US debt and continues to be a primary concern for the current administration, dominating headline rhetoric between the Federal Reserve and the White House. 

What to Watch Next Week

Next week in Canada we’ll get the Industrial Product Price Index, Raw Materials Price Index and the Payroll Employment Change (Survey of Employment, Payrolls and Hours). In the US, we will get durable goods orders and University of Michigan Sentiment and Inflation Expectations.

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Authors: Adam Ditkofsky, Pablo Martinez, Sandor Polgar, Steven Lampert, Craig Jerusalim, Diana Li, Mona Nazir, Mickey Ganguly, Kwaku Apraku, Greg Gipson, Eric Morin, and Michael Sager

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