Market Update
During the first quarter of 2025, global markets benefitted from the lack of trade-related noise over that time frame, with markets outside of the U.S. continuing to outperform year-to-date. Despite the relative calm on the tariff front, there were important developments elsewhere. Notably, another interest rate cut by the Bank of Canada, the appointment of Mark Carney as Canada’s Prime Minister, and reports that a federal election will take place in April. Overseas, a partial ceasefire was negotiated between Ukraine and Russia. Meanwhile, some budget changes were approved in Germany that set the stage for a significant increase in military spending and infrastructure investment. Below, we address the U.S. Federal Reserve’s latest update, which pointed to some stagflationary effects – where growth slows, and inflation rises - this year.
The U.S. Federal Reserve kept interest rates unchanged at its recent meeting. Nevertheless, it revised a few of its economic projections. Its forecasts for economic growth (i.e. GDP) were revised lower: to 1.7% (from 2.1%) for 2025, and to 1.8% for both 2026 and 2027, respectively (from 2.0% and 1.9%, previously). Meanwhile, its inflation projection for this year was revised higher, to 2.7% from 2.5%, but its estimates for 2026 and 2027 were left unchanged. In summary, it expects lower growth through the next few years, and a temporary bump in inflation this year before it reverts to lower levels. The Fed also revealed that, on average, its policy makers expect two interest rate cuts this year, followed by two more in 2026, and one in 2027, which was unchanged from its prior assessment late last year.
The Federal Reserve’s official statement suggested it felt that U.S. economic activity was “solid”, with a healthy labour market, and inflation that remained “somewhat elevated”. It acknowledged that uncertainty had risen, and it was paying close attention to the risks of both sides of its dual mandate: unemployment and inflation.
Chairman Jerome Powell’s comments during his press conference were more interesting, in our view. He acknowledged some slowing in consumer spending, recent deterioration in sentiment, and higher levels of uncertainty resulting from a U.S. government that is making big changes in policy. But he reminded people that the U.S. economy was at least starting from a position of strength. Meanwhile, he was less concerned about an uptick in consumer inflation expectations and characterized any potential inflation stemming from tariffs as “transitory”. The latter remark was not particularly comforting as he also used the same term to describe inflationary pressures that emerged during the early stages of the pandemic.
Our simple takeaway is that the Fed is nearly as uncertain over the trajectory of the U.S. economy as everybody else. It is hard to fault them as government policy has been erratic through the first few months of the year. As a result, the Fed now finds itself in a more difficult position where growth is slowing, and inflation is rising. A recent RBC report compared the Fed’s position as being akin to a goalkeeper trying to save a penalty kick in football (i.e. soccer). If they overcommit to one side, they increase the odds of saving the economy from that scenario (i.e. slower growth), but it may then become more difficult to prevent the other scenario (i.e. higher inflation) from unfolding. As a result, a more suitable approach may be to stand pat, which is what they are doing for now.
The start of April has brought on more volatility and unknowns with an announcement of sweeping global Tariffs and then a Tariff pause from the White House. Global equity markets fell sharply following the revelation from the U.S. administration that its reciprocal tariffs will be much broader and larger than most investors expected. The “Liberation Day” announcement raised the spectre of a more global trade war between the U.S. and many, if not all, of its trading partners. Below, we summarize recent trade developments, its implications on the economic outlook, and the response across equity, fixed income, and currency markets.
The U.S. unveiled a 10% baseline tariff on all imports, plus much higher individual duties to be applied on close to sixty countries. Only for these to be put on pause at the last moment to allow countries to have dialogue with the US after announcing that 75 countries had come forward. In a somewhat positive surprise, Canada and Mexico were spared, as neither country will face additional levies. This removes, for now, some of the worst-case scenarios that investors were anticipating for both countries. As a reminder, Canada is already facing a 25% tariff on goods, including autos and parts made in Canada, not covered under the USMCA trade agreement signed in 2018, a reduced 10% duty on energy and potash not covered under USMCA, and a 25% tariff on steel and aluminum.
The market reaction to the tariff developments was predictable in some cases, and surprising in others. The U.S. stock market bore the brunt of the weakness, continuing a trend that’s been in place this year. Technology and industrial sectors were particularly weak as investors are increasingly questioning the resilience of the U.S. economy and the growth expectations embedded in its stock market. The Canadian market fared a bit better, with bank stocks demonstrating some resilience, helping to offset some of the weakness from the Energy sector. Overseas equity markets were also lower, albeit to a lesser degree. The markets have seen some record setting trading days to both the downside and the upside over the past weeks. The big moves to the upside remind us why it’s important to remain invested through the volatility. Often, the large positive days in the market come when we don’t expect them and can provide investors with a large part of their overall returns, over time.
Not surprisingly, government bond yields moved lower (and prices higher) as investors have grown concerned about global growth and have sought safe-haven assets. The bond component of portfolios has performed as expected during times of equity market stress and has provided a nice ballast to portfolios. This is a great reminder of the benefit of maintaining an allocation to bonds during market cycles. The move in U.S. bond yields was noticeably more pronounced than in Canada. The bigger surprise may have been in the currency markets with the Canadian dollar, Euro, and Japanese Yen, among others, rising meaningfully following the tariff announcement. Traditionally, the U.S. dollar has been the key beneficiary in a “flight to safety” environment marked by equity market selloffs. But, that has not been the case recently, and may be indicative of investors reassessing the U.S. from multiple perspectives.
The high level of uncertainty in recent months caused by the threat of tariffs may have already resulted in some economic impact in the form of slower spending, investment, and activity. But the tariff announcements over the past weeks represents a new possible shock to the global economy that could result in higher prices across a range of products, lower spending, and shifting supply chains as businesses and consumers look for substitutes where possible. And while a recession is by no means a foregone conclusion, the risk of one occurring has risen. Central banks like the U.S. Federal Reserve are unlikely to stand pat should economic trends deteriorate but lowering rates in the face of rising prices may be somewhat uncomfortable for them.
We continue to manage portfolios in this environment with a degree of caution, ensuring our equity exposures have been rebalanced and do not exceed the targets laid out in the investment policies and financial plans that we have designed for our clients. Those plans assume that market drawdowns, such as the one we are living through, may occur from time to time and to varying degrees. Sticking to a plan ensures that we remain disciplined in our approach which is particularly important during periods of market duress where emotions can often get in the way. In times of volatility, we want to ensure that any short-term cash needs will not be subject to a pull back in the markets. As always, please keep us informed of any upcoming cash requirements so we can be well prepared. This could include, but is not limited to, things like travel, car purchases, home repairs or real estate transactions that haven’t already been planned for.
Our team is in the office and happy to speak with you if you need to discuss anything.