Global markets have benefitted from the lack of trade-related noise over the past few weeks, 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, including 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. Some budget changes were approved in Germany that set the stage for a significant increase in military spending and infrastructure investment. We plan to discuss these items over the weeks to come. Below, we address the U.S. Federal Reserve’s latest update, which pointed to some stagflation effects (slower growth accompanied by rising inflation).
The U.S. Federal Reserve kept interest rates unchanged at its recent meeting. Its forecasts for economic growth 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). Its inflation projection for 2025 was revised higher from 2.5% from 2.7%, while its estimates for 2026 and 2027 were left unchanged. The Fed expects slower 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 later this year, followed by two more in 2026, and one in 2027. This expectation was unchanged from its assessment late last year.
The Federal Reserve’s official statement reflected a view that U.S. economic activity is “solid”, with a healthy labour market and inflation that remains “somewhat elevated”. It acknowledged that uncertainty had risen, and it would pay close attention to risks to both unemployment and inflation.
Chairman Jerome Powell’s comments during his press conference were interesting. 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 policy changes. He also reminded people that the U.S. economy was starting from a position of strength. 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 since he had also used the same term to describe inflationary pressures 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 everyone else, given that the President’s policy positions have been erratic through the first few months of the year. The Fed now finds itself in a more difficult position in which growth is slowing and inflation is rising. A recent RBC report compared the Fed’s position to a soccer goalkeeper trying to save a penalty kick. 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 the Fed is doing for now.
Given a more cautious mindset, we continue to review portfolios, ensuring that asset allocations are in-line with the targets set in our investment policies and financial plans. Generally, we are more enthusiastic about investing opportunities when negative sentiment is at an extreme and valuations are cheap. The sentiment side, while not yet at an extreme, has turned more negative this year. Stock valuations would need to decline further to be considered “cheap”.
If you have any questions, please feel free contact us.
Drew M. Pallett LL.B.
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities