MWW- 38 Years Old

This week marked two big events for Canadians: The August 19 deadline for 50% U.S. tariffs on US$20 billion of Canadian exports; And the very next day, the 10^th anniversary of The Tragically Hip’s final concert. And what better way to assess the current state of play on the trade front and the economy more broadly than by recognizing some of the best songs from that quintessentially Canadian group? Starting with the title song of this week’s commentary, we’ll point out that the original Canada-U.S. Free-Trade Agreement (FTA) was signed in early 1988 and went into effect on January 1^st 1989; so, like the song itself, the FTA is soon to hit its 38^th birthday. The agreement has gone from the FTA, to NAFTA in 1995, to the USMCA in 2020, to—sadly—a trade skirmish in 2025-26. There are hints that some sort of agreement is in place, but as of writing this Friday we are still largely in the dark.

Courage: Despite dealing with 21 months of tariffs, trade threats and all the uncertainty that flows from that, the Canadian economy has held up remarkably well. In fact, consumers have been particularly courageous. While growth and employment were basically flat in the first year of the trade fight, there are mounting signs that the economy is turning the corner with purpose more recently. We now expect Q2 GDP to have grown at almost a 4% annual rate (data due August 28), and July’s sturdy employment report revealed a 0.9% y/y advance, much stronger than either of the U.S. job measures. Between the snapback in growth, still-firm oil prices, hopes for a trade deal, and a small sag in the U.S. dollar, the Canadian dollar is now at its strongest level in almost three months at above 72 cents (or $1.387/US$). For the record, that’s actually even stronger than prior to the very first threat of a 25% tariff way back in late November 2024. Not unrelated, note that the TSX has been on an absolute tear, hitting a series of record highs this week and is now up a towering 45% since the first tariff threat. Courage!

Fifty-mission Cap: A key reason that the U.S. dollar has sagged somewhat in recent days is due to waning expectations of Fed rate hikes. Little more than two weeks ago, markets were pricing in as much as 50 bps of tightening by the end of this year; their very own 50 mission cap. Since then, Chair Warsh gave no blessing to those expectations, payrolls fell in July, while CPI was tame as expected (with core up 0.2%, shaving the yearly rate to a five-year low of 2.5%), as were producer prices, and July retail sales disappointed with a chunky 0.6% drop (and even down 0.4% for the control measure). Make no mistake: the U.S. economy still has momentum—Q3 GDP could still be quite strong—but the strength is very much concentrated in business investment and, more specifically, the AI build-out. Expectations of imminent rate hikes have melted, with now only one 25 bp move fully priced in over the next year. Of course, we will still get another full month’s cycle of data before the next FOMC decision on September 16, as well as Warsh’s sermon from Jackson Hole two weeks hence, all of which could reshape expectations.

Blow at High Dough: A series of generally bond-friendly U.S. economic releases in the past week has acted as only a small relief valve for bond yields. Thirty-year Treasuries at 5.25% are near their highest level since June 2007 (just before the GFC blew wide open, crushing rates everywhere), while this week’s auction priced at the highest 30-year yield since 2001. Topping that, long-term Japanese yields have recently hit 4%, a 10-fold increase from pre-Covid lows, while 10-year JGBs at almost 2.9% are at 30-year highs. The upswing in Japan, where yields had been zero or even negative for years, has been a key pressure point on bonds globally. Weakened fiscal finances almost everywhere are adding to the mix; it didn’t help that the U.S. reported its largest budget deficit ever for July (at $432 billion this year). That figure was lifted $100 billion by timing factors, but this year’s deficit is still headed for $2.1 trillion (or 6.5% of GDP). Piling on, the tech companies are rapidly ramping up borrowing programs to fund the AI build-out. Estimates are that global investment grade corporate debt issuance is up 22% y/y so far in 2026, and is on track to top $4 trillion or double levels prevailing just three short years ago (which had already doubled from five years earlier).

Nautical Disaster: Of course, another big factor behind the rise in yields this year has been the fundamental shift in central bank policy. After two years of rate cuts, policy has suddenly swung to hikes this year for some banks, and the Fed is at least considering such a step. Much of this shift reflects the upturn in headline inflation globally as a result of higher energy prices and, specifically, the closure of the Strait of Hormuz. Oil prices oscillated this week, but are holding north of $80/barrel, up a third from pre-war levels of closer to $60. While well down from the peaks of above $100 in the spring, this has still lifted headline inflation by 1 percentage point in both the U.S. (to 3.4%), and in Europe (to 2.9%).

New Orleans is Sinking: That may be true, but the refineries in the region are getting a huge lift from record crack spreads. Even as headline crude oil costs have eased notably, gasoline and, especially, diesel prices have stayed sticky. While down from the peaks, the 3-2-1 spread remains huge at $64/barrel, versus a more normal $20. In other words, a blend of gasoline and diesel prices is trading at the equivalent of about $40-45/barrel higher than the widely reported crude oil costs. And that’s probably more meaningful for the inflation outlook.

Wheat Kings: Food costs have added a second layer of pressure to inflation in the past year, with notable strength in beef and coffee prices. There was some relief in the July CPI, as U.S. food prices rose just 0.1% m/m (and grocery prices dipped 0.1%), although the annual rate stayed close to 3%. The outlook remains fraught for food prices, however, with diesel costs weighing heavily and now Russian grain exports bracing for a decade low. Ukraine’s drone attacks on grain terminals at Novorossiysk, and Russia blocking Ukraine’s Black Sea exports have helped drive wheat futures up almost 30% y/y and corn up 22% y/y.

At the 100^th Meridian: Not helping wheat prices are growing drought conditions in the Prairies, which persist across the U.S. Plains—with Colorado and Wyoming experiencing severe to exceptional drought. In Canada, 38% of the Prairie region is classified as Abnormally Dry. It may be even more intense in Europe, which has been dealing with an extreme drought in many regions (notably Britain).

Long-time Running: Despite the lingering concerns around food and energy prices, core inflation remains stable in most major economies, with U.S. and Canadian core CPI grinding lower on softening shelter trends. In turn, the equity market has shrugged off both the trade war and the Iran conflict, and rallied on. The MSCI All Country Index has powered up 23% in the past year to an all-time high, with a 15% rise since the end of last year. The market is now working on almost a four-year rebound from the Oct/22 lows, which has seen global equity prices double (a gain of roughly 20% per year, before dividends).

Ahead by a Century: No secret that the tidal wave of AI spending has been the driving force behind the rally. While it’s still a bit below its early June highs, the Nasdaq 100 has nevertheless managed to soar 180% from its late 2022 lows, or, yes, about 100% above the rise in the Dow since that point.

Fully, Completely: Even with the sustained and broadening equity rally, there’s little doubt that valuations are on the rise. Bulls could readily respond that the 10-year history may be interesting for earnings, but on the ground they are on track to have soared 50% y/y in Q2. Yes, that gaudy figure comes with plenty of asterisks, but even underlying trends are still in the 20%-to-25% range, a formidable pace at this stage of the cycle. We’ll just conclude by suggesting that valuations are fully, if not completely, building in some serious growth and productivity gains from AI in the years ahead.