February Market Newsletter

The past month has been marked by significant economic developments on both sides of the border, with trade tensions, central bank policies, and market performance dominating headlines. The lingering threat of tariffs between the U.S. and Canada has added a layer of uncertainty to an already complex economic outlook. Initially, U.S. President Trump imposed sweeping tariffs—25% on all non-energy Canadian imports and 10% on energy imports—only to delay their implementation by 30 days. This temporary pause offers a potential pathway for resolution, but the specter of tariffs continues to weigh on GDP forecasts, currency markets, and investor sentiment. Canadian real GDP contracted by 0.2% in November, driven largely by a sharp decline in the mining, oil, and gas sectors. However, early estimates for December suggest a modest rebound, buoyed by robust retail activity during the tax holiday period.

Monetary policy remains a central focus, particularly in Canada, where the Bank of Canada (BoC) eased its policy rate by 25 basis points in January. Unlike previous rate cuts driven by inflation concerns, this decision appears more influenced by risk management considerations, specifically in response to trade threats. The BoC’s cautious approach signals that slower GDP growth may be a greater concern than inflationary pressures. In the bond market, declining real yields have led the recent rally in Canadian government bonds, reflecting investor caution amid trade-related uncertainties. While BMO Economics forecasts Canadian GDP growth at 1.7% for 2025—down from an earlier estimate of 1.9%—they also highlight the potential for further rate cuts if tariffs materialize. The Canadian dollar has also remained under pressure, with forecasts now suggesting it will stay above C$1.40 throughout the year.

In the United States, economic resilience continues to shape Federal Reserve policy. U.S. GDP grew by 2.3% in the fourth quarter, with labor markets remaining robust and consumer spending showing sustained strength. Despite inflation readings coming in hotter than expected, Federal Reserve Chair Jerome Powell indicated that the Fed is adopting a "wait-and-see" approach. The Fed’s preferred inflation measure, Core PCE, aligned with expectations, providing some reassurance that inflation remains under control. However, heightened policy uncertainty, driven by unpredictable trade policies and geopolitical concerns, has led the Fed to remain cautious. Gold prices have reached all-time highs as investors seek safe-haven assets, while the bond market reflects mixed signals, balancing inflation expectations with economic resilience.

Trade tensions between the United States and Canada remain at the forefront of market concerns following a series of policy shifts by U.S. President Donald Trump. The initial announcement of sweeping tariffs—25% on all non-energy Canadian imports and 10% on energy imports—sent shockwaves through financial markets. However, in a surprising turn, the administration delayed the tariffs by 30 days, pushing the implementation date to March 4. This temporary reprieve offers both nations a chance to negotiate and potentially avoid a trade conflict. Yet, the uncertainty surrounding these tariffs has already impacted economic forecasts, with BMO Economics revising Canada’s 2025 GDP outlook down to 1.7% from 1.9%, citing trade risks and currency depreciation. The Canadian dollar, now expected to stay above C$1.40 for the year, reflects this heightened uncertainty, and additional downside risks persist should trade talks falter.

The impact of these tariffs extends beyond GDP forecasts. Canada’s reliance on U.S. markets—where exports account for nearly 20% of GDP—makes it particularly vulnerable. Key sectors such as energy, agriculture, automotive manufacturing, and broader industrial production could see ripple effects if tariffs take hold. Michael Gregory, BMO Capital Markets’ Deputy Chief Economist, noted that while the immediate market reaction was severe, the 30-day delay provides breathing room. However, April 1 looms large, as various U.S. government departments are expected to present assessments that could lead to further tariff announcements. Gregory emphasized that while Canada should continue efforts to diversify trade relationships, addressing internal barriers to interprovincial trade could provide a meaningful long-term economic boost, potentially adding between 4.5% and 8% to GDP.

Amid these trade tensions, economic uncertainty has become a dominant theme in both corporate boardrooms and the Federal Reserve’s policy discussions. Federal Reserve officials have repeatedly cited this uncertainty as a primary reason for adopting a cautious approach to monetary policy, despite positive economic indicators. The delayed tariffs, coupled with ongoing trade disputes with China and elevated geopolitical risks, have contributed to increased market volatility. Gold prices have surged to all-time highs, reflecting a flight to safe-haven assets, while the yield curve has steepened slightly as investors recalibrate their expectations. The heightened uncertainty has also led to delayed business investments and cautious hiring, as companies await clearer policy direction. Notably, major corporations such as Alphabet, Pepsi, and Mondelez have flagged these economic concerns as potential headwinds for 2025 during recent earnings calls.

Adding to the policy uncertainty, Elon Musk’s recent actions concerning DOGE (Decentralized Operational Government Expenditures) have sparked fresh debates in Washington. In an unexpected move, Musk launched a campaign aimed at reducing U.S. government spending by $1 trillion to $2 trillion. While details remain sparse, this initiative has complicated ongoing negotiations in Congress, particularly as the government faces a potential shutdown on March 14 when the current continuing resolution expires. The timing of Musk’s intervention could not be more critical, as bipartisan efforts are already strained by trade disputes and looming fiscal deadlines. The interplay between Musk’s cost-cutting agenda, trade policy uncertainty, and upcoming tariff decisions creates a volatile mix that could have profound implications for both economic growth and market performance in the coming months.

Debbie, Chris, Mark and Rosemary

Escalating Trade Tensions and Global Implications

Through the beginning of 2025, the global trade environment has undergone seismic shifts, with significant tariff-related developments redefining market dynamics. President Donald Trump has reaffirmed that 25% tariffs on all Canadian and Mexican imports will proceed as scheduled in early March, excluding Canadian energy imports, which will face a 10% duty. This firm stance has dashed earlier hopes of postponements and introduced fresh uncertainties for industries heavily reliant on cross-border trade. Sectors such as manufacturing and construction have seen increased volatility, with industrial stocks declining due to rising input costs and supply chain disruptions. These measures are part of a broader strategy that the administration claims will generate revenue and bolster U.S. job creation, but the economic consequences could be far-reaching.

The tariff landscape is further complicated by targeted measures. On February 12, the administration imposed 15% tariffs on Canadian and Mexican steel and aluminum imports, triggering renewed fears over industrial slowdowns in North America. Although there was temporary relief when the planned 25% tariffs on Canadian automotive imports were postponed until Q3 2025, uncertainty persists, leaving automakers exposed to potential production bottlenecks. Simultaneously, the U.S. indicated potential postponements of broader steel and aluminum tariffs targeting European imports, citing ongoing negotiations. However, markets remain cautious, with investors skeptical about the long-term resolution of these disputes, as geopolitical risks continue to weigh heavily on sentiment.

International retaliation has intensified the situation. In response to the 10% U.S. tariff on Chinese imports, China imposed reciprocal tariffs on U.S. agricultural products, technology components, and rare earth metals, critical for the electronics and defense sectors. These countermeasures, effective February 20, 2025, have exacerbated global supply chain disruptions and heightened inflationary pressures worldwide. The Chinese yuan weakened to its lowest level in six months, reflecting market concerns about prolonged trade tensions and a slower export growth outlook. The Canadian dollar also depreciated to $0.68 USD, signaling reduced investor confidence in Canada’s trade-exposed economy. This currency depreciation, coupled with inflationary pressures, will complicate monetary policy decisions for central banks in the coming months.

The economic and market repercussions are profound. According to BMO Economics, Canada’s GDP is forecast to contract by 2.8 percentage points in 2025, highlighting the macroeconomic fallout of sustained trade pressures. Multinational corporations in industries such as automotive, consumer electronics, and energy are now reassessing procurement strategies as they grapple with rising input costs and potential supply disruptions. With companies warning of consumer price increases, inflation risks are becoming more entrenched, forcing central banks to rethink easing strategies. The S&P 500, along with other major indices, has responded with increased volatility, reflecting investor anxieties surrounding inflationary headwinds and geopolitical uncertainties.

Finally, broader geopolitical dynamics have come into play. Senior trade advisor Peter Navarro suggested the U.S. could expel Canada from the Five Eyes intelligence alliance, leveraging security alliances as bargaining chips in trade negotiations. This proposal signals a dramatic shift in U.S.-Canada relations, where economic disputes intersect with security considerations. Sectoral performance has mirrored these geopolitical risks, with trade-sensitive industries underperforming due to margin pressures and heightened geopolitical uncertainty. The volatility index (VIX) surged to multi-month highs, highlighting fragile investor sentiment amid uncertain policy directions. The reintroduction of protectionist trade policies, combined with China’s retaliatory actions, suggests that geopolitical divides will remain a central theme for markets throughout 2025. Investors must prepare for continued currency volatility, inflationary pressures, and geopolitical realignments, all of which central banks will need to consider in their monetary policy frameworks moving forward.

Canadian Economic Summary

The Canadian economy enters 2025 with cautious optimism, navigating a complex landscape shaped by trade uncertainties, evolving inflation dynamics, and monetary policy shifts. While the looming threat of U.S.-imposed tariffs has injected near-term uncertainty, several underlying strengths suggest Canada is well-positioned to weather potential disruptions. The Bank of Canada (BoC) has played a pivotal role in stabilizing the economic outlook, implementing a 25-basis-point rate cut in January—a move primarily driven by risk management considerations in response to tariff threats. With BMO Economics projecting an additional 50 basis points of rate cuts by the summer, particularly if tariffs are imposed in full, the Canadian dollar is expected to remain above C$1.40 throughout the year. Despite external risks, domestic fundamentals—including robust employment growth, a competitive currency, and stable commodity prices—provide a solid foundation for resilience.

Inflation Trends (CPI):

Canada’s inflation picture remains relatively contained, offering the BoC flexibility in its monetary policy decisions. Consumer prices rose 0.1% in January on both raw and seasonally adjusted bases, nudging annual inflation to 1.9%, aligning with consensus expectations. The headline inflation rate remains below the BoC’s 2% target, aided by a temporary sales tax break that peaked in January. While gasoline prices provided upward pressure, climbing 4% month-over-month, rents posted their first monthly decline in over two years (-0.1%), easing the annual rent inflation rate to 6.3%. Mortgage-interest costs also moderated, falling to 10.2% year-over-year from 11.7% in December.

Recent research highlights Canada’s unique advantage in the global inflation landscape. Even after adjusting for temporary tax relief, underlying inflation trends are just above 2.5%, placing Canada among the lowest inflation rates in the industrialized world. This subdued inflation backdrop leaves the door ajar for further rate relief if needed. Deflationary factors such as the economy operating below its output capacity until at least 2026 and the dampening effect of a potential trade war on GDP growth further mitigate price pressures. Additionally, Canada’s competitive currency, which has depreciated by 5% over the past year, partially offsets inflationary risks by bolstering export competitiveness, despite adding modest near-term inflationary pressures through import costs.

GDP Performance:

Canadian real GDP contracted by 0.2% in November, driven by a notable 1.6% decline in mining, oil, and gas sectors. However, early estimates for December suggest a modest rebound of 0.2%, supported by strong retail activity during the tax holiday period. Despite these mixed monthly readings, BMO Economics has revised its 2025 GDP growth forecast downward to 1.7% from 1.9%, citing trade risks, a weaker loonie, and political uncertainty affecting foreign direct investment. Should tariffs take effect in March, downside risks to growth could intensify, with estimates suggesting a potential GDP hit of 2% or more under worst-case scenarios.

Despite recent soft GDP readings, longer-term growth trends remain solid. Since 2000, Canadian real GDP growth has averaged 2.0% annualized, closely tracking the U.S. at 2.1%. Furthermore, Canada stands to benefit disproportionately from falling interest rates due to its highly interest-rate-sensitive economy. Residential construction, a key economic driver, represents roughly twice the share of GDP compared to the U.S., positioning Canada for a robust recovery as borrowing costs decline. The BoC’s aggressive monetary easing—200 basis points in the past eight months, the most among mature economies—further enhances the economic growth outlook. These factors, combined with stable commodity prices and a balanced trade position, suggest that Canada’s growth trajectory may surprise to the upside if trade tensions ease.

Bank of Canada Policy Outlook:

The BoC’s January rate cut signaled a shift in focus toward supporting growth amid external risks. The bond market echoed this sentiment, with real yields driving a 60-basis-point rally in 10-year Government of Canada bonds after peaking at 3.56% in mid-January. The steepening yield curve and declining short-term rates indicate investor expectations for further rate cuts. BMO’s economists project the BoC will lower the overnight rate to 1.50% if tariffs are fully imposed. In the absence of tariffs, two additional rate cuts by the summer remain likely, although trade-related uncertainties present meaningful downside risks to the policy rate.

The BoC’s flexibility is underpinned by Canada’s favorable inflation dynamics and manageable fiscal position. Government deficits are expected to total 2.4% of GDP in FY24/25, significantly healthier than the U.S., where deficits approach 7% of GDP. Net foreign buying of Canadian bonds totaled a record $197 billion in 2024, driving 10-year Government of Canada yields to hover below 3.2%—a substantial 130-basis-point discount to U.S. Treasuries. These deeply negative yield differentials reflect investor confidence in Canada’s fiscal discipline and expectations of lower nominal GDP growth. The BoC’s proactive stance, combined with strong domestic demand and stable commodity prices, positions the Canadian economy for a measured recovery, even in the face of external trade shocks.

Labor Market and Employment:

Canada’s labor market remains a pillar of strength, providing a crucial buffer against economic uncertainty. Employment rose by 76,000 jobs in January, following a 91,000 gain in December. Full-time employment contributed significantly, with total hours worked advancing by 0.9% month-over-month. The unemployment rate declined to 6.6% from 6.9% in November, remaining below the 7.0% median since 2000. Wage growth, although cooling to 1.6% year-over-year in January, continues to outpace inflation, suggesting real labor income is growing at roughly 4% annually.

Employment growth of 2.0% over the past 12 months outpaces the U.S. (1.5%), supported by robust population growth and rising participation rates. The participation rate for those aged 15-64 stands at a record 80%, highlighting underlying labor market resilience. Wage growth consistently outpacing inflation suggests strong consumer spending potential, even amid the upcoming wave of mortgage renewals. This combination of solid job growth, rising real incomes, and resilient consumer demand positions the Canadian economy to absorb potential shocks from trade disruptions, providing a firm foundation for continued expansion.

Housing Market Dynamics:

Canada’s housing market remains stable, with existing home sales down 3.3% month-over-month but up 2.9% year-over-year. The MLS benchmark price was virtually unchanged in January, reflecting balanced market conditions. Residential mortgage growth reached 4% for the first time since mid-2023, as lower interest rates reignite buyer interest. Borrowers increasingly prefer floating-rate loans, anticipating further BoC rate cuts, which could provide additional momentum in the housing sector.
The housing market’s calm, balanced state contrasts with its typically volatile nature. Inventories, sales-to-new-listings ratios, and regional price divergences indicate a stable environment. Affordability has improved modestly from the challenging conditions of two years ago, and further interest rate reductions would provide additional support, especially if trade disputes weigh on consumer confidence. Given the housing sector’s outsized role in Canada’s GDP, its resilience is a critical component of the broader economic recovery narrative.

Conclusion:

In summary, Canada’s economic outlook is delicately balanced but underpinned by several quiet strengths. Inflation remains contained, providing the BoC with room to support growth through further rate cuts. The labor market and housing sector exhibit resilience, while stable commodity prices and a competitive currency bolster external competitiveness. Although trade uncertainty—particularly regarding U.S. tariffs—continues to cloud the growth outlook, Canada’s favorable fiscal position, robust domestic demand, and interest-rate-sensitive economy position it well for recovery. The BoC’s policy path, coupled with trade resolution outcomes, will be key determinants of Canada’s economic trajectory throughout 2025.

U.S. Economic Summary

The U.S. economy enters 2025 with a steady but cautious tone, supported by resilient consumer spending, a robust labor market, and stable inflation trends. However, trade uncertainties, particularly regarding tariffs with key partners such as Canada and China, continue to loom large. The Federal Reserve (Fed) remains in a "wait-and-see" mode, balancing stronger-than-expected economic performance against persistent inflation concerns and elevated geopolitical risks. While markets initially expected rate cuts by mid-2025, recent inflation data and hawkish Fed commentary have tempered those expectations. With U.S. GDP showing moderate growth, inflation moderating but still above target, and monetary policy on hold, the path forward remains dependent on incoming data and the resolution of trade-related headwinds.

Inflation Trends (CPI & PCE):

U.S. inflation remains a key focus for policymakers and investors alike. The January Consumer Price Index (CPI) report came in hotter than expected, with headline inflation rising 3% year-over-year and core CPI (excluding food and energy) increasing by 3.3%. These readings exceeded consensus forecasts, signaling that progress toward the Federal Reserve’s 2% target has stalled. Inflationary pressures were broad-based, with notable increases in used vehicle prices, motor vehicle insurance, travel services, shelter, and a surprising 15.2% surge in egg prices from December levels.

The Fed’s preferred inflation measure, Core Personal Consumption Expenditures (PCE), came in line with expectations, offering some reassurance that inflation remains under control. However, the higher-than-expected CPI print has led to a reassessment of market expectations for rate cuts, with traders now pricing in the first potential cut no sooner than Q4 2025. Inflation remains sticky due to resilient demand in key sectors, but a cooling labor market or slowing consumer spending could provide the necessary disinflationary pressure. The Fed remains concerned that inflation expectations could become unanchored if inflation does not show further signs of deceleration in the coming months.

GDP Performance:

The U.S. economy posted solid growth in the fourth quarter of 2024, with real GDP expanding at an annualized rate of 2.3%. This growth reflects sustained consumer spending, which remains a critical driver of the economy. The Institute for Supply Management (ISM) Manufacturing PMI returned to expansion territory for the first time since October 2022, signaling a potential rebound in manufacturing activity. Additionally, business investment held steady despite elevated interest rates, with particular strength in technology and energy infrastructure.

While growth remains robust, the outlook for 2025 is clouded by policy uncertainty, particularly surrounding trade. The February Empire State Manufacturing Report indicated a sharp drop in business optimism, driven by concerns over tariffs, higher mortgage rates, and rising costs. The National Association of Home Builders (NAHB) also reported declining builder sentiment for similar reasons. Despite these concerns, underlying growth trends remain positive. The U.S. economy’s ability to grow at a 2%+ pace amid elevated interest rates highlights its underlying resilience, though any escalation in trade disputes could weigh on investment and hiring decisions in the coming quarters.

Federal Reserve Policy Outlook (FOMC):

The Federal Open Market Committee (FOMC) remains cautious in its policy stance, with Chair Jerome Powell emphasizing a data-dependent approach during his bi-annual Humphrey-Hawkins testimony. The hotter-than-expected January CPI print has reinforced the Fed’s message that monetary policy may need to remain restrictive for longer. Markets, which had previously priced in rate cuts as early as mid-2025, have now shifted expectations toward a potential first cut in Q4 2025. Some market participants are even speculating that the next move could be a rate hike if inflation remains persistently above target.

Despite speculation about potential rate hikes we maintain the view that two rate cuts are still possible in 2025, contingent on labor-market weakness rather than significant inflation progress. The Fed’s cautious stance is driven by heightened policy uncertainty under the current administration, particularly surrounding trade and fiscal policy. The yield curve remains inverted, signaling market concerns about future growth prospects. However, the Fed appears comfortable maintaining a restrictive stance, given the economy’s resilience and the absence of significant stress in credit markets. The coming months will be pivotal as the Fed evaluates inflation trends, labor market developments, and the potential impact of trade policy on economic growth.

Labor Market and Employment:

The U.S. labor market continues to show strength, supporting broader economic resilience. Weekly jobless claims remain low, while the Job Openings and Labor Turnover Survey (JOLTS) indicates sustained demand for labor. The ADP National Employment Report also showed steady job creation, suggesting that the labor market remains tight. Wage growth remains robust, providing a key pillar for consumer spending, though some moderation has been observed in recent months.

The labor market’s resilience is a double-edged sword. While it supports consumer spending and economic growth, it also complicates the Fed’s efforts to bring inflation back to target. Persistent labor market tightness could sustain inflationary pressures, delaying rate cuts. However, should trade tensions escalate and weigh on corporate profits, hiring could slow, easing wage pressures and providing the Fed with greater flexibility to cut rates. For now, the labor market remains a bright spot, but its trajectory will be closely watched for signs of cooling that could alter the monetary policy outlook.

Trade and Tariff Developments:

Trade uncertainty remains a significant headwind for the U.S. economic outlook. President Trump’s decision to impose a 25% tariff on all non-energy Canadian imports and a 10% tariff on energy imports—subsequently delayed by 30 days—has created additional uncertainty for businesses and investors. The potential for further tariffs, particularly in critical sectors such as autos, pharmaceuticals, and semiconductors, adds to the economic overhang. Additionally, the ongoing 10% tariff on Chinese goods remains in place, further complicating global supply chains.

The outcome of trade negotiations with Canada and China will be critical in shaping the economic outlook for 2025. A favorable resolution could remove a significant headwind, while an escalation could dampen business investment, disrupt supply chains, and weigh on GDP growth. The White House has requested various government agencies to provide recommendations on existing tariffs by April 1, making the coming months pivotal for trade policy clarity. From a broader perspective, while trade policy remains unpredictable, markets appear cautiously optimistic that cooler heads will prevail, avoiding a full-scale trade war that could derail economic momentum.

Financial Markets and Currency Trends:

Financial markets remain resilient, with the S&P 500 hovering near all-time highs, supported by strong corporate earnings and investor optimism about long-term growth prospects. Notably, 77% of S&P 500 companies that have reported Q4 earnings beat expectations, with nine of eleven sectors showing positive year-over-year growth. However, market volatility has increased in response to shifting interest rate expectations and trade-related risks.

The U.S. dollar remains strong, supported by higher relative interest rates compared to global peers. This strength, while reflective of U.S. economic resilience, poses challenges for exporters and could exacerbate trade tensions. Meanwhile, gold prices have reached record highs, reflecting heightened demand for safe-haven assets amid policy uncertainty. The bond market shows signs of cautious optimism, with yields stabilizing after recent volatility. The yield curve remains inverted but less severely so, signaling that while recession risks persist, the market expects a soft landing rather than a sharp contraction.

Conclusion:

The U.S. economy heads into 2025 with notable resilience, underpinned by strong labor markets, robust consumer spending, and steady GDP growth. However, the path forward is marked by elevated uncertainty, driven by persistent inflation, cautious Federal Reserve policy, and unresolved trade tensions. Inflation remains above target, complicating the Fed’s ability to ease monetary policy despite market hopes for rate cuts later in the year. The labor market continues to provide critical support, though its strength may prolong inflation pressures. Financial markets remain robust but sensitive to policy shifts, with investor focus squarely on the interplay between monetary policy and trade outcomes. Overall, while risks remain, the U.S. economy’s solid fundamentals position it for continued growth, provided key policy uncertainties are resolved favorably.

Looking Ahead: Key Dates and Market Catalysts

As we move into March and beyond, several pivotal events will shape the economic and market outlook. Foremost among these are upcoming trade policy decisions, particularly regarding the U.S.-Canada tariffs. The 30-day delay granted by the U.S. administration pushes the implementation deadline to March 4, a critical juncture that could significantly influence market sentiment, currency dynamics, and sector-specific performance. Should tariffs be fully imposed, they could impact cross-border trade volumes and corporate earnings expectations, necessitating swift policy responses from the Bank of Canada (BoC).

Another key date is March 12, when the U.S. tariffs on steel and aluminum are scheduled to take effect. These tariffs are expected to reverberate across various industries, potentially raising input costs and weighing on industrial production and construction sectors. Furthermore, the April 1 deadline for U.S. government agencies to report on existing tariffs and propose adjustments will be closely watched, as any new recommendations could redefine trade dynamics, particularly in manufacturing and technology sectors.

On the monetary policy front, the Bank of Canada’s next rate decision on March 12 will provide crucial insights into how policymakers plan to navigate slowing GDP growth, trade uncertainties, and evolving inflation dynamics. With inflation moderating and the Canadian dollar under pressure, the BoC’s approach to interest rates will be instrumental in shaping the domestic growth trajectory. Similarly, the Federal Reserve’s policy stance will remain under scrutiny, with markets keenly watching upcoming speeches from Fed officials for hints on the timing of potential rate adjustments.

Beyond North American borders, global trade developments and geopolitical risks will continue to influence market volatility. The potential for retaliatory tariffs from key trading partners, evolving energy market dynamics, and central bank policies in Europe and Asia will all play roles in shaping investor sentiment. Market participants