Tectonic plates are moving. The recent “Liberation Day” tariffs, even with the 90-day delay, have significantly increased U.S. import duties, leading to tariff rates unseen for nearly a century.
The U.S. is using tariffs as a tool of dollar diplomacy in an effort to reshape trade dynamics, aiming to strengthen U.S. manufacturing, and undermine the perceived threat from China as a global competitor in tech and long-term military rival.
Despite significant economic headwinds and elevated uncertainty, we expect the U.S., Canada, and the global economy to avoid recession in the next 12 months, although downside risks have clearly increased.
We project a more pronounced growth slowdown in the U.S. than in other economies, reflecting the cumulative impact of global tariffs. For Canada, our outlook encompasses an initial negative uncertainty shock to economic activity until a trade agreement is reached with the U.S. Subsequently, we expect a muted rebound in growth to a pace around potential. Elsewhere, we anticipate negotiations leading to lower tariffs; stable growth in the Euro zone, supported by monetary policy and fiscal stimulus; limited downside on Chinese growth amid increasing stimulus and tech investment; and lower oil prices to provide an additional cushion against tariffs.
Given the highly uncertain policy landscape, we recommend a neutral stance on equities relative to bonds for the next 12 months. While the near-term balance of risks favours bonds, we are in a rapidly evolving environment where tariffs threats are magnified by negotiation tactics, meaning that a shift in narrative could lead to a more constructive outlook for risky assets. Timing the market is challenging for investors in the best of times, and is a daunting prospect in the current environment.
Within equity markets, dollar diplomacy is now challenging the perception of U.S. exceptionalism, making overvalued U.S. equities vulnerable to reduced demand from foreign investors, whose holdings are at record highs. We have a positive bias for Canada and Europe. In fixed income, U.S. government bonds are attractive. In foreign exchange, we expect the U.S. dollar (USD) to weaken further, and the Canadian dollar to gradually strengthen against the USD.
In highly uncertain times, it’s crucial for investors to stay disciplined and focused on long-term investment objectives and maintain a well-diversified portfolio. While uncertainty may sustain heightened market volatility for an extended period, history shows that asset markets can overcome significant shocks, such as COVID-19, decades-high inflation, and rising interest rates, as seen over the past five years. Investors who weathered these challenges fared well.
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