[Spring 2025 GPS]US/Canada Macro Economy

US: A land of unpredictability

In May, U.S. large-cap stocks posted their strongest monthly performance in 35 years as global equities surged amid easing trade tensions. Despite this remarkable stock market rally, many investors remain apprehensive about the sustainability of such a rapid recovery, concerned about the impact of tariffs, rising US federal debt levels, and the potential for inflation to reemerge as a factor. We still believe that the situation is precarious until we gain more clarity on the potential economic effects of the U.S. government's disruptive trade policies. The US administration is actively negotiating its trade deals with primary partners while working through its tax plan with the Senate. As a result, we expect financial markets to remain volatile throughout the summer and possibly until the end of the year. Let's take a closer look at the current U.S. situation:

1. Tariffs:
   1. The Trump administration's realignment brings tariffs closer to a level the economy can tolerate, despite the potential for further developments. Reciprocal tariffs remain suspended until July 7^th and until August 14^th for China. While an indefinite extension remains possible, the unpredictability of Trump's presidency makes that far from certain. The growing judicial involvement in US tariff policy only adds to the confusion. In short, it’s unclear what President Trump intends to do, as well as the actions he can legally take. What we do know is that he has little incentive to trigger a recession, and the best way to avoid one is to continue on the path of de-escalation and pursue trade deals.
   2. We must also acknowledge that the extent of the global economy's damage from these tariffs remains unclear. Part of the uncertainty stems from the lagged nature of their impact, which may not be immediately evident in key economic indicators. This delay helps explain why the most recent US inflation data still shows inflation decreasing. Trump's tariffs have directly impacted business and consumer confidence, typically a negative indicator of the economy's future. In response, many companies have suspended forward-looking profit guidance for at least this quarter. Many organizations, including major retailers that rely on Chinese imports, report dwindling pre-tariff inventories. These retailers are warning consumers to expect shortages of specific items and increased prices for goods in transit.
   3. If Trump succeeds in securing better trade agreements between the United States and its key trading partners, the likelihood of a sustained rally in the second half of 2025 may rise. That outlook also depends on the extent of the economic damage already incurred. Even if a severe slowdown occurs sometime later this year, equities could still benefit, particularly if the downturn prompts the US Federal Reserve to lower interest rates.

2. Budget:
   1. The “big, beautiful bill” passed a vote in the US House of Representatives and now awaits consideration by the Senate, which is expected to pass it by August at the latest to avoid hitting the debt ceiling. The bill sparked a bitter feud, culminating in a high-profile online exchange between the President and the world's wealthiest man, Elon Musk.
   2. Current plans for tax cuts and spending reductions are projected to add $2.3 trillion to the U.S. national debt over the next decade. Theoretically, increased tariff revenue, estimated between $2.1 trillion and $3.0 trillion, could help offset spending; however, the strategy of boosting spending while relying on uncertain tariff revenues does little to reverse the trajectory of budget deficits.
   3. The bill carries significant implications for Canadian investors, and if passed, it could override the Canada–US tax treaty. We’ll wait and see if the bill passes without changes before offering specific guidance.

3. Interest Rates:
   1. Financial markets typically respond to two main levers: fiscal (Budget and Taxes) and monetary (Interest rates set by central banks). Under the current US administration, a third factor has emerged: trade policy.
   2. For now, markets anticipate the US Federal Reserve to remain patient for a few more months, likely delaying its first rate cut until later this year. So far, there’s no sign of urgency. For instance, the Dallas Fed's weekly economic indicator, which combines various data, including retail sales, jobless claims, and rail traffic, continues to show no indications of an economic decline.
   3. The U.S. Federal Reserve is expected to begin discussing rate cuts next fall when the effects of the Trump administration's policies on inflation and growth can be more accurately assessed.

Canada: A golden opportunity

Following Canada's 45^th federal election, Mark Carney became Canada's 24^th Prime Minister. His government has made U.S. trade relations its top priority. Trade Cconcerns ranked high among voter issues, and most Canadians believed Mark Carney was the best choice to manage them. This played a significant role in the election's outcome.

The Liberal Party has proposed a new spending plan totalling $129 billion. Under the party’s platform, the fiscal deficit is expected to widen to $62.3 billion (~2% of GDP) for the current fiscal year (FY), up from $50.3 billion in FY 2024/2025. While rising expenditure and growing fiscal imbalance raise concerns, the proposed policies mark a significant shift from the Trudeau era. The Carney platform emphasizes shifting funds away from government operations to bolster economic growth. If implemented successfully, this reallocation could boost market confidence and improve the near-term economic outlook, potentially helping to reverse Canada's sluggish productivity and weak business investment. Let’s now take a closer look at some current dynamics in Canada’s financial landscape.

1. Interest Rates/Unemployment:

In May, Canada's unemployment rate reached 7 percent -the highest level since 2016, excluding pandemic years. Statistics Canada’s June 7^th report signals deeper strain in the labour market and reinforces the case for interest rate cuts later this year. Conditions have shifted from a tight labour market to one where finding work is increasingly difficult, especially in the manufacturing sector. Ontario's trade-sensitive regions have been hit hardest, and even with slowed population growth, new arrivals have contributed to the rising jobless rate.

Despite growing pressure in the labour market, the Bank of Canada held its benchmark interest rate at 2.75 percent in its June meeting, citing lingering uncertainty related to U.S. tariffs. Governor Tiff Macklem noted that the bank is taking a "less forward-looking" approach than usual, awaiting further clarity before making any policy moves. Economists still expect the Bank of Canada to cut rates by another 75 basis points this year, which would bring the rate down to 2 percent. The Bank of Canada's next interest rate announcement is scheduled for July 30^th, 2025. After that, there will be three more in 2025, in September, October, and December.

2. Bill C-5:

On June 6^th, Prime Minister Mark Carney’s government introduced Bill C-5, also known as the "One Canadian Economy" bill, which primarily aims to expedite large-scale national projects. The bill will create a list of major national projects, based on recommendations from Canada’s premiers. Examples of projects that will be considered include ports, mines, renewable energy, and oil and gas pipelines. After a project is added to the list, the government will publish a document outlining all the conditions the builders must follow. A single designated minister would be responsible for listing the projects and issuing a conditions document. In the past, major Canadian projects have been hindered by bureaucracy, and this bill aims to address that issue.

The bill will not be easy to pass in the House of Commons. It is criticized for interfering with indigenous rights and environmental protection. Opposition also came from the Conservative Leader Pierre Poilievre, who responded critically, saying, "It’s a small step, but it is breadcrumbs when we needed a bold move.”

Only time will tell if this bill proves helpful in Carney’s toolbox and whether it achieves its promised outcomes. As we discussed in our last newsletter, Canada has a significant opportunity to redefine and reshape its role in the global economy through structural reforms that focus on deregulation and empowering the private sector. Carney and his government face a challenging path ahead: Steering the Canadian economy out of what we believe is a recession, reducing reliance on US trade, and expanding Canada’s influence on the global stage.

3. CAD/USD:

Back in January, Canada was on the brink of a recession (and we may still be in one), the loonie had fallen to 68 cents, and political resignations were making headlines. Fast forward to Q1, GDP was up over 2%, the CAD is now above 73 cents, and the TSX has been making new all-time highs for several weeks.

This may seem confusing, but the explanation lies in the details. The Canadian dollar hasn’t necessarily strengthened - instead, the U.S. dollar has weakened. The decline in the USD has been broad and pronounced this year, driven by two key factors; a) Foreign investors have been unwinding their previously overweight positions in US assets, and b) Confidence in the United States—and the U.S. dollar’s status as the dominant global reserve and transactional currency—is eroding because of the ever increasing US debt and recent protectionist policies.