ECONOMIC & FIXED INCOME COMMENT- “Is the global economy heading for a Trump Recession?”

Last week’s “Liberation Day” marked the White House’s introduction of reciprocal tariffs that surpassed even the most aggressive forecasts. A fundamental 10% tariff on all countries is set to be implemented on April 5^th, followed by steeper increases based on bilateral trade deficits scheduled for April 9^th. Although markets had anticipated tariff announcements, the severity was greater than expected. Key countries critical to global supply chains, including Vietnam (46%), China (34%), Korea (25%), India (26%), Japan (24%), and the EU (20%), will now encounter significant tariff hikes (see chart). Importantly, Canada and Mexico were exempted from the newly imposed reciprocal tariffs; however, existing tariffs are still effective. Specifically for Canada, there are 25% tariffs on goods and automobiles that do not meet USMCA standards, along with a 10% tariff on Canadian energy and critical minerals.

The significant change in trade policy is expected to have detrimental effects on market sentiment and global economic activity. The Organization for Economic Co-operation and Development (OECD) released its latest economic outlook, downgrading global growth for 2025 and 2026. The adjustment is largely in response to the increasing trade tensions among major economies. In addition, to the reciprocal tariffs announced on April 2^nd, there is considerable uncertainty surrounding retaliatory tariffs and how long they will remain in effect.

The Canadian economy entered 2025 in a solid position, characterized by robust growth, stable unemployment and inflation running close to the central bank’s 2% target. However, slowing population growth and the impact of tariffs on business and consumer sentiment are expected to dampen economic activity. As a result, Canadian GDP has been reduced for 2025 to 0.9% from 1.8%.  In response, the Canadian government has introduced fiscal initiatives to mitigate the impact of tariffs. These include: 1. expanding eligibility for employment insurance and 2. offering reimbursements to help Canadian businesses affected by import tariffs—particularly those unable to source certain goods from non-U.S. markets

On March 12^th, the Bank of Canada (BoC) lowered the overnight bank rate by 25 basis points to 2.75%- just inside the BoC’s long term policy guidelines of 1-3%.  Moving forward, the BoC will prioritize risk minimization when determining interest rates. They are shifting away from attempts to chart an optimal monetary policy path based on unpredictable economic forecasts. Consequently, the BoC will adopt a cautious stance in its monetary policy, aiming to reconcile the challenges of slowing economic activity with inflationary pressures exacerbated by tariffs. The BoC will remain committed to controlling inflation, despite the economic disruptions caused by the trade war. While initial price increases may occur due to tariffs, monetary policy must work to contain these direct effects from propagating further. For 2025, if tariffs are only temporary, we expect the BoC to lower its policy rate to 2.5% throughout the year. However, if 25% tariffs remain in place, we anticipate more significant rate cuts, potentially reducing rates to 1.75% to stimulate economic growth and support employment.

The current U.S administration's emphasis on implementing tariffs to tackle trade deficits and promote investment in American manufacturing is negatively impacting consumer sentiment and spending. Consequently, U.S. GDP has been revised down to 1.7% for 2025.

On March 20^th, the Federal Reserve (Fed) maintained the Fed Funds Rate at 4.5%. In its latest economic forecast, the Federal Open Market Committee (FOMC) revealed through the “dot plot” two rate cuts in 2025. However, the growth outlook has been revised down from 2.1% to 1.7%. Furthermore, the FOMC raised its inflation expectations, projecting that the Fed's preferred measure, the Personal Consumption Expenditure (PCE), will rise to 2.7% in 2025, up from a previous forecast of 2.5%. These adjustments imply that the Fed expects tariffs to dampen economic growth and lead to a one-time price adjustment, causing a temporary rise in inflation. In a recent speech, Jerome Powell acknowledged that escalating global trade tensions have introduced real risks to both the inflation and growth outlook. However, he reiterated that the current data does not yet warrant a shift in policy, and the Fed sees no immediate need to adjust rates. Overall, we believe that the Fed continues easing monetary policy, although the pace has moderated, with the Fed Funds rate likely to settle within the 3.5%–4.0% range this year.

For fixed income investors, understanding the potential impact of protectionist trade policies is crucial, particularly in relation to central bank responses. The "stagflation" effects of a tariff shock—initially driving inflation upward and subsequently leading to stagnant economic growth—pose a significant challenge for monetary policy. Typically, the response to a one-time price shock has been to "look through" the temporary inflation effects and concentrate on the impact on growth. So far, central banks have approached the possible tariff shock with caution. The recent rise in inflation may prompt central banks to re-evaluate their strategies as they consider the duration of the tariff shock and its evolving effects on inflation expectations.

The bond market is currently facing a challenging environment influenced by economic growth obstacles and trade tensions. During the quarter, bond yields declined, generating positive rates of return. In the near-term, amid heightened uncertainty, bonds offer a compelling source of stability. Specifically, short- and intermediate-term bonds provide attractive yields and the potential for capital appreciation should economic growth fall short of expectations.