Talking Points
May 02, 2025 | 12:51
The New Abnormal
Economics
Economics
It’s been exactly one month since Reciprocal Tariff Day, sometimes known as Liberation Day. And financial markets have basically made one great round trip over the course of that month, even as the U.S.-China trade war rages on almost unabated. With the S&P 500 working on a nine-day winning streak, many major averages are now back to level with the closes on April 2. Ten-year Treasury yields were also right back to month-ago levels of around 4.2%, before backing up closer to 4.3% after a solid payrolls report on Friday morning—but very little movement on net, given the fireworks of the past month. |
That’s not to say that there have been no market changes as a result of the ongoing trade tussle. Even with some backing down, the reality is that the U.S. is still imposing a base 10% tariff on almost everything coming in from overseas, and carries a combined average tariff of around 25%, still the highest in more than a century. Plainly put, this is not normal. Where we have seen some market response to this abnormality is in currencies, with the dollar index down 3% in the month (and down 7% from its early-year peak). As well, the Treasury curve has steepened notably on balance over that period, with the gap between 30- and 2-year bonds widening by 40 bps to around 100 bps. And perhaps most importantly for the economic outlook, oil prices have tumbled 18% in the past month to now sit below $59/barrel, amid OPEC’s plan to boost output and concerns over global growth. Even with those adjustments, the overriding sense in financial markets is a return to some kind of calm after the high drama in the first two weeks in April. The VIX has receded below 23, above the past-year median of 16.4, but basically back at pre-reciprocal days and less than half the peak hit on April 8. Even the April employment report sent a message of calm: payrolls topped expectations with a middle-of-the-road 177,000 advance, while the prior month was revised down to a similarly non-descript 185,000 gain (from 228,000 initially). The headline unemployment rate held steady at 4.2%, while the broadest measure actually ticked down for the second month in a row (to 7.8%). Meantime, aggregate hours worked managed to nudge up 0.1% m/m, and April’s level stands at a 2% annualized rate above Q1’s average, sending no sense of trauma for the economy. |
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Despite that calming vibe from both equity markets and the latest jobs data, there is little doubt that plenty of economic cracks are emerging. There’s the opening bid that GDP fell 0.3% annualized in Q1, the first quarterly drop in three years. While distorted by a pullback in defence outlays and an import surge (which mysteriously wasn’t fully matched in the data by higher inventories or spending), it still brings the economy halfway to a technical recession. More tellingly, the factory ISM saw steep declines in April production (44.0) and export orders (43.1), both fully consistent with an outright decline in GDP. Consumer confidence fell further into the tank last month, as the Conference Board reported that expectations have dropped to the lowest since 2011 (i.e., worse than during the pandemic). On the ground, we have seen McDonald’s report a heavy decline in same-store sales amid rising consumer strains, and—unsurprisingly—a sudden stall in container traffic between the U.S. and China. Of course, one reason why many of the major macro indicators are still holding up well, and looking normal on the surface, is because of a pre-tariff burst of activity, which is distorting all manner of statistics. U.S. auto sales hit their highest level in almost four years in March at 17.8 million, and only backed off a smidge last month to 17.3 million. Factories in Europe and Japan reported a pick-up in activity in April, as companies rushed to front-run tariffs—many are racing to beat the next deadline day of July 8, when the 90-day reprieve on extra reciprocal tariffs ends. The Fed will be gamely trying to navigate this heavy fog at the FOMC meeting next week, accompanied by earlier foghorn blasts of criticisms aimed its way. We could probably count on one hand the number of people that expect a rate cut next week, but markets are still assigning reasonable chances to a trim at the following meeting in June. We have been looking for rate cuts to resume in July and are comfortable with that moderately delayed timing in light of the still-firm employment backdrop and plenty of questions on the inflation backdrop. After all, as many wise voices have noted, we are all dealing with two thick layers of uncertainty: 1) no one can say for sure where the trade war is ultimately headed, and 2) no one can say for sure how the economy will react to that ultimate destination, as none of us have ever seen such a level of tariffs before. And that makes the quick market comeback all the more curious. Canada may be dealing with as much uncertainty as any economy, especially since almost 20% of its GDP is exported to the U.S., and so many of its major industries face extra tariff carve-outs—autos, metals, lumber. But at least this week’s federal election put to rest the political uncertainty that has loomed since the start of the year. The results were astonishingly close to the final polls, albeit a late rush by the Conservatives just denied the victorious Liberals a majority government. Perhaps the most notable stat was that the combined support of the top two parties was the highest since the 1950s at 85% (43.7%/41.3%), as support for all the smaller parties waned or even crumbled. Prime Minister Carney will now meet President Trump next Tuesday at the White House. He will name a cabinet the week of May 12 and re-open Parliament shortly thereafter on May 26 (with King Charles to give the Throne Speech the next day). There was a morsel of good news for Canada on the U.S. trade front as USMCA auto parts will be free of tariffs, even as the rest of the world will now face the full force. While that’s cold comfort for auto assemblers in Canada and Mexico, at least the two-year parts reprieve will allow for a modicum of normalcy in U.S. production. Still, the new regime somewhat normalizes the broader tariffs on autos and threatens production in Canada—as one analyst put it, the parts reprieve is like a band-aid on a bullet wound. And we are highly skeptical that the, so far, positive tone between the two leaders will translate into a quick reversal of tariffs and counter-tariffs—the gap between Mr. Trump’s goals (a shift in auto production from Canada to the U.S., as well as the bountiful tariff revenue) and Canada’s are a bridge too far. (More broadly, we are also highly skeptical of any impending ‘deals’ with other major economies—the EU and Japan strenuously object to the baseline 10% tariff, let alone any reciprocal add-on.) Aside from the fraught trade outlook, PM Carney’s platform was replete with measures to support the economy, from direct spending, to infrastructure and defence, to a cut in the lowest marginal tax rate, to an activist agenda for housing. This week’s data showed an economy that managed to churn out 1.5% annualized GDP growth in Q1 even amid all the tariff drama, and a similar pre-tariff burst in auto sales. Yet, financial markets largely yawned at the election results, with GoC yields barely budging for the week, the TSX just edging up, and the Canadian dollar seeing a late-week pick-up to 72.5 cents, largely due to a sag in the greenback. While the minority result was a small surprise, Canada has been dealing with such since 2019, and it is likely to prove a stable minority. After four months of seemingly unending uncertainty, markets willingly accepted that stability. |