The market may look stable on the surface, but beneath it lies a swirling storm of conflicting forces. "One might think that not much has happened," notes Martin Lefebvre, Chief Investment Officer at National Bank Investments, "but investors are facing major conflicting forces." Indeed, the economic landscape of early 2025 is anything but calm, as persistent inflation concerns, an unpredictable Trump administration, and looming trade wars create a potent cocktail of uncertainty.
The Soft Landing Mirage
If you listen to the optimists, the U.S. economy is well on its way to a soft landing. Of the six key criteria established by Lefebvre’s team to confirm this much-desired outcome, four have been met: slowing wage growth, a resilient labor market, a rebound in manufacturing, and inflation dipping below 3%. "In theory, all that remains is for the Federal Reserve to take its foot off the brake," Lefebvre says, suggesting that one or two more rate cuts this year should be enough to neutralize policy.
But let’s not pop the champagne just yet. While the Fed signals a cautious stance, the bigger question remains: how much economic damage can the administration inflict before markets lose patience? Trump’s self-professed love affair with tariffs—what he calls "the most beautiful word in the dictionary"—is poised to disrupt the current fragile equilibrium. Trade wars are back, and this time, Canada and Mexico are in the crosshairs.
Tariffs: The Inflationary Poison Pill
"The U.S. President's ability to sow confusion on the trade relations front has broken records since his inauguration," Lefebvre observes. He’s not wrong. After initially floating 25% tariffs on Canada and Mexico, the administration backed down—temporarily. But the damage was already done: the Canadian dollar sank, the Bank of Canada slashed rates, and uncertainty spread through supply chains like wildfire.
While the political posturing continues, the economic impact is clear: tariffs are inflationary. "A blanket 10% tariff would translate into a roughly 1% rise in CPI," Lefebvre points out. That’s not exactly ideal when inflation remains the market’s Achilles’ heel. Worse yet, history suggests that tariffs tend to stick around longer than politicians promise. The last trade war lasted two years. Expect no different this time around.
Equities Looking for Direction, Bonds Holding Firm
The good news? The market has yet to panic. Despite the political noise, equities ended January with gains, with Canadian markets outperforming their global peers. The S&P/TSX rose 3.5%, driven by strong showings in technology (+10.0%) and materials (+10.2%). The S&P 500 added 2.8%, though U.S. tech took a hit after China’s DeepSeek AI emerged as a formidable challenger.
Bonds, meanwhile, provided a safe haven. "The Canadian fixed-income universe got the year off to a good start with gains of 1.1% in January," Lefebvre notes, as lower yields helped prop up prices. But fixed income investors shouldn’t get too comfortable—if tariffs escalate, inflation could come roaring back, forcing central banks to rethink their easing trajectory.
Energy: The Wildcard
Trump has also set his sights on slashing energy prices, promising to "cut energy prices in half within 12 months." That’s a bold claim, given that most U.S. energy firms are in no rush to boost production. "The case for a substantial increase in oil production does not seem compelling," Lefebvre states, citing the latest Dallas Fed survey. To significantly ramp up output, WTI would need to rise above $84 per barrel—a level that would exacerbate inflation rather than reduce it.
Meanwhile, Canada remains the U.S.’s largest oil supplier, accounting for nearly 60% of imports. "Coming to terms with Canada may be unavoidable," Lefebvre hints, as American refineries remain heavily dependent on Canadian crude. So much for a hostile trade policy.
What’s Next?
With no shortage of uncertainty, Lefebvre’s team is maintaining a balanced approach. "For now, we are keeping our asset allocation unchanged, having passed the stress test of recent days relatively well." The preference remains for North American equities over other markets, with a slight tilt toward value over growth and small caps over large. The U.S. dollar remains a favored asset in an increasingly unstable global environment.
But adjustments may be on the horizon. "Persistent uncertainty increases the risk of negative surprises for global growth in 2025," Lefebvre warns, adding that the firm may tweak its strategy as conditions evolve. Investors should take note: in a world where trade wars, tariffs, and political brinkmanship dominate the headlines, a flexible approach will be essential.
As history has shown, markets can survive—and even thrive—amid uncertainty. But as we enter another volatile chapter of Trump-era policymaking, the question remains: how much disruption can the economy endure before the cracks start to show?
Copyright © AdvisorAnalyst, National Bank Investments
