Market Brief: Tariff Uncertainty Weighs on Markets and US Consumption 

The dollar remains firmly on the offensive after Donald Trump reiterated his threat to impose near-universal 25 percent tariffs on Canada and Mexico as soon as next week. Ten-year Treasury yields are trading close to the 4.25 percent threshold after having lost almost 35 basis points since the middle of the month, the S&P 500 and Nasdaq stock indices have given back all of this year’s gains, and a sense of caution is gripping currency markets as a range of indicators point to an uncertainty-driven slowdown in the world’s largest economy—and in the countries that it trades with.

The US president triggered a selloff yesterday morning with a post on his social media platform that claimed drugs “are still pouring into our Country from Mexico and Canada at very high and unacceptable levels,” saying tariffs scheduled for March 4 “will, indeed, go into effect as scheduled”. He also said imports from China, which are already facing a 10 percent tariff, would be subject to an additional 10 percent levy on the same date. If implemented in full, this would amount to the biggest shock to American trade since the Smoot-Hawley Tariff Act of 1930, which triggered widespread retaliation and led to an offsetting drop in exports. All three of the targeted countries have promised to retaliate this time as well.

We remain convinced that an increasingly-negative reaction from business owners, voters, and markets will ultimately compel the president to enter into face-saving deals with Canada and Mexico, meaning that even if tariffs are implemented, they won’t last long. But all three North American economies could suffer significant damage in the interim, justifying a more defensive stance from market participants for now.

The Federal Reserve’s preferred inflation measure* accelerated slightly in January, helping justify the Federal Reserve’s move to the sidelines. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index rising 0.3 percent in January from the prior month—matching market forecasts—and on a year-over-year basis, core price growth fell to 2.6 percent, aligning with economist estimates. The overall personal consumption expenditures index also rose 0.3 percent relative to the prior month, and was up 2.5 percent from a year ago.

Consumer spending ratcheted lower. Inflation-adjusted personal consumption slid -0.5 percent in January from December, missing expectations for a -0.1 percent decrease, and marking the biggest drop in two years. The drop was potentially driven by harsh winter weather more than the uncertainty-driven sea change in sentiment levels that has unfolded in the intervening period, but nonetheless suggests that investors should take a cautious view on consumer spending growth.

Separately, the Canadian economy expanded much more quickly than forecast in the fourth quarter of 2024, suggesting that the Bank of Canada would be moving to the sidelines if a tariff threat wasn’t also darkening the outlook. Numbers released by Statistics Canada this morning showed real gross domestic product growing at a 2.6 percent seasonally-adjusted annual rate in the three months ended December, with a significant jump in household consumption pairing with strong export and investment growth to generate a solid pickup from the prior quarter’s 2.2-percent increase. Separate data showed the economy growing 0.3 percent in month-over-month terms in January, up from 0.2 percent in December.

The economy’s underlying momentum has improved, but major challenges lay ahead as extreme uncertainty levels cripple business investment and hamper consumer spending. On a per-capita basis, Canada’s post-pandemic recovery has been the weakest among Group of Seven countries, and we suspect that this isn’t likely to improve dramatically until Trump's trade threats are addressed—if they ever are. The Bank of Canada should maintain a dovish stance for now, and the Canadian dollar will remain on the defensive as traders brace for another round of tariff-related turbulence early next week.

*We’re obligated under the laws of financial punditry to include this phrase.

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