Macro & Strategy - March 2025

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The Fog of (Trade) War

Section I: Trade wars – a historical perspective

The persistent shadow of trade wars

Few policy decisions have the far-reaching consequences of trade policy. Although often framed as a tool to protect domestic industries and workers, trade restrictions tend to trigger retaliation, disrupt supply chains, and reshape global economic alliances.

The Trump administration’s decision in 2018 to impose tariffs on steel and aluminum imports marked a turning point in modern U.S. trade policy. For decades, the global economy had been moving toward greater integration, but these tariffs—and the retaliatory measures they gave rise to— exposed the fragility of the system. Even though the overall tariff increase in Trump’s first term was modest—from 1.4% of total imports to 3% by 2021, the U.S.-China trade war that ensued had significant economic repercussions, raising costs for businesses, reducing corporate investment, and distorting global trade flows.

But trade conflicts are not unique to the 21st century. History offers valuable lessons on the economic costs and unintended consequences of protectionism. From the Tariff of 1828, which deepened the sectional divide in the United States, to the Smoot-Hawley Tariff Act of 1930, which worsened the Great Depression, trade wars have frequently exacerbated economic downturns rather than solving the issues they were meant to address.

As trade tensions resurface in 2025, with a plethora of new tariff threats in the Trump administration’s second term, it is crucial to understand these historical parallels—not only to anticipate the economic and market implications but also to recognize patterns of policy mistakes that could be avoided.

Global trade: a historical perspective

The post-1970s global economy: the era of trade liberalization

The modern era of globalization began in the 1970s, driven by technological advancements, reduced trade barriers, and pro-market economic reforms. Over the next five decades, this shift transformed the global economy, allowing countries to specialize in areas of comparative advantage, enhancing productivity, and fostering economic interdependence.

Several milestones defined this period:

• The creation of the World Trade Organization (WTO) in 1995 institutionalized global trade rules, making disputes more manageable.
• China’s accession to the WTO in 2001 was a pivotal moment, leading to an explosion in global trade flows.
• Average U.S. tariffs fell dramatically, declining from more than 30% in the early 20th century to low single digits by the 2000s.

These developments helped fuel economic growth worldwide, lifting hundreds of millions out of poverty and dramatically expanding global supply chains. But they also created vulnerabilities, particularly for regions and industries exposed to outsourcing, offshoring, and competitive wage pressures. The trade conflicts of the 2010s—and potentially the 2020s—can be seen as political responses to these disruptions.

The benefits of trade: a counterpoint to protectionism

Throughout history, trade has been one of the most powerful drivers of economic prosperity. It has:

• owered costs for consumers by allowing efficient global production;
• fostered competition and innovation, forcing firms to improve productivity; and
• enabled rapid industrialization in countries such as South Korea, Singapore, and China, turning them into global economic powerhouses.

Countries that embraced trade saw significant improvements in their economic output and living standards, whereas those that erected barriers often stagnated. Thus, history overwhelmingly favours open trade over protectionism, even as political cycles sometimes push nations in the opposite direction.

Trade agreements: building blocks of economic integration

Trade wars may dominate headlines, but trade agreements are the foundation of economic cooperation.

The North American trade landscape evolved over decades, with three major agreements shaping the region’s economic trajectory:

1. The Canada-U.S. Free Trade Agreement (1988) – A landmark deal that set the stage for deeper North American economic integration.

2. NAFTA (1994) – Expanded free trade to include Mexico, eliminating most tariffs and boosting supply-chain interconnectivity.

3. USMCA (2020) – Modernized NAFTA, introducing new rules on labour, digital trade, and auto manufacturing.

Each step deepened economic ties but also created political friction over perceived job losses, trade deficits, and regulatory differences. As the risk of a new trade war emerges, these agreements become even more critical. They provide legal frameworks that protect against extreme policy swings, ensuring a baseline of stability for businesses making longterm investment decisions. They also provide leverage for countries to negotiate trade disputes through structured mechanisms rather than retaliatory tariffs.

Should trade tensions escalate again, the obvious question will be whether these agreements are strong enough to withstand the pressure. Some damage may have already occurred: The Trump administration’s apparent disregard for the legal framework of the USMCA is likely to have a cooling effect on investment decisions throughout North America.

Lessons from the past: when protectionism backfires

Despite the political appeal of tariffs, history has repeatedly shown that protectionism often does more harm than good.

Three key episodes highlight this pattern:

1. The Tariff of 1828: a lesson in unintended consequences. Also known as the Tariff of Abominations, this law imposed extraordinarily high duties to protect U.S. manufacturers. It benefited the industrial North but deeply hurt the agricultural South, which relied on trade with Britain. The backlash led to the Nullification Crisis of 1832, foreshadowing the tensions that would later erupt into the Civil War. Takeaway: Tariffs can exacerbate internal divisions, making them as much a political risk as an economic one.

2. The Smoot-Hawley Tariff Act (1930): making a crisis worse. Designed to protect U.S. farmers and manufacturers during the Great Depression, it raised tariffs on more than 20,000 goods. Other countries retaliated, leading to a 65% decline in global trade and worsening the Depression. The Act is widely seen as one of the most damaging trade policies in U.S. history. Takeaway: In times of economic stress, protectionism often deepens recessions rather than alleviating them.

3. The 2018 trade war: a case study in market disruption. The Trump administration, imposed tariffs on $250 billion worth of Chinese goods, citing intellectual property theft and unfair trade practices. China retaliated, targeting U.S. agriculture and manufacturing. The result? Higher costs for U.S. businesses, market volatility, and disruptions in global supply chains. Takeaway: Even when tariffs aim to correct real imbalances, they often introduce more uncertainty than solutions.

The U.S. economy: This is not 2018

Trade tensions are resurfacing in an economic landscape distinctly different from that of 2018. Back then, inflation was at target, and the U.S. economy had been running under its potential for years after the global financial crisis (GFC).

Donald Trump’s key policy was substantial tax cuts, which stimulated the U.S. economy, boosting the ISM manufacturing index to almost 60. Even with the tax cuts, the U.S federal government deficit was a manageable 3.5%, and the household sector had a significant buffer, with a savings rate of more than 5.7%.

In 2025, the U.S. economy is running hot, with core inflation exceeding 3%, and the 2% inflation target was last reached in 2021. The manufacturing sector does not have the same momentum, as evidenced by manufacturing PMIs close to 50, and there are no substantial tax cuts coming, with the deficit now pushing toward 8%. Household savings, at 3.8%, are also low by historical standards.

With the U.S. economy constrained by high inflation and a high government deficit, there is little room for error. If we add the Fed’s higher-for-longer policy, resulting in tighter financial conditions, the buffer against trade shocks is diminishing.

The economic considerations listed above might not be sufficient to convince President Trump that his trade policies are ill-advised and poorly timed, but they should be enough to convince investors that the Trump administration is playing a risky game, and that a fair amount of uncertainty should be injected into any investment view until more clarity is provided.

For now, the repeated strategy of tariff threats followed by implementation delays has been met with cautious optimism from market participants, but it creates the risk of complacency in the face of danger.

Conclusion: the fog of trade war

History is clear: Protectionism carries significant economic risks. Even though tariffs may be framed as defensive measures, they often spiral into retaliatory actions, disrupting trade, increasing costs, and ultimately slowing growth.

As policymakers reconsider trade strategies, the lessons of the past should serve as a warning: In the pursuit of economic strength, trade wars often weaken the very economies they aim to protect.

Section 2: Amidst uncertainty, Canada’s incipient economic recovery

For much of the past year, discussions surrounding the Canadian economy have been dominated by negativity—fears of a prolonged slowdown, persistent inflationary pressures, and, more recently, the spectre of trade-war risks. Given Canada’s deep economic integration with the U.S., the potential for tariffs on key exports has cast a shadow over business investment decisions, corporate earnings, and market sentiment.

Beneath the surface of this pessimistic discourse, key economic indicators are starting to turn positive. Although Canada has faced significant headwinds—a stagnating economy, high interest rates, and a cooling housing market—recent data suggest that the worst may be in the rearview mirror.

The Bank of Canada’s decision to cut rates by 200 basis points since spring 2024 is beginning to filter through the economy, providing a much-needed tailwind to growth. From housing to employment to manufacturing, signs of stabilization are emerging, indicating that Canada’s economic outlook may not be as bleak as feared. That said, beyond trade tensions, major structural challenges remain, which cannot be resolved by the current cyclical recovery.

Lower interest rates are revitalizing the economy

Monetary policy works with a lag, meaning that the effects of interest rate hikes—and more recently, rate cuts—take time to affect economic activity fully. Now, with rates having fallen significantly since early 2024, we are starting to see the first meaningful signs of recovery in key sectors of the economy.

One of the most immediate and visible effects of lower interest rates can be seen in the housing market, a key driver of economic activity. After experiencing a deep correction after the Bank of Canada’s aggressive tightening cycle, the market is showing early signs of stabilization:

• Housing starts are stabilizing below their peak and are showing tentative signs of a rebound, signalling that developers are regaining confidence in demand.
• The real value of residential building permits is rising, indicating a pipeline of future construction projects that could support economic growth in the coming quarters.
• Even though home prices remain below their 2021 peaks, the recent stabilization suggests that demand is gradually returning, helped by improving affordability conditions.

Business investment: a cautious recovery

Lower interest rates typically encourage business investment, as borrowing costs decline, and firms regain confidence in future demand. Such an improvement can be seen in in the latest Bank of Canada Business Outlook Survey, indicating an appetite for higher investment. That being said, the uncertainty surrounding trade policy—particularly the risk of U.S. tariffs—remains a major headwind.

For example, capital expenditures may remain subdued in industries exposed to potential trade disruptions (such as autos, aluminum, and agriculture). In contrast, service-oriented sectors and domestic-focused industries are more insulated from trade risks and may see earlier signs of investment growth.

The overall takeaway? Business investment should improve in 2025, but tariff uncertainty could delay a full recovery.

A resilient labour market is driving consumption

The Canadian labour market has stayed remarkably resilient in the face of a slowing economy. Although job growth weakened in 2023 and early in 2024, recent data suggest that we may be seeing a turning point:

• Unemployment has begun to decline, even as more Canadians re-enter the workforce.
• Job creation is shifting to the private sector, with construction and manufacturing showing particular strength—two sectors that benefit from lower interest rates.
• GDP per capita, which had been in decline, may be bottoming, with employment growth now outpacing population growth.

This improvement in the labour market is critical for consumer spending, the largest driver of Canadian GDP. With retail sales recovering—rising every month since July 2024 and surging by 2.5% in December—we are seeing early signs of a consumption rebound. Moreover, the finances of Canadians are improving, and a high personal savings rate provides a buffer against shock and room to improve consumption.

Lower interest rates are also supporting manufacturing

One of the more promising signals emerging from recent data is the rebound in Canadian manufacturing activity. The manufacturing PMI rose between July 2024 and January 2025, suggesting that the sector may be at the beginning of a new growth cycle. Stronger U.S. demand is lifting Canadian exports, given the deep integration of the two economies. Also, a potential turn in the industrial cycle could benefit Canadian manufacturers, particularly those tied to machinery, auto parts, and energy-related production. The Canadian economy has even created 100,000 manufacturing jobs over the past 30 months, whereas the opposite holds in the United States.

Even so, a key risk remains: the possibility that manufacturers are front-loading production to get ahead of U.S. tariffs. If trade tensions escalate, some of this momentum could fade later in the year.

The Bank of Canada is in no rush to cut further

With rates at 3%—the upper end of the BoC’s estimated neutral range—policymakers have room to assess incoming data before making their next move.

The market currently expects two more cuts in 2025, with one in April and another in the fall. We think this baseline scenario makes sense, but stronger growth could lead to fewer rate cuts than expected. Tariff implementation, however, could shift the balance in favour of deeper cuts.

Implications for financial markets

When we look at the Canadian dollar, we see the potential for an inflection point.

The loonie has remained under pressure in recent quarters, reflecting three main factors: a wide interest rate differential between Canada and the U.S., soft commodity prices, particularly in energy and base metals, and, of course, uncertainty over potential tariffs, which could negatively affect tradesensitive sectors.

That being said, a Canadian economic recovery could shift this narrative. More precisely, if growth exceeds expectations, we could see a narrowing of the interest rate differential, providing support for the loonie. Alternatively, a resolution to the trade uncertainty would most likely trigger a meaningful rally, as markets repriced risk premiums.

Although a full reversal is unlikely in the near term, we do expect a positive, albeit bumpy, path ahead for the loonie in 2025.

TSX outlook: selective strength

The TSX is often more influenced by global trends than domestic factors, given its high exposure to commodities, financials, and energy. But a strongerthan-expected economic recovery could have a positive impact on specific sectors:

• Financials and consumer discretionary stocks should benefit from improving domestic conditions.
• Industrials and manufacturing-linked names could benefit from a pickup in North American investment spending.
• The wildcard remains commodities, where a recovery in demand could provide broad-based support for the index.

Conclusion: Canada’s recovery amidst uncertainty

Although trade risks persist, Canada’s economic fundamentals are improving. With lower rates feeding through to housing, labour markets strengthening, and consumption rebounding, the narrative is shifting from recession fears to cautious optimism. This momentum could accelerate with the implementation of public policies to tackle some of the structural problems that have plagued the Canadian economy for several years, notably interprovincial trade barriers and low levels of private-sector investment.

Investors should keep an eye on the following key variables:

1. Trade developments: Tariffs remain the single biggest downside risk.

2. Interest rate expectations: The market’s pricingin of BoC cuts may adjust.

3. Global commodity trends: A pickup in demand could fuel a broader TSX rally.

4. Implementation of growth-friendly public policies at both federal and provincial levels.

The fog of trade war may still linger, but the outlook for Canada could finally be starting to clear.

Current positioning

Our equity positioning remains largely unchanged, with a continued overweight in North American equities, particularly in Canada and the United States. We find the earnings cycles in these markets favourable, and we expect solid returns for the remainder of the year.

We are also considering a broader global equity allocation, with potential opportunities in Europe and emerging markets, especially China, as they show signs of recovery.

Even though we have not yet made significant tactical moves in this direction, we are actively seeking opportunities to rotate into markets benefiting from improving growth dynamics and potential stimulus.

Our view on government bonds is mixed. High yields currently offer a reliable source of return and can hedge equity risks. Even so, persistent inflation and resilient growth present challenges for this asset class in the short term. Consequently, we prefer an overweight position in equities, because we think the balance of risks favours equities over bonds in a broad asset allocation context.

As for currencies, we are overweight the Japanese yen, which we see as a unique opportunity. After years of depreciation, the yen is the most undervalued currency in developed markets. Low interest rates have dampened its attractiveness, but emerging inflationary pressures in Japan may prompt the Bank of Japan to normalize interest rates faster than expected. Higher rates would enhance the yen's carry dynamics and attract inflows into the Japanese bond market, closing the undervaluation gap. Additionally, Japan's status as a country with a large current account surplus and as a net international creditor means the yen tends to appreciate in risk-off environments, providing desirable diversification properties. As a result, we are overweight the yen and expect it to appreciate relative to other developed-market currencies.