Macro & Strategy - May 2025

Read the full article (PDF)open_in_new

The Tariffman Cometh

Section 1: The aftermath of “Liberation Day”

April 2, 2025, may well go down as one of the most iconic turning points in the postwar global economic order. What began as a highly choreographed press conference quickly turned into something more consequential: the formal declaration of a new U.S. trade doctrine. With one hand holding a Sharpie and the other clutching a poster board covered in tariff rates by country (including, bewilderingly, Antarctica), President Trump set the tone for what may be remembered as the day U.S. economic policy pivoted decisively away from openness and toward protectionism.

Beyond the spectacle and the inevitable memes that followed (questions abounded about what the penguins could possibly have done to deserve such treatment), the underlying signal was clear and, in our view, deeply consequential. For the first time in modern history, the world’s largest economy is actively withdrawing from the global trading system it helped build and has led for more than seven decades. This shift, which had been hinted at in rhetoric, is finally becoming embedded in policy. And it threatens to reshape not only trade patterns, but also capital flows, business confidence, consumer psychology, and the macroeconomic playbook that has underpinned global asset allocation for a generation.

Markets responded swiftly and rationally. With the abruptness of the announcement and the aggressive tone of its delivery, investors began questioning whether the United States could continue to play its traditional role as anchor of the global economy. What we have long called “U.S. exceptionalism” —the post-GFC phenomenon of U.S. outperformance— suddenly appeared more fragile, even reversible.

But what is U.S. exceptionalism, really?

It is a set of reinforcing dynamics that has allowed the U.S. economy to lead the developed world in innovation, productivity, and profitability over the past 15 years. Since the global financial crisis, the United States has grown faster than most other advanced economies, fuelled by resilient consumer demand, a robust and flexible labour market, deep capital markets, and an unmatched technology ecosystem. These strengths have been reflected in equity market performance: The S&P 500 has outpaced virtually every global benchmark, and U.S. equities now account for more than 70% of the MSCI World Index, up from about 42% in the immediate aftermath of the crisis.

Capital flowed in accordingly. The U.S. dollar remained the world’s dominant reserve currency. U.S. Treasuries were the safe asset of choice. Foreign direct investment surged, and global investors increased their allocations to U.S. equities at the expense of more cyclical or unstable markets. In times of turmoil, the instinct was simple: Flee to the safety of the U.S. system, where rule of law, policy transparency, and open markets offered security and opportunity in equal measure.

But now that narrative is under threat. Trump’s new tariffs —which, if fully implemented, would raise the average U.S. tariff rate from about 2% to nearly 25%— represent the most aggressive and comprehensive trade policy reversal in modern U.S. history. And although the administration’s rhetoric has framed the reversal as a necessary act of “economic liberation,” the implications for growth, inflation, monetary policy, and global capital flows are troubling.

Let us walk through them.

First, growth is likely to take a meaningful hit. Tariffs are taxes, and they will fall disproportionately on U.S. consumers and businesses. The cost of U.S. imports will rise sharply, putting pressure on household budgets already stretched by recent price increases. Business input costs will climb as well, especially in U.S. industries reliant on complex international supply chains.

We estimate that the direct effects of a full implementation of the proposed tariff schedule will subtract roughly 100 basis points from real GDP over the next 12 months. Even a partial implementation would most likely reduce growth by at least 75 basis points. These are not marginal effects. They represent the difference between continued expansion and a recession; hence, we now expect a downturn to begin later this year, ranging from moderate to severe depending on policy followthrough.

Second, uncertainty is exerting its own drag. Even before any tariffs come into force, the ambiguity surrounding their scope and duration is causing businesses to pull back on capital expenditures, hiring plans, and long-term strategic decisions. Surveys of business confidence and investment intentions have fallen sharply in recent weeks. In private conversations, executives are telling investors that they simply cannot model their future cost structures under this new regime. That uncertainty alone is enough to delay investments and, if replicated across a critical mass of firms, to amplify the slowdown.

Third, the Federal Reserve may be less helpful than markets expect. Even though rate cuts are being priced in —about 100 basis points of easing over the next year— we see risks in the opposite direction. Tariff-driven price increases could push core inflation back above 4% by the end of the year, especially in goods categories with few domestic substitutes. That would complicate the Fed’s mandate and reduce its ability to stimulate the economy in the face of a supply shock. Moreover, absent any coordinated fiscal response, monetary easing may not be sufficient to offset the contraction in demand.

Fourth, the U.S. financial account —the mirror of its current account deficit— could face renewed scrutiny. For decades, the United States has relied on inflows of foreign capital to finance its persistent trade deficit. These flows have been justified by its reputation as a reliable, rule-bound, innovation-driven economy. But if the U.S. is now perceived as unpredictable or antagonistic in its global relationships, foreign investors may begin to question their overexposure. Because these continued flows helped push U.S. asset valuations higher, helping create a “U.S. exceptionalism” premium, their reversal could place sustained downward pressure on the dollar and raise the cost of capital for the U.S. government and corporations alike.

Lastly, the wealth effect could turn negative. Household equity holdings are at historic highs, equivalent to 2.5 years of disposable income for the median household and roughly 70% higher than the peak reached during the dot-com bubble. This wealth has fuelled consumption, particularly among higher-income cohorts. But a sharp decline in equity markets, already under way, could prompt precautionary saving, reduce discretionary spending, and trigger a self-reinforcing cycle of lower income and lower demand.

Solid macro analysis involves estimating the secondand third-round effects of any event. Beyond the initial, direct hit, the consequences are wide-ranging. For example, a decline in household and business confidence, which reduces consumption, hiring, and capital expenditure, could eventually push the economy over the brink and into a recession.

Globally, the response has been measured but resolute. No major trading partners have followed the U.S. down the protectionist path. Instead, they have responded with targeted retaliations, while redoubling efforts to diversify their trade relationships and build new partnerships.

Europe, for instance, has chosen to negotiate price floors with China on electric vehicles rather than impose its own tariffs, sending a clear signal of strategic openness. China, for its part, has retaliated with precision (blocking Boeing deliveries, raising tariffs on U.S. goods, and restricting exports of critical minerals), while insisting on “mutual respect” as the basis for any future dialogue.

In this context, a key macro consequence emerges: The inflationary impulse may remain largely U.S.- centric, while the rest of the world retains the ability to ease monetary policy. This divergence adds another layer of complexity to global asset allocation and puts into question the long-term assumption of U.S. market supremacy.

Section 2: Oh, Canada!

Canada and Mexico emerged from April 2 relatively unscathed. Even though the term “lucky break” might overstate the outcome, the absence of direct retaliatory tariffs from the United States is no small relief. In a global context where trade tensions are rapidly escalating and uncertainty has become the norm, being spared from punitive measures offers more than just short-term stability; it provides space to reflect, recalibrate, and prepare.

For Canada, this breathing room is particularly valuable. In practical terms, it means fewer inflationary pressures imported through the price of goods, especially in critical sectors, such as food, autos, and machinery. Thus, the Bank of Canada can maintain its policy focus: It can ensure that inflation expectations remain anchored, without being forced to overreact to a trade-induced inflation shock originating from abroad.

Indeed, during its most recent press conference, the Bank of Canada made it clear that even though U.S. policy developments are being monitored, they do not automatically translate into Canadian action. The priority remains domestic: shielding households from persistent inflation without choking off growth. With core inflation continuing to gradually recede and labour-market conditions softening at the margins, the Bank is now in a more comfortable position to proceed with rate cuts, if needed, particularly as the global cycle starts to tilt toward disinflation. But the moment also calls for introspection. For too long, Canada’s economic fortunes have been deeply, and perhaps excessively, intertwined with access to the U.S. market.

This reliance is beneficial in many respects but has also encouraged a degree of complacency. By acting as a gravitational pull for Canadian exports and capital, the U.S. market has dulled the urgency to address structural weaknesses at home.

Over the past decade, Canada’s real GDP per capita has largely stagnated and not because of demographics alone. The underlying driver has been a marked decline in investment per worker, especially in comparison with the United States and other peer economies. Since 2015, business investment per employed Canadian has fallen by double digits, even as the U.S. and some European countries, such as Germany, have maintained or even expanded theirs, despite their own macroeconomic headwinds.

This persistent investment gap has led to an equally persistent productivity gap. Canadian labour productivity (broadly defined as output per hour worked) has grown by just 0.2% annually over the past decade. In contrast, U.S. productivity growth over the same period has averaged 1.8% a year. Even though these differences may seem small in isolation, their compounding effect over time is significant. In practical terms, they translate into slower income growth, diminished national competitiveness, and reduced fiscal capacity to respond to future economic shocks.

The roots of this underperformance are multifaceted. High industry concentration, particularly in the finance, telecom, and transportation sectors, limits competition and reduces incentives to innovate. Regulatory complexity, especially for large-scale projects in infrastructure, energy, and manufacturing, acts as a further deterrent to capital formation. Taxes are relatively high and do not always incentivize higher investments.

In light of these factors, the Canadian government’s current policy posture may need to evolve. There is growing recognition among economists, business leaders, and policymakers that the time has come to move beyond temporary fixes and toward structural reform. Earlier this month, we published a white paper outlining a framework for such a reform agenda, with three key pillars:

1. Fiscal policy reform: Canada must urgently reevaluate the investment climate it offers to domestic and foreign businesses. Even though macro stability and sound public finances are key strengths, our tax structure remains relatively uncompetitive. Rethinking capital cost allowances, corporate tax rates, and targeted incentives could help unlock private capital and reverse the investment malaise.

2. Streamlined regulation: Across the country, largescale economic projects, whether they relate to energy, housing, or technology, face approval timelines that are excessively long and increasingly unpredictable. Environmental assessments and impact reviews remain important tools, but they must be reformed to increase transparency, reduce redundancy, and speed up execution. Countries that manage to cut red tape without compromising standards will hold an advantage in attracting capital.

3. Reimagining trade strategy: Although U.S. access will always remain a cornerstone of our external trade, Canada must continue to deepen economic ties elsewhere. This means not only accelerating free-trade agreements with Europe, the Indo-Pacific, and Latin America, but also liberalizing internal trade, an area where Canada underperforms significantly. According to IMF estimates, removing interprovincial trade barriers could add 3 to 4% to GDP over the long term.

Taken together, these reforms would help reposition the Canadian economy for a more competitive and resilient future. More important, they would allow Canada to shape its destiny proactively in a world where economic alliances are being redefined and old certainties no longer hold. The lesson from April 2 is not simply that Canada dodged a bullet; it’s that, in a more fragmented world, resilience must be earned — not assumed.

Section 3 – The markets speak

If policy shifts define the macro landscape, it is the markets that provide the most immediate feedback. After the April 2 announcement, the reaction from global financial markets was swift and sobering — a potent reminder that investor psychology is deeply sensitive to shifts in uncertainty, credibility, and perceived regime change.

In many ways, the bond market has become the principal arena where these tensions are playing out. Although equity markets were already jittery before “Liberation Day,” it was the dramatic repricing of sovereign debt that truly signalled a shift in narrative. Within days of the announcement, yields on 10-year U.S. Treasury notes surged by nearly 50 basis points, reaching 4.5% before pulling back somewhat. The 30-year Treasury yield briefly surpassed 4.9%, raising alarm bells across global fixed income desks. These are not ordinary moves; they suggest a market grappling with a rare and uncomfortable blend of inflation fears, policy uncertainty, and reputational risk.

What makes this episode so unusual is the breakdown of historical correlations. Traditionally, rising fears of recession or financial-market volatility prompt investors to seek refuge in U.S. Treasury bonds, which are considered the ultimate safe haven. Instead, we saw the opposite: Treasury prices fell as yields rose, even in the face of heightened geopolitical risk and souring equity sentiment. This divergence is not just a curiosity; it is a potential signal that confidence in the United States’ fiscal and institutional stability is eroding.

Behind the bond market tremor lies a more systemic concern, namely that the U.S. is entering a phase of strategic overreach, where fiscal, trade, and monetary policies become increasingly politicized and unpredictable — circumstances that are typically associated with emerging markets and not stable safe havens.

Markets have begun to whisper about the return of the “bond vigilantes” — a term last popularized in the 1990s to describe investors who punish governments they perceive as fiscally irresponsible by demanding higher yields. In fact, some have gone so far as to draw comparisons with the 2022 “minibudget crisis” in the United Kingdom under Liz Truss, when a surprise fiscal package lacking credibility caused an investor revolt that ultimately brought down her government. Although the scale and context are different, the analogy is telling: When confidence fades, the consequences can escalate quickly.

The reputational consequences extend beyond bonds. In currency markets, the U.S. dollar has failed to play its usual role as a countercyclical anchor. Despite rising global uncertainty and signs of economic fragility, the greenback has weakened against most major currencies. This decoupling from its traditional safe-haven status reinforces the impression that the U.S. is no longer seen as a predictable steward of global economic stability.

The rhetoric emerging from Washington is adding fuel to the fire. Hints that tariff revenues could be used to fund politically expedient tax cuts have raised red flags about long-term fiscal sustainability. This is particularly alarming in a year when interest payments on the national debt are expected to exceed $1 trillion, a number that could rise dramatically if borrowing costs remain elevated. If so, debt service would exceed the defense budget. The combination of an increasingly erratic trade policy and ballooning fiscal deficits, with no clear plan to reconcile the two, has led some foreign investors to rethink their allocations. Although no exodus has occurred, anecdotal evidence points to a growing appetite for diversification away from U.S. Treasurys and into sovereign bonds from other G10 economies or emerging markets with improving fundamentals.

The shift in sentiment is subtle but potentially profound. After decades of being the cornerstone of global portfolios, U.S. assets are being questioned not just on their return potential, but also on their political and institutional risk profile. Investors accustomed to assigning a near-zero risk premium to U.S. credit and currency risk are faced with a paradigm shift. The implications for portfolio construction are significant — from currency-hedging strategies and sovereign bond allocation to equity risk premiums and long-term expected returns.

What is ultimately being re-evaluated is not the economic performance of the U.S. in isolation, but the broader idea of economic trust — trust in the rules, in the institutions, and in the commitment to multilateralism. For decades, U.S. policy has rested on a foundation of credibility, built gradually through predictable policy, transparency, and institutional independence. That foundation is showing cracks, and markets are reacting accordingly.

The key question is not simply whether the U.S. enters a recession, or whether tariffs shave 1% or 4% off U.S. GDP. These matters are important, but they are cyclical considerations.

The deeper issue is structural: Are we witnessing a regime shift in how the world perceives and prices U.S. assets? If so, the consequences will be felt far beyond 2025 in the pricing of risk, in global capital flows, and in the architecture of the international financial system.

Conclusion – A new investment reality

The implications of April 2 go far beyond trade flows or inflation forecasts. What we are observing is the early stage of a potential reordering of global economic leadership. For more than a decade, U.S. exceptionalism was anchored in its openness, its dynamism, and the perceived reliability of its institutions. That perception, once taken for granted, is being questioned — and markets are recalibrating.

For Canada, this moment is both a warning and an opportunity. Even though we avoided the worst of the immediate trade fallout, the vulnerabilities exposed in our own economic structure are too significant to ignore. The time to act on productivity, investment, and diversification is now, not when the next shock arrives.

For investors, the message is equally clear. The assumptions that underpinned asset allocation over the past cycle may no longer hold. U.S. assets, long viewed as the safest and most rewarding, must now be evaluated through a different lens, one that accounts for rising geopolitical risk, deteriorating fiscal coherence, and a fragile consensus.

In this new reality, prudence lies in diversification, not only across asset classes, but across geographies, regimes, and risk factors. The next decade may be shaped not by the same old playbook, but by the discipline to recognize when the old playbook no longer applies.

Current positioning

Last month, we highlighted our evolving equity positioning, with a growing preference for international equities, particularly in Europe and China, over U.S. equities. This shift was driven initially by diverging growth prospects, with Europe and China showing improvements while the U.S. and North America decelerated. Recent U.S. policy actions have reinforced our view, leading investors to demand a higher risk premium for U.S. assets.

We have come to a turning point: After years of U.S. equity outperformance, we foresee a new era where investors are less inclined to pay a substantial valuation premium for U.S. stocks. As global capital flows shift, the valuation gap between the United States and regions such as EAFE, EM, and Canada is set to narrow. Even though we remain tactical and nimble in our positioning, we expect this theme to unfold over an extended period.

In currency markets, we are increasingly convinced that the greenback has entered a bear market. In previous reports, we noted our long position in the Japanese yen relative to the U.S. dollar, given its sharp undervaluation and role as a hedge against risk events. Over the past month, we have increased this position and initiated a short position in the U.S. dollar versus the euro.

In response to the “Liberation Day” tariffs, we think European investors may start to hedge against the greenback, pushing it lower. Repatriation and sales of U.S. assets could further strengthen the euro.

Regarding fixed income, we think the Fed may struggle to mitigate the impact of tariffs on growth, especially if they simultaneously drive inflation higher. But this view is tempered by the attractive real yields currently available on government bonds, which offer decent value for investors.

Even though bonds may not be the most tactical position in the current environment, we continue to see them as essential for return generation, risk management, and portfolio construction, particularly at current yield levels.