Trade and Tariffs Take Centerstage

The S&P 500 Index and the S&P TSX Index both registered healthy gains during the month of November as the North American equity markets celebrated the results of the United States Presidential Elections.  Equity Investors viewed the expectations of continuing tax breaks from 2017 and less onerous regulations as a positive.  The fixed income asset class was also green on both sides of the border; however, we think this was largely driven by investors dialing back expectations of higher inflation due to trade wars. The Cabinet announcements by the President-Elect, Donald Trump, were keenly analyzed by investors. The announcement of ‘Scott Bessent’ being picked as a Treasury Secretary, who has been known to have a moderate and prudent voice about tariffs, brought some relief to fixed income investors after a tough October. Higher tariffs will increase the cost of imports and, therefore, are inflationary.  

The uncertainty around the policy rate trajectory has increased again with a higher potential of trade wars and its inflationary impact. Although the details on tariffs are still missing, initial volleys have been fired. China has prohibited exports of Gallium, Germanium, and Antimony to the United States in response to the USA's latest ban on export of advanced memory chips and chip-making tools to China. These banned materials are used in applications across semiconductors, solar cells, and military. The fixed income markets have reacted adversely to the developments given the impact of tariffs on inflation and the rate trajectory. Equity markets, however, are still to discount this development, in our view.

The United States accounts for nearly two-thirds of Canada’s trade and therefore tariffs will have a substantial impact on the Canadian economy. Whether tariffs are implemented or not remains to be seen, however, it is certain that the rhetoric on trade will increase with the incoming United States administration. We think it will bring idiosyncratic volatility to the North American equity markets.

Notwithstanding some concerns, the macro environment has continued to remain mostly favorable for the markets so far, in our view. The headline inflation has been benign for Canada and the United States (see Figure 1). The unemployment rate in Canada has continued to increase; while the unemployment rate in the United States has remained low by historical standards (see figure 2). Given the increase in unemployment numbers in Canada, industry participants are expecting a 50 basis points cut in policy rates after the upcoming Bank of Canada meeting on the 11th of December. In the United States, the expectations are more muted at 25 basis-points cut on the 18th of December.

Figure 1: Headline inflation remains benign in Canada and the United States

Source: Bloomberg

Figure 2: Unemployment has been rising in Canada

Source: Bloomberg

Looking ahead, we think some market jitters can be expected due to the tariff talks and the potential escalation in geopolitical tensions. However, as long as macro environment remains favourable with robust economic data and accommodative Central Banks policies; the markets should overcome any short-term jitters and extend the current bull run. We wish our readers very Happy Holidays.