Full circle

The week began on a quiet note as the US was closed on Monday for Martin Luther King Jr. Day and market participants watched President Trump be sworn in as the US President. Ahead of the inauguration there was optimism from US trading partners as reports signaled the new administration was going to be more measured with tariffs, which sent bond markets rallying. That sentiment quickly faded as the US President then announced 25% tariffs could be in place for Canada and Mexico by February 1, 2025.? The threat counters one of his first executive orders that requires a full economic assessment of the impact of tariffs by April 1, 2025. However, reconciling comments and actions in the current environment may prove to be difficult. The consequences of tariffs on the Canadian economy will be detrimental.

The Bank of Canada (BoC) attempted to measure the economic impact of a sweeping 25% tariff on the economy in 2019 and concluded the result would be a 6% detraction to real gross domestic product (GDP). A 6% decline in Canadian real GDP would require significant intervention from the central bank with overnight rates revisiting the lows seen during and prior to the pandemic. In addition to actions taken by the BoC, provinces and the federal government would be required to inject fiscal stimulus pushing borrowing programs larger and likely reinforcing a substantially steeper interest rate curve. Of course, at this stage there is no clear probability of these tariffs coming to fruition. Markets will continue to swing from headline to headline much like the previous Trump administration, we’ve come full circle.

Economic data

In other notable news, the Canadian market digested Consumer Price Index (CPI) figures for the month of December. CPI came in below market expectations with the headline number at 1.8%. However, a larger contributor to the lower-than-expected figure was a result of the HST pause. The core measures weren’t impacted by the HST relief and rose by 0.3% Month-over-Month (M/M) and 2.4% on the year. The discouraging impact from the 0.3% monthly increase is that the 3-month annualized core measure moved higher to 3.5%—a signal the BoC would like to see. Retail sales disappointed for the month of November, coming in flat while ex. auto sales retracted -0.7% versus the expectation of a 0.1% increase. Canadians likely pushed some of their spending into December in anticipation of the HST break, which was evident by the forecasted uptick in sales to 1.6% in December. The BoC will likely see these two data points as reinforcement for a more gradual approach to lowering interest rates and continue cutting interest rates by 25 basis points (bps) at its next meeting.

Bond market reaction: Subdued this week

Bond markets were relatively more subdued with the short US trading week. Yields were modestly higher on the week with the 10-year Government of Canada bond moving higher by approximately 5 bps. Yield curves were also unchanged on the week with the 2-year and 10-years Canada yield slope remaining close to 35 bps. Central bank expectations were little changed with the BoC expected to cut interest rates two more times and finish at 2.75% against the US Federal Reserve (Fed) expectations closer to 4%.

Stock market reaction: Volatile this week

As news continued to flow from the new administration in the US, the stock market reacted in sympathy— marking a volatile trading week. Despite the volatility, equity markets continued to drive higher with the S&P500 breaking through the 6,100 level—an all-time high. Earlier in the week, artificial intelligence (AI) thematic equities got a boost as Softbank, Oracle, and OpenAI formed the “Stargate” Joint Venture where the parties committed US$500 billion in capital over the next four years to boost AI development in the US.

While political news remained prevalent, we also saw strong corporate results this week. Notably, Netflix delivered blockbuster (pun intended) results topping 300 million subscribers and raising its 2025 guidance, thanks to its IP and live sports. On the flip side, Electronic Arts delivered disappointing results and guidance, leading to the biggest intraday drop since 2008. Next week should continue to be eventful for equity markets as we’ll see more technology, media and telecommunications companies report on both sides of the border.

What to Watch Next Week

Next week’s big event will be the BoC and Fed meetings on January 29, 2025. The market is currently assigning an 85% probability of a 25 bps interest rate cut by the BoC while the Fed is expected to remain on hold.

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Authors: Adam Ditkofsky, Pablo Martinez, Sandor Polgar, Steven Lampert, Craig Jerusalim, Diana Li, Mona Nazir and Mickey Ganguly

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