Written by: Alex Da Costa
“Boy, that escalated quickly!”
This unforgettable line from the hilarious “Anchorman” springs to mind as we observe the unfolding tariff war initiated by the new US administration. For those who haven’t seen the film and are in need of some light relief (aren’t we all?), we highly recommend adding it to your watchlist. In our January letter, we highlighted the prospect of higher volatility but what unfolded in the first few days of April was beyond what most, including ourselves expected.
Writing this towards the end of April, a lot has already changed since we sent our clients an update regarding tariffs earlier in the month. The situation feels like it’s changing almost daily, and it will likely be several months before we have a clearer picture of where things will settle.
Amidst all this uncertainty, two things are becoming apparent:
The first is that tariffs in some form are likely not going away anytime soon. President Trump’s tariff concerns date back 40 years. He levied tariffs on China during his first term and campaigned with a heavy tariff message in the lead up to this term. The surprise was not so much that tariffs came but the scope and scale of the tariffs. Canada and Mexico were first in the firing line. This was surprising particularly considering that President Trump initiated and concluded the renegotiation of NAFTA into USMCA only a few short years ago. The aggressive rhetoric towards Canada, one of the US’s closest allies, shocked Americans, Canadians and indeed the world. Then along came April 2, when the world watched in bewilderment as President Trump rolled out a global tariff plan which included huge tariffs on small island nations many people have never heard of. Much has been written questioning the rationale for this unprovoked assault on otherwise peaceful penguins (along with countless entertaining memes). But the serious question is whether there is some method to the seeming madness. This we may never know but the intent is clear: This administration sees trade deficits as harmful to the US and is intent on rebalancing global trade and reversing decades of global trade integration.
The second is that markets are a force unto their own and are the ultimate disciplinarian. Politicians may conceive the most grandiose plans, but if the market jumps up and smacks them in the face, those plans will need to be modified. This is particularly true in a highly financialized economy such as the US which has electoral cycles every two years. Let’s take equities as an example: While many households do not own equities directly, the many that do drive a large portion of consumer spending which in total accounts for 70% of US GDP. This so-called “wealth effect” means that large equity declines have a direct impact on economic activity. Clearly equity markets cannot be ignored, but the bond market is arguably even more important to the government. The US has huge national debts ($36 trillion USD and counting) and $9 trillion of that needs to be refinanced in 2025. Disruption in equity and bond markets also has a direct impact on companies which depend on these markets for capital. In periods of high volatility, corporations reduce activity such as hiring, M&A and investment. We may never know if the market “getting a little yippy” (the US President’s words, not ours) was a factor in the decision to pause some of the tariffs for 90 days, but it seems reasonable to believe that it was.
Taking these two observations together, our expectation is that trade deals will be worked out with a large number of countries. Some tariffs will remain but the extraordinary and curiously calculated “reciprocal tariffs” will likely be abandoned. Whether this can be done in 90 days is questionable, but that is the trajectory we expect. The exception to this may be China where a dangerous game of chicken is being played between the two largest economies. The US is already indicating a willingness to significantly lower tariffs on some goods from China, which is an indication that this situation too may also resolve with time. It is hopefully appreciated by some in the US administration that China holds a strong hand in this game and has a number of aces which could be played with devasting effect (e.g., shutting off the supply of rare earth metals which are essential to the US military, dumping treasury bonds and currency devaluation, to name a few).
Economic Implications:
Our view is that, even if all tariffs were to be withdrawn, damage has already been done to the global economy. Almost every business owner we speak to has seen activity slow and surveys clearly show consumer confidence has taken a hit. This means that growth is likely to slow in the near term and, if policy uncertainty lingers, recession becomes more likely. If the economy does avoid a technical recession, a slowdown in growth may still feel like a recession to many people. Animal spirits may take a while to rekindle.
This slowdown in growth is likely to be accompanied by a tariff-fueled uptick in inflation. If unemployment were also to start rising, this trifecta would start to raise concerns over a damaging period of stagflation and complicate central bank decision making.
Market Implications:
During periods like these, the stock market tends to get most of the attention. But in the last couple of weeks, bond markets have had investors on the edge of their seats. In early April 2025, as equity markets plunged post the initial tariff announcement, expectations of deeper Federal Reserve cuts rose and bond yields fell. This dynamic is fairly typical in a market sell-off, but the surprise was that bond yields then suddenly reversed and started rising sharply even as stock markets fell further. So, what’s happening here? Our guess is a combination of several things including market expectations of higher inflation, concerns over the US deficit and large upcoming refinancings, unwinding of leveraged bond arbitrage trades, and foreign holders of US bonds selling as a protest against the tariffs. A continued sharp rise in bond yields would be concerning and is something we are watching closely. The Federal Reserve has already said that that they will intervene if bond markets become unruly. We take them at their word and acknowledge that while stock markets cannot be easily controlled, the Fed does have tools to ease stress in bond markets (e.g., quantitative easing).
This takes us to the US Dollar. Typically, in periods of financial stress, the USD rises. That has not been the case this time with the USD falling sharply, accelerating a weakening from the multi-year high reached in February this year. As we highlighted in our last letter, we see several paths which could lead to further USD weakening over the medium term and we think it would be wise for foreign investors to be cautious about being too overweight the USD. Markets are always two-way streets and there are paths for the USD to strengthen but the balance of risks seems to be to the downside. Gold prices have been rising sharply in response to USD weakness and could continue to act as a hedge. (Note that foreign investors should own gold in securities which are hedged back to their home currency such as Canadian Dollar hedged gold ETFs.) Another way to mitigate US Dollar weakness would be to invest in ETF’s and fund share classes that are “CAD Hedged”, which removes currency fluctuations from the returns you earn, net of a reasonable hedging cost.
Tumultuous periods like these are always unsettling but this is the nature of markets and we are at least as excited about the tremendous opportunities which will inevitably emerge as we are cautious of the risks. We invite our families to read our latest Asset Class Outlook for our current thoughts.
In our Quarterly client letter, we discuss all of these asset classes in more detail. If you would like to learn more about Prime Quadrant, please contact Bailey Cochrane at businessdevelopment@primequadrant.com.
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