Market Brief: Regularly-Scheduled Programming Resumes

A sense of normalcy is returning to financial markets this morning after Donald Trump backed off threats against Canada and Mexico, granting the countries a 30-day reprieve from his proposed 25-percent tariffs. The dollar is retreating amid sluggish price action in currency markets, ten-year yields are down as inflation expectations recede, and equity markets are setting up for a soft open. Measures of implied volatility are coming off their highs, but remain elevated relative to recent history.

The stay of execution was achieved after leaders in each country agreed to bolster border security in telephone calls with Trump. Bafflingly, the specific measures announced are essentially unchanged from previous commitments: excepting a pledge to install a “fentanyl czar”, Canadian Prime Minister Justin Trudeau seems to have simply reiterated a plan originally announced in December, and Mexican President Claudia Sheinbaum’s offer to send 10,000 troops to the border mirrors an agreement forged under her predecessor, who agreed in 2019—after similar tariff-driven brinkmanship—to deploy 15,000 soldiers.

With the sword of Damocles still hanging over both the loonie and peso, they will remain under pressure relative to the US dollar for now. This could boost competitiveness for export sectors in each economy and widen US deficits, but persistently-elevated uncertainty levels will also have a deleterious effect on business investment and consumer sentiment, compounding underlying economic weakness—particularly here in Canada, where the events of the last week appear to have come as a major shock to citizens. Further monetary easing seems likely in both countries, with the Banxico delivering its next cut on Thursday, and the Bank of Canada following suit in March or April.

Taxes on imports from China did go into effect this morning, lifting the average duty payable on products from the Asian manufacturing giant to roughly 15 percent. In response, Beijing announced additional tariffs of between 10 and 15 percent on US farm equipment, cars, and energy products including crude oil, liquefied natural gas, and coal. As in Trump’s first term, this might raise inflation in a limited set of categories and contribute to a gradual shift in supply chains to other countries*, but won’t deliver the sort of economic shock that had been feared among market participants just a few days ago—and could also be reversed when the president speaks with Chinese leader Xi Jinping in the coming days.

There are no first-tier data releases in the docket for Canada today, but the US will publish its latest Job Openings and Labor Market Turnover Survey, providing insight into the evolution of supply and demand conditions in the jobs market. The number of vacant positions available in December is expected to slip slightly to around the 8-million mark after November’s surprising jump to 8.1 million, but the quits rate—an indicator of worker confidence—could rise modestly (if other measures of consumer spending and sentiment provide any indication). US labour markets are cooling, but not quickly enough to move Federal Reserve expectations at the margins.

We also note that President Trump yesterday signed an executive order to create a US sovereign wealth fund, saying “I think in a short period of time, we’d have one of the biggest funds. And you know, some of them are pretty large. I think it’s about time that this country had a sovereign wealth fund”. This is odd, given that such vehicles are typically used to reinvest revenues earned by large manufacturing powers with interventionist central banks—like China—or oil exporters such as Saudi Arabia. The US runs substantial budget and trade deficits, meaning that it is forced to borrow from global markets to sustain current expenditures, and has no surplus to invest. But if the administration does move ahead—perhaps by reallocating borrowed funds from other agencies—the fund could be used to exercise industrial policy on a bigger level, investing in businesses that policymakers want to succeed, and acting as a counterbalancing currency intervention mechanism by buying foreign exchange. This would continue a long trend in which governments have expanded their involvement in economies, and mark a step further away from the free-market ideals that dominated the world two decades ago.

*As we've argued previously, it is clear that supply chains are lengthening, with the origin of many products remaining in China and final processing happening in intermediary countries. This makes it likely that the Trump administration will attempt to extend protectionist policies further upstream in the months ahead.

**Apologies for the slightly-delayed send this morning, I managed to break the hotel wifi.

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