Market Sentiment Improves

The month of April proved to be a roller coaster for investors around the globe. The markets were jolted as Trump administration unveiled his Reciprocal Tariff plans. If implemented as indicated, the plans implied that supply chains would choke, inflation would rise due to supply shortages; and economic growth would suffer as high uncertainty would force corporates to postpone capital expenditure decisions and households to curtail discretionary spending. Mr. Market immediately gave a thumbs down to the Trump administration’s announcements and the probability increased that a high volatility in capital markets could even lead to a systemic event. We believe the reaction from Mr. Market led the Trump Administration to re-think their plan. After going back-and-forth on the tariffs policy several times during the month, it now appears that there is an overall gradual de-escalation of the rhetoric on trade war.

The soft economic data points such as consumer confidence, investor sentiment, inflationary expectations, and CEO confidence all showed a decline. The hard data such as unemployment, inflation, and retail sales have held up well. The divergence suggests that the impact of the tariffs policy is yet to be seen on the real economy. The good news is that the Trump administration is dialing back its hawkish stance and back peddling on many of the announced tariffs. The bad news is that a baseline 10% tariff on most goods is still in place, which is still high by historical measures. In addition, the adverse impact of policy uncertainty on the real economy is yet to become apparent, i.e. the hard economic data could also show softness in the coming months, in our view.

In the short-term, we think risk assets are likely to welcome the developments as the outlook relatively improves from worse to less bad. In the medium-term, we think risk assets will have to discount the reality of the economic impact as it becomes apparent in the coming months. It is likely that inflation shows an uptick, and that unemployment also rises while economic growth slows. The ‘stagflationary’ environment will complicate the task of the U.S. Federal Reserve as its dual mandate (low inflation and low unemployment) could be at odds with each other. In such a scenario, lowering interest rates to support the softening economy (and thus help decrease unemployment) could further add to inflationary pressures. After its latest (Federal Open Market Committee) FOMC meeting, the US Federal Reserve decided to hold policy rates steady at +4.50%. The Fed chair, Jerome Powell, mentioned that it is likely that the Fed might face rising inflation and rising unemployment rates due to the tariffs and that the Fed would prefer to see how it plays out before deciding on policy rates. The Bank of Canada also decided to hold rates steady at +2.75% given the tariff uncertainty.

Looking ahead, we think the labor market data will be closely watched for any signs of deterioration in the real economy. If inflation rises due to the supply shock, the policy rates will be less effective in combating the same, in our view. If unemployment rises as economic growth slows, we think the Federal Reserve will not have a very strong argument to hold interest rates steady - even in face of higher inflation. Policy support should keep the overall investor sentiment constructive even if the economy witnesses some hiccups in the interim. Barring any further escalations on the trade war, we think the risk-on market sentiment is likely to prevail until hard economic data shows any signs of softness.

Sources: Bank of Canada, US Federal Reserve, and Bloomberg

Vipul Arora is a Portfolio Manager with Assante Capital Management Ltd. The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd. Please contact him at 613-258-1997 or visit ofarrellwealth.com to discuss your particular circumstances prior to acting on the information above. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. Insurance products and services are provided through Assante Estate and Insurance Services Inc.