Key Takeaways:
- Shifting Economic Sentiment: U.S. Gross Domestic Product (GDP) growth projections have weakened as retail sales and business confidence decline.
- Policy Uncertainty Rises: Initial optimism around Trump 2.0 is fading amid concerns over tariffs, tax cuts, and deregulation timing.
- Inflationary Pressures Return: Core goods inflation is back, while Supercore inflation accelerates, pushing Consumer Price Index (CPI) further from the Fed’s target.
- Tightening Labour Market: Migrant worker deportations are reducing labour supply, driving up wages and inflation.
- Canadian Dollar at Risk: Interest rate differentials and looming tariffs point to further downside for the Canadian dollar.
U.S. Economic Outlook Weakens
The Atlanta Fed’s GDPNow estimate for the first quarter of 2025 (Q1) has dropped from 3.9% to 2.3% as of February 19, reflecting weaker-than-expected economic data. January retail sales fell 0.9%, significantly missing expectations of a 0.1% decline, with the “Control Group” (sales excluding motor vehicles, gas, and building materials) contracting 0.8% instead of the anticipated 0.3% gain.
Business sentiment has deteriorated as initial optimism over Trump’s second term gives way to uncertainty surrounding tariffs and policy shifts. Manufacturing saw a slight uptick due to ‘onshoring’ initiatives, but the services sector declined sharply, with its Purchasing Managers’ Index falling to 49.7, signaling contraction. Rising input costs and declining ‘prices received’ are squeezing profit margins, increasing economic headwinds.
Policy Uncertainty and Market Impact
The four key Trump policies—tax cuts, tariffs, deregulation, and the Department of Government Efficiency (DOGE)—are advancing at different speeds. DOGE has moved swiftly, with up to 100,000 government employees accepting buyouts, targeting areas such as USAID and the Pentagon. While this may not significantly reduce government spending, the shift in direction is clear.
Pro-growth measures like tax cuts and deregulation are progressing slowly, while businesses are grappling with uncertainty over tariffs, making strategic decision-making difficult. Initial economic optimism is now giving way to concerns over potential “stagflation,” where growth slows while inflation remains elevated.
Inflation Pressures Resurface
January CPI data showed inflation accelerating beyond expectations:
Core goods inflation, which had been a deflationary force in early 2024, is now contributing to rising prices. With inflation drifting further from the Federal Reserve’s 2.0% target, continued price pressures could complicate future monetary policy decisions.
Additionally, the deportation of illegal migrant workers has begun, removing a segment of low-wage labour from the workforce. This development—aside from political and humanitarian considerations—reduces labour supply, increases average wages, and places upward pressure on inflation.
Core Goods Inflation Returns
While services also accelerated in January
Source: Bloomberg. January 2025.
Mind the Jump
Transportation services boosted Supercore measure in January
Source: Bloomberg. January 2025.
Canadian Dollar Faces Further Downside Risks
The temporary delay in tariffs has provided a brief reprieve for the Canadian dollar, but downside risks remain. At 70.3 U.S. cents, the tariff discount/risk has largely been priced out, suggesting further depreciation as implementation dates approach. The Canadian dollar remains highly sensitive to interest rate differentials with the U.S., and current spreads are at their widest in over 20 years:
These significant yield gaps will continue to exert downward pressure on the Canadian dollar.
The commentaries contained herein are provided as a general source of information based on information available as of February 26, 2025 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Market conditions may change and Caldwell Investment Management Ltd. accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
Published on February 26, 2025