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Recap of impacts on markets (so far)
The market response to the US tariff announcement on April 2, has been sharp and broadly characterized as a textbook “risk-off” environment. The news came after the markets had closed and initial investor sentiment was surprisingly constructive. The first headlines indicated a uniform 10% tariff, which markets interpreted as less severe than expected. As a result, US equity futures rose and Treasury yields edged higher in a brief risk-on relief rally.
However, this optimism quickly faded as details of the larger-than-anticipated “retaliatory” measures emerged. Investor sentiment turned sharply negative.
The escalation by the US has triggered a reassessment across asset classes, with investors rapidly pricing in the increased likelihood of a full-scale trade war between the world’s largest economies. The resulting shift reflects growing concerns about slower global economic growth and heightened market volatility, prompting a broad move away from risk and into defensive assets.
On April 3 and 4, global markets experienced a broad-based and sharp repricing across asset classes, reflecting a decisive shift to risk-off sentiment. From Wednesday’s close through Friday, we witnessed the following market reactions:
Equities
- S&P 500 Index dropped 10.5%.
- S&P/TSX Index fell 8.4%.
- EuroStoxx 50 Index declined by 8.0%.
- Japan’s Nikkei Index lost 5.5%.
Fixed income
- US Treasury yields declined: two-years by 24 bps; 10-years by 17 bps.
- Canada government bond yields fell: two-years by 7 bps; 10-years fell by 4 bps.
- Investment-grade credit spreads widened by approximately 13 bps.
- High-yield spreads jumped by 68 bps.
In currency markets, the Canadian dollar firmed slightly, gaining 0.40% against the US dollar, while the US dollar index (DXY) weakened by about 0.90%. The Japanese yen, a traditional safe-haven asset, appreciated notably by 3.1% versus the US dollar.
Commodities were not spared. Brent crude fell by roughly 12% on fears of global demand destruction tied to recession risks. Intriguingly, spot gold declined by 4%, diverging from its usual safe-haven behaviour, suggesting deeper market concerns may be developing beneath the surface.
Economic and political fallout
If — a big if — these tariffs stay in place for the rest of the year, the world economy would be hit by the largest trade shock in more than a century. The average tariff rate on US imports would rise from 2.3% last year to 22%. Starting April 9, US imports from China will be tariffed at around 70%. If China keeps importing Venezuelan oil, it will get slapped by an additional tariff — a fourth round, for those keeping count — bringing the average tariff rate to almost 100%. Direct trade between US and China could be whittled to almost zero. By our estimates, trade between the European Union (EU) and the US could drop by around 50%.
Any economic forecast hinges on whether these tariffs are permanent, or a temporary part of a negotiating tactic. If US tariffs and matching retaliatory tariffs on US exports stay in place for the rest of 2025, a global recession is very likely. US real GDP could drop by 1-2% over the next year; less severe than in 2008 or 2020, but a recession, nonetheless. US consumer prices would increase by around 1.5%. With core inflation recently sticking around 3%, tariffs could bring US inflation well above 4%.
Even if most tariffs are unwound over coming weeks, the impact on economic uncertainty will be long-lasting. The US would avoid an inflation shock, but economic growth would probably remain muted for the next few quarters, with businesses paralyzed by uncertainty.
Impacts of tariffs on Canada
Last Thursday, Canada suddenly went from being a primary target of US trade attacks to one of the least-tariffed countries on the planet. But still, its economic prospects are much dimmer than they were a week ago. If current tariffs hold, most estimates have Canadian GDP dipping by close to 2% over the coming year.
Possible mitigating policy actions ahead
It is highly unlikely that recently announced US tariffs will exist in isolation. Retaliatory actions have already begun, with both China and Canada announcing countermeasures. It is also reasonable to expect that other major economies, including the EU, will follow suit. Many countries and regions are likely to implement domestic policy measures aimed at offsetting the economic drag caused by trade restrictions. These could include targeted fiscal stimulus, tax relief measures and potential monetary easing to support domestic demand and cushion growth.
Canada’s current election cycle adds a layer of uncertainty to near-term fiscal policy decisions. While a fiscal support package is likely at some point, it is expected to be relatively modest — unlikely to reach the scale of multiple percentage points of nominal GDP. This reflects Canada’s limited exposure to recent US tariffs: most goods under the USMCA remain exempt, Canada was excluded from the universal 10% tariff imposed by the US, and no reciprocal tariffs have been introduced, at least for now. Should the US administration revise its stance and broaden tariff coverage to include more Canadian exports, the likelihood of a more substantial Canadian fiscal response would increase.
In the US, the proposed extension of the Tax Cuts and Jobs Act (TCJA), potentially with additional fiscal incentives, is gaining momentum in Congress. This could deliver meaningful stimulus to the US economy in the near term.
In Europe, Germany has already committed over €1 trillion in fiscal support, making further stimulus less likely. However, countries like France, Spain and Italy are now openly discussing new fiscal initiatives. France’s political constraints and Italy’s unspent EU allocations may limit execution.
Meanwhile, China has launched aggressive fiscal measures targeting industrial and asset-heavy sectors since September. With the US imposing outsized tariffs, China may pivot toward consumer-focused stimulus in the coming months.
The central bank reaction function becomes more nuanced in a stagflationary setting — characterized by rising inflation alongside slowing growth — because it does not offer a straightforward policy path. While tariffs are generally expected to drive prices higher, the key question is whether these are one-time price level adjustments or the beginning of a more persistent inflation trend that could influence expectations beyond the next year.
Both the Bank of Canada and the US Federal Reserve currently view the inflationary effects of tariffs as transitory, or “one-off,” and therefore unlikely to alter medium-term inflation expectations. However, a significant segment of the market disagrees, anticipating more lasting inflationary consequences. This divergence supports the view that both central banks would lean toward easing policy to cushion against a material economic slowdown, rather than tightening to combat near-term inflation.
It is worth recalling that although COVID-era price shocks were initially viewed as transitory, they proved to be more persistent than expected. Broadly, we anticipate G10 central banks — including China — to err on the side of further accommodation. In contrast, many emerging market central banks, given their historical experience managing inflation and currency pressures, may maintain a more neutral or moderately restrictive stance.
Concluding thoughts
There is no question that the recent tariff announcements represent an economic shock, upending the global trading order that has been in place for several decades. The precise impact to the factors that drive expected returns including inflation, economic growth and earnings growth is highly uncertain. It is in this context that we continue to believe in the importance of diversification by asset class and geography, a long-term outlook and disciplined decision-making over emotional reaction to headlines.
As we have described above, there are several off-ramps available from the current state of play and we await the catalysts to understand more fully the future direction of asset classes in a more uncertain environment.
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