Weekly market wrap

Tariffs spark volatility: Key implications for investors

Key Takeaways: 

• On April 2, President Donald Trump announced U.S. tariff plans that were more aggressive than expected. A 10% minimum tariff will apply to all imports coming into the U.S. beginning April 5 while higher tariffs will be charged on countries that the U.S. has larger trade deficits with. The new tariffs are estimated to raise the effective tariff rate on U.S. imports from 2.3% in 2024 to between 20% - 25%, the highest in at least 100 years.
• Canada was exempt from the new U.S. tariff announcement, however, previously announced tariffs will remain in effect.
• China announced retaliatory tariffs on the U.S., matching the new U.S. tariff rate of 34%.
• The tariff announcement, and China's retaliation, drove risk-off sentiment in markets, with equities finishing the week sharply lower and government bond yields in Canada and the U.S. declining.
• Tariffs pose a headwind to Canadian and U.S. economic growth and put upward pressure on prices in the near term. However, the Canadian and U.S. economies entered 2025 with strong momentum. Additionally, the Federal Reserve is likely to step in to support softening economic growth if U.S. labour-market conditions show meaningful signs of weakening. In Canada, the Bank of Canada could continue easing policy while the government could provide fiscal support to households and businesses if economic conditions soften.
• While volatility is never comfortable, we recommend investors stick with their long-term investment strategy, with an emphasis on quality and diversification. Avoid making emotionally charged investment decisions, and remember that time in the market has proven to be a better strategy over time than trying to time yourself in and out of the market.

What was announced?

On April 2, U.S. President Donald Trump announced highly anticipated tariff plans under the International Emergency Economic Powers Act. The U.S. will impose a 10% tariff on all countries, which will take effect on April 5, along with higher tariff rates on nations the U.S. has larger trade deficits with, which will take effect on April 9. China will be charged a tariff rate of 34%, which will stack on the 20% tariffs imposed earlier this year. Other major trading partners of the U.S., such as the European Union, Vietnam and Japan, will be subject to tariff rates of 20% or more.

Canada was exempt from the new U.S. tariff announcement. However, Canada will be subject to a 25% tariff on all non-USMCA compliant goods along with a 25% tariff on steel, aluminum and autos. Prime Minister Mark Carney announced that Canada would retaliate by placing a 25% tariff on vehicles imported into Canada from the U.S.

Additionally, China announced retaliation to the U.S. tariff announcement by imposing a 34% tariff on U.S. goods, matching the tariff rate the U.S. announced on April 2.

Markets responded in risk-off fashion, reversing gains from earlier in the week and finishing lower, while bond yields declined. To assess what's next for markets, we examine the potential implications of tariffs on the economy and inflation and discuss actions for investors in the current environment.

Economic growth is poised to slow from above-trend rates

While Canada was exempt from the new U.S. tariff announcement, the previously announced levies still pose a headwind to economic growth. Trade as a percent of GDP in Canada is roughly 67% with the U.S. responsible for roughly 76% of Canadian goods exports.⁵ If the U.S. economy slows due to the recent tariff announcements, Canadian growth will likely slow as well.

Additionally, energy and autos are Canada's largest exports to the U.S., while commodities, which include steel and aluminum, are among the top 10. Each of these will be subject to tariffs from the U.S., which will likely weigh on activity in these sectors. Last week's labour force survey showed Canadian employment contracted modestly in March while the unemployment rate ticked higher to 6.7%, perhaps signaling businesses have already adjusted hiring plans based on the policy uncertainty.³

However, the Canadian economy entered 2025 with strong momentum. Real GDP expanded at a healthy 2.6% rate in the fourth-quarter driven by robust household spending.³ Additionally, the Canadian Government has room to provide fiscal support to businesses impacted by the tariffs, which could provide support to the economy over time.

In the U.S., the magnitude of the announced tariffs will likely serve as a headwind to economic growth. Tariffs can pressure corporate profit margins through higher input costs and weigh on household spending through lower inflation-adjusted incomes. Consumer-spending data has already shown signs of slowing in the first months of 2025, as the uncertain policy backdrop has weighed on sentiment. Additionally, retaliatory measures, such as those taken by China and Canada, can weigh on activity in U.S. businesses that are reliant on exports to drive sales.

From 2000 - 2024, the average U.S. tariff rate for all imports was a modest 1.7%.¹ Based on the announced tariffs, the average U.S. tariff rate is expected to jump to between 20% – 25%.² In 2024, the U.S. economy imported roughly $3.3 trillion of goods.³ Assuming an average tariff rate of 20%, this would equate to tariff revenue of roughly $660 billion, or roughly 2.3% of 2024 GDP.³

How the incremental revenue from tariffs is used will be critical in determining the economic impact on the U.S. If a large portion of this revenue is deployed to areas that promote growth, such as financing lower taxes, economic growth could hold up better. However, if a majority of the additional tariff revenue is used to reduce the U.S. fiscal deficit, U.S. economic growth could slow more meaningfully.

While tariffs will serve as a headwind to economic growth, the U.S. economy is entering this period from a position of strength.

• U.S. real GDP has expanded at an above-trend pace over the past two years, and S&P 500 earnings per share grew by 18% in the fourth quarter, the strongest growth rate since the fourth quarter of 2021.³
• Household balance sheets remain healthy, with the average household debt-service ratio (the percent of household disposable income spent to service debt payments) below pre-pandemic levels.³
• Labour-market conditions remain healthy, even as some softening is expected ahead. Initial jobless claims have averaged roughly 221,000 thus far in 2025, well below the 30-year average of over 360,000.³ Nonfarm payrolls grew by a healthy 228,000 in March, well above consensus expectations for 130,000, while the unemployment rate rose modestly to 4.2%.³

While recession risks have clearly risen, in our view an economic downturn is not a foregone conclusion. A strong starting point could provide support to the Canadian and U.S. economies. Additionally, with U.S. monetary policy in restrictive territory, the Fed has ample room to cut rates if the economy shows meaningful signs of slowing. While the BoC has cut rates more aggressively, additional rate cuts could be on the table if economic conditions slow, while fiscal stimulus could provide support as well.

Inflation could rise, but the Fed will likely focus on downside risks to growth

The proposed tariffs could put upward pressure on inflation in the U.S. and Canada in the near-term, as importers are likely to pass on part of the cost from higher tariffs to consumers. However, we believe the downside risks to economic growth outweigh the upside risks to inflation in both economies.

During the 2018 – 2019 U.S. tariff announcements, prices of goods in the U.S. rose modestly from low levels before subsiding shortly after.³ Based on the magnitude of the tariffs announced last week, the impact on inflation will likely be more significant this time around.

However, there are potentially mitigating factors.

• Foreign manufacturers and importers or retailers could choose to absorb part of the cost instead of passing higher prices on to the consumer. However, for certain products where profit margins are slim, such as perishable food, any additional costs are more likely to be fully passed on to the consumer.
• Importers may find substitutes for products when available, and over time supply chains may be altered or brought on-shore, although the latter will require investment and more time.

Ultimately, we believe tariffs represent a one-time increase in prices as opposed to an ongoing source of inflation. The 10-year U.S. breakeven inflation rate, which is a market-based measure of expected inflation over the next 10 years, has fallen from 2.4% to below 2.2% since the end of March, near the low end of its three-year range.³ In our view, this signals that longer-term inflation expectations remain anchored and that downside risks to the economy likely outweigh the upside risks to inflation. This should give central banks flexibility to lower rates if economic growth shows signs of slowing.

Implications for investors

While the April 2 announcement provides some clarity into the U.S. administration's trade framework, it remains uncertain as to how the impacted countries will respond. Some may take a similar approach to China and Canada, retaliating with levies on U.S. exports, while others may seek negotiations to lower tariff rates over time. We expect this process to play out in the weeks and months ahead, likely keeping market volatility elevated in the near term.

With uncertainty likely to remain in the coming weeks, we recommend investors resist the urge to make emotionally charged decisions, and instead stick with their long-term investment strategy. It's important to remember that on average, the S&P 500 experiences three to four pullbacks of 5% per calendar year and one pullback of 10% per year. Additionally, pullbacks of 15% occur on average once every two years, while pullbacks of 20% or more occur about once every three years.⁴

Over the long run, we believe time in the market is a better investment strategy compared with timing the market. In fact, missing just a handful of the best days of the S&P 500 over the past 30 years would have led to meaningfully lower returns. What's more, many of the best days in the market have come during periods of market volatility, highlighting the importance of maintaining a long-term focus through turbulent markets.

Portfolio opportunities

After two years that were dominated by outsized returns in U.S. large-cap stocks, diversification has showed its merit in 2025. Despite volatility in U.S. equity markets, overseas stocks and investment-grade bonds have outperformed, helping offset the impact of U.S. stock underperformance for investors with well-diversified portfolios. We believe diversification will remain a key theme over the remainder of 2025. Incorporating allocations to a variety of different asset classes can help smooth periods of volatility and help investors benefit from periods of rotating leadership.

We recommend investors maintain balance between growth- and value-style investments. We remain overweight U.S. small- and mid-cap stocks, which generate a higher portion of their revenue from the U.S. and are potentially less exposed to tariffs. Additionally, we recommend investors maintain strategic allocations to Canadian investment-grade bonds and international bonds, which have served as a safe-haven during market volatility.

While volatility is never comfortable, it is a normal part of investing. We believe investors are best served during this time by sticking with an investment strategy aligned to their financial goals as opposed to reacting to the short-term headlines.

Brock Weimer, CFA
Investment Strategy

^{Sources: 1. U.S. International Trade Commission 2. Bloomberg 3. FactSet 4. FactSet, Edward Jones calculations. 5. World Bank, FactSet}
 

Weekly market stats

Source: FactSet, 4/4/2025. Bonds represented by the Bloomberg Canada Aggregate Bond Index. Past performance does not guarantee future results. * Source: Morningstar Direct, 4/6/2025.

The Week Ahead

Important economic releases this week include U.S. CPI inflation and a read on U.S. consumer sentiment.