Following the election of a new U.S. president, it has been the norm that the first state of the union speech takes place after the first year in office. Well for President Trump that simply wasn’t good enough, and hence we had his speech to a joint sitting of the House of Representatives and the Senate this week. If you had been locked in a cave for the past month with no access to factual data, you might have believed Trump’s messaging that the U.S. was in great shape and getting better.  For the rest of us, it was more of the same disconnect from reality, extending to how markets are voting on his economic policies to date.

As Ally messaged me after the speech, he certainly is a wealth of fodder for our blogs and newsletters. Case in point, his reference to the “big beautiful drop” in bond yields on Tuesday. As drops go, I wouldn’t say it was massive and definitely not beautiful. The chart above shows the 10-year U.S. treasury note yield and like I discussed on this week’s conference call, yields on both sides of the border have seen a significant decline since mid-January. This has not come about as a result of further easing by the Federal Reserve, as Powell and crew have been on hold now since December. Nor has this rally been prompted by friendlier inflation figures. In fact, core measures remain above levels needed for the Fed to resume rate cuts.

No, Trump has gotten his beautiful bond rally by good old fashioned gloomy economic prospects. 10-year yield fell to below 4.1% on Tuesday as a result of a sharp drop in equities, thanks to the imposition of 25% tariffs on Canada and Mexico at midnight. After weeks of anticipation, market participants finally woke up to the reality that a trade war was finally here in North America, as well as between the U.S. and China. The retaliation by Canada was swift and stern, with countervailing tariffs being placed immediately and a second wave of tariffs planned for 21 days out.  In addition, Ottawa and most provinces agreed on non-tariff measures, including Ontario’s plan to levy an export tax on electricity transmitted to the U.S. and a potential turning off of the hydro taps.

At its worst point on Tuesday the S&P500 had tested down below 5780, reversing all of the gains since the election in November. Yes, the balloon filled with all that pro-growth euphoria after Trump’s victory (the so-called Trump put), has escaped. More importantly for investors that don’t have all their eggs in the equity basket is that the negative correlation between stocks and bonds is firmly at play. While the pace of retracement in stocks has jolted individuals, the positive offset from a rally in the North American bond market has muted the overall impact on the portfolio.

Growth expectations are indeed being adjusted lower faster than inflation worries are being adjusted higher – not quite the elixir that Trump had promised everyone. At the time of writing, it still wasn’t clear whether the U.S. tariffs were going to remain in place. Not only had the White House eliminated the tariffs on autos after finding religion on exactly how important the industry is to U.S. economic health, as well as Canada’s, but later Thursday afternoon, Trump once again kicked the tariff can down the road by suspending the 25% tariff on most goods from Canada and Mexico covered under the USMCA until April 2^nd. In return, Canada said it would delay its second tranche of tariffs until that same date. And so, the needless trade drama continues.

We have already seen large Canadian and U.S. companies struggle with not only providing guidance on where they see revenues and earnings over the coming quarters because of this senseless policy volatility, but they are also revisiting capital expenditure and hiring plans. This morning we got the February non-farm payrolls report, which showed a monthly gain of only 151,000 and a downward revision to January. More importantly, the unemployment rate ticked up to 4.1%, which will further contain consumer confidence, or the lack thereof.  An even more striking indicator this week was the latest Challenger, Gray and Christmas layoff tally, which I show in the chart above. Last month saw just over 172,000 layoffs and if we exclude the pandemic, this was the highest level since February 2009. Now, there are a ton of federal employees in this number thanks to chainsaw Musk, but he hasn’t hacked as many as he has indicated…yet. As Pacino said in Scent of a Woman, “I’m just getting started”.  Well, perhaps not. Following the data, Trump said that the DOGE team is now going to be limited to only an advisory role and actual employment decisions will come from the various departments.

Stress in the U.S. labour market is bad enough, but what if we don’t see further progress on inflation that allows the Fed to provide some insulation through lower rates? I’m not just talking about the short-term inflationary impact from tariffs should President Trump actually put them in place for more than a couple of days. Rental costs, which are a large component in the consumer price index, have improved but this downward trend in rent inflation could be short-lived. As the chart below shows, the recovery in U.S. housing starts, in response to lower rates starting last summer, has stalled. The trend since 2022 is not encouraging. And if you think that displaced workers are at a higher risk of being pushed into a situation of selling their homes in lieu of renting, then the lack of growth in new rental units could cause a demand-supply imbalance that sends rents higher, not lower.

If the tariffs come back on, then we need to add in the second-order effects on other groups like agriculture. U.S. farms send a lot of produce to Canada, but not as much as what heads out to Asia. China’s decision to impose tariffs on U.S. agricultural imports is a double-edged sword. Not only do U.S. farmers face a potentially weaker demand for produce abroad, but placing a tariff on Canadian potash creates a squeeze that many farms can’t cope with. Needless to say, the phones in the White House were probably lighting up this week with calls from Midwest representatives and senators, asking for either an end to tariffs on Canadian potash or support cheques to keep farms afloat.

Which brings back to the big delusion.  Yes, bond yields have fallen substantially, but there are limits to how far this bond market rally can run and it’s not just about inflation. President Trump promised large-scale tax cuts, primarily by extending the relief measures he put in place in his first term. This was a central election platform pledge, yet he needs to pay for it. Failure to do so will send the fiscal deficit even higher and push republican deficit hawks away. How about the revenues from tariffs? A drop in the bucket compared to the size of the deficit. And despite all the cuts Elon is making to government fat, this too is going to be slim pickings when it comes to offsetting large-scale tax reductions. And if economic growth is weakening, then tax revenue growth is likewise going to shrink.

Back in 2018-19 during the last Trump tariff frenzy, the federal government’s fiscal situation was in much better shape than today. There was room to provide support to affected businesses from the trade war, even with Trump’s tax cuts. Today, the U.S. finds itself in a fiscal fiasco and if the White House pushes ahead with extension of the previous tax cuts and adds in more, then the bond market is not going to be happy.  If you want an idea of what could happen, take a look at what has happened to European bond yields in recent weeks as governments there announce plans to open the taps on military spending. As the chart below shows, the German 10-year government bond yield is approaching 3% for the first time since 2023, while Italian 10-year yields are approaching 4%.

Bottom line, the fiscal worries that bond investors have been expressing could be validated. Instead of a big beautiful drop in yields, we might instead experience a thud as they hit a floor.

With all this uncertainty, just think of what small businesses are going through.

This past Tuesday, eight hours after the White House imposed tariffs on Canada and the U.S., I participated in a panel discussion on how tariffs could impact local businesses. I had the honour of interviewing Bob Armstrong, who has 50 years experience in supply chain management, consulting and trade advisory. There is an understandably high level of anxiousness among Canadian small businesses. If they are importing from the U.S., what is the impact on their margins from tariffs? More Canadians are shunning U.S. retailers in favour of home-based ones, but what of a local retailer that sells U.S. products? And what about Canadian companies that do the bulk of their business in the U.S.? 

The message at the end of the discussion centred on two key positives from all of this. First, Canada hasn’t been this united for a long time and that is good for Canadian businesses. Second, inter-provincial trade barriers are finally going to get taken down, which is extremely positive for the economy overall. The third message was that we must get our act together in terms of finally diversifying our trade relationships away from the U.S.  That means opening up trade delegations to other countries to small and medium-sized companies as well as our larger ones. It also means that we need to bolster our trade infrastructure, including a massive reinvestment in our ports. How governments prioritize this remains to be seen.

For the rest of us, this on and off again tariff world that Trump has brought upon Canada does introduce more risks to our portfolios, but it also offers up opportunities.  Some of those opportunities will be here in Canada, while others will be outside of North America, as we are witnessing in Europe this week. Needless to say, adhering to your individual investment strategy is more important than ever.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle