We head into 2025 with the degree of policy uncertainty around the world far greater than usual. Not so much in Canada, though the reality of a federal election by no later than October will start to dominate attention by late summer. And at this point, the result already looks like a foregone conclusion. Bank of Canada policy is rather clear-cut in the sense that the easing cycle is very likely going to continue, given the state of the economy (moribund) and the fact that the disinflationary output gap shows further signs of widening.
But greater uncertainty can be seen in the economic, political and budgetary strains in core Europe, with France in crisis mode and Germany seemingly heading back into recession. It’s also evident in the complicated picture in Asia, where the Bank of Japan is fearful of restoring positive real interest rates to a country that is experiencing real economic growth and rising inflation – the anxiety of a repeat of the unwinding of the global “carry trade” policy last summer and all the market havoc that wreaked. More of that turbulence is probably in store for 2025. There also is ample room for China to disappoint, as policy measures have fallen flat in their bid to resuscitate an economy grappling with the aftershocks of an epic property bubble collapse and a continuing balance sheet recession.
Today’s China looks a lot like Japan did for the past few decades, and the significance for Canada should not be understated in terms of what this means for the commodity sector outlook. More generally, Canada’s economy, financial markets and the loonie basically take their direction from global GDP, and the prospects here for the coming year look none too good.
But the biggest challenge ahead is the United States: specifically, president-elect Donald Trump’s quest to radically change American trade policy in a way that would make his initial tariff-happy tenure from 2016 to 2020 look like a walk in the park. There is no doubt the size of the tariffs he is talking about would send Canada and Mexico, the only two countries on the planet that ship more than a 20-per-cent share of GDP to the United States, into a deep recession. That’s not to mention the risks of a broader global trade war taking hold, which would add another layer of complication for small and open countries. At this point, it is tough to handicap the odds of the tariff hikes, and the hope is that incoming Treasury secretary Scott Bessent will be able to curb Mr. Trump’s worst impulses. That, my friends, is the key question that so far has no concrete answer.
Then there is the question of what the U.S. Federal Reserve’s response – the reaction function – will be to the inflation risks from higher tariffs, restrictive immigration policies and the prospect of higher budget deficits. There isn’t enough in terms of discretionary spending for the new government efficiency czar Elon Musk to cut unless he wants to fire the entire federal civil service.
As far as I am concerned, the Fed’s reaction function is the most important risk and source of uncertainty going into 2025. That’s especially so since the markets are still anticipating two more rate cuts after trimming those expectations since the Nov. 5 U.S. election and sending the bond market into a tizzy, at least for a while.
The biggest of the high and rising risks ahead, principally the one thing Mr. Trump can do independently, is an epic hike to tariffs, with his proposals of up to 60 per cent on China and a blanket 20 per cent for everyone else. We really shouldn’t underestimate how important this is to the president-elect as an old-style mercantile industrial policy, nor should we underestimate the responses by other countries. Either governments elsewhere begin a process of negotiation and appeasement ahead of time, or we risk a backlash that could bring the world to a 1930s-style “beggar-thy-neighbour” global trade war. We should pray for the former but still be discounting some non-trivial risk of the latter.
And so as we enter the new year in a complete policy bog, we need to know how best to position ourselves.
Warren Buffett has built a massive, indeed record, US$325-billion cash hoard in light of all this uncertainty – half of that built up just this year alone (and his reporting showed that this usual optimist took continued to reduce his equity position in the third quarter). The Fed’s Jerome Powell has subtly altered his dovish stance since the recent FOMC meeting.
We should probably be behaving like Mr. Buffett and Mr. Powell, which is acting prudently at a time of re-emerging tail risks and heightened uncertainty. Greater uncertainty means (or should in any event) a reduced risk tolerance. This applies to equities (reduce exposure), Treasuries (shorten duration) and credit (step up in quality). U.S. dollar strength, which is the natural byproduct of U.S. tariffs, means commodities will be in the penalty box, exacerbated by the sustained weakness in the Chinese economy. If you want an inflation hedge that won’t hurt you as the dollar appreciates, perhaps consider the Treasury Inflation-Protected Securities (TIPS) market.
For the time being at least you will get paid to wait – and not take a severe haircut if you are positioned the wrong way – by shifting the portfolio more heavily into cold hard cash with a completely safe 4.5-per-cent yield if holding three-month U.S. T-bills that are devoid of any capital risk or duration risk.
I am emphatic in the view that, at least until the policy dust settles and today’s tail risks vanish, prudence dictates reducing risk across all asset classes. Once we have a better handle on when this extremely uncertain policy outlook is going to be resolved, we will be able to go back to the drawing board and put that cash to work. Depending on the outcome and how the markets behave over the near and intermediate term, who knows – I may even turn bullish on equities. And I will relish the opportunity to go long bonds again, which has been my natural habitat, and the Treasury market, unlike the stock market, has at least already corrected sufficiently to make it look interesting – especially since so much of the expectation of further Fed easing has already been removed.
But I am reluctant for the time being to be buying long-dated securities of any kind, and instead am keeping my powder dry and ensuring that I am highly liquid and ready to re-engage in an environment where forecasting confidence levels are re-established, and a more investable climate where risk can be more appropriately priced, have been restored.
David Rosenberg is founder of Rosenberg Research.
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