Let’s talk tariffs

Bannon Kopko: Good morning, everyone. Wow, what a couple days so far? Liberation Day happened and the global trade fight kicked into full gear. Thinking this is another one of those moments where we're all going to remember where we were. So many moving parts, tariffs, reciprocal tariffs, countries and target sectors. You're seeing it out there, equities, commodities, currencies, feeling it. What's the CEO to do? It's not much easier for investors.

Great timing to get our experts together to talk about what's happened, what it means and where things could go. It's my pleasure to introduce some of Scotia's experts on this topic and host today's Let's Talk Tariffs webcast. Each has already published lots on the subject. We're going to hear from this morning in order our capital markets economist, Derek Holt, US rate strategist Boris Sender, the Canadian rate strategist, Roger Quick, and then our portfolio strategist, Hugo Ste-Marie.

If you have any questions for our speakers, there should be a Q&A box on your screen. Please put your questions in there and I can relay that to our speakers at the end of the call. Derek, on that, why don't I hand the call over to you. What's changing?

Derek Holt: Yeah, sure thing, Bannon. Okay, well done. So, it's I know where we were in economics last night and it was a very late night, so we're going to take a crack at trying to assess the macroeconomic implications to what just was brought down at 4:00 PM yesterday afternoon.

There's a lot to digest here. My summary point in terms of much of our audience is that Canada and Mexico didn't go down with the ship, but they're kind of left bobbing away in frigid waters because of the damage that will be done by the US actions against many of much of the rest of the world. What the United States has done here is to raise its effective tariff on imports into the country by roughly 20 percentage points compared to what had been previously the case. And the estimate, exact estimates depend upon a few assumptions and whether you include goods or services, I won't get into that, but you can take roughly 20 percentage point increase. Our macro econometric model we have used in order to assess the impact of this upon US growth going forward and what it could mean. Check if the tariffs persist, if they are sustained, for every five-percentage point increase in that effective tariff rate, you knock about half a percentage point off US GDP growth going forward.

That means that if we're dealing with four times that effective tariff increase, you're probably knocking 2 percentage points off US GDP growth. Our baseline forecasts going forward for the US economy before all this stuff happened was for growth of about 1 1/2 to 2% or so. And that means that if you are taking this effect and the model suggests that you the peak effects would unfold toward the second half of this year and on into early next year, then you probably are on the borderline between a mild growth in a recession called roughly flat in terms of GDP tilted towards recession. Why? Because what our model is capable of doing is very, very good in many respects in terms of estimating what is essentially the terms of trade tariff shock to the US economy. The unknowns, however, are multiple in nature.

For one thing, you've got a whole generation of folks out there who never really knew what the word tariff meant. This is the biggest tariff fight that we've dealt with since 1930 of the Smoot Hawley Tariff Act in the United States. So, we're in somewhat uncharted waters in terms of how behavior responds and how people react and how confidence evolves.

Secondly, supply chains are enormously complex. It's like going back to the CDO squared, CDO cubes, flow chart diagrams and the GFC. It's that complicated in terms of our ability to try to understand and trace through the full effects of what happens when you shock global trade channels in the manner in which the United States has done here today. We have to be circumspect, humble, careful, biased toward a negative outcome for the US economy nevertheless, and it could be bigger than what we are estimating. The magnitude of the tariffs on a country-by-country basis. Again, I'll come back to the opening positive point, could have been a lot worse for Canada and Mexico.

We escaped the baseline 10% tariff that the United States imposed on all countries as a minimum. We escaped any reciprocal tariffs, but at the same time we're dealing with sectors specific tariffs like a 25% tariff on autos, 25% tariff on base metals and steel and aluminum and possibly copper in the coming weeks and all the derivative products. We're dealing with an increase in lumber tariffs, possible increases in other tariffs applied to US strategic industries, and the spillover effects upon Canada.

And remember, at the end of the day, Canada is an open economy that trades an awful lot with the rest of the world and is significantly influenced by commodities. It's that commodity connection which will dampen growth in Canada as well as we import the negative effects of what the United States has done to China, what it has done to Europe, and what it has done to a number of other countries. China's tariff rate skyrocketed to over 50%. That’s bone crushing from an export competitiveness standpoint into the US economy.

What could happen from here going forward? Very, very uncertain. We're on a fluid situation here. Governments and markets are reacting. They're trying to digest what was announced. They're trying to determine next steps here. I think some of these tariffs are bound to persist for an extended period of time. Maybe not all of them, but some of them.

Trump's bias appears to be a romanticized interpretation of past tariff episodes, like the 1880s and President McKinley and what happened in those previous periods of time. He ignores other things that were going on at the time, like surging population growth, like the fact that trade as a share of global GDP was much smaller, like the fact that you didn't have today's complex supply chains that were intertwined across the whole global economy. It's a very, very different environment. But that's his bias, that it's a good thing to create a protectionist wall, keep a lot of exports out of the system, and to keep U.S. economic momentum going by way of encouraging foreigners to locate in the United States. Some of that will happen. We saw some hints of that overnight. We saw some announcements by some auto companies announcing they would shift production to the United States in part. But at the end of the day, I'm convinced that this is bad for economic growth.

Many U.S. companies will pull in their horns on investment growth going forward. Many U.S. companies, given the soaring trade uncertainty and overall policy uncertainty, won't have the confidence to stick their necks out and invest in this cycle and probably for a long period of time. Consumption benefited from the fact that imports of a lot of cheaper products created a greater amount of variety at lower price. And now that's being reversed. US fiscal deficits are probably going to be impaired greater than what the Senate plan the other day would suggest and the House plan would suggest as well. That's because those plans are probably incorporating overly rosy assumptions on GDP growth going forward.

Add it all up. It's tough to see how you get faster growth out of the US economy through the export channel when you're hammering everyone else's economies. Rates will adjust here in the interim period of time. I want to see what the Federal Reserve’s top officials have to say when we hear two governors speak today, another two tomorrow, and most importantly, Federal Reserve Chair Jay Powell.

I'm not totally convinced that you could have an easing bias come out of the Fed, at least in the immediate term. I think you'll probably still get a patient message from the chair tomorrow; I think he will probably still be biased toward wanting to see what happens and not overreacting and seeing how other countries evolve here. Being cognizant of the inflation risk that we are stocking and the complicated picture in terms of downside risk to growth and upside risk to inflation. I am biased toward viewing the markets is getting a little bit too carried away in terms of the bias on rate cuts. But I want to see what the Federal Reserve's top officials have to say.

With that, let's keep an eye on further steps. In closing, we'll hear from Prime Minister Carney later today. He has pledged retaliation. I would be surprised if Europe gets a coordinated act together and negotiates with the United States, given the variety of opinions. Europe will be Europe and all of this. But we have to be watching all the next steps very, very carefully.

That's it, Bannon, and over to Boris Sender. Thank you.

Boris Sender: Thank you, Derek. That was a great overview. So, I would say what was put forward yesterday was quite a bit better than expected for Canada and Mexico as Derek emphasized, but certainly a lot worse than expected on the rest of the world.

Nobody in their minds thought that the effective tariff rates on China would be north of 50% as it stands today. And you know, 30 to 45% in the rest of Southeast Asia, 20% on Europe. I mean, if you look at the effective tariff rate going to 20%, that's already bumping up against the, the optimal tariff rate that was found by some of Trump's economic advisers. So, there's so if the, if the tariff rates were to go up from here would be quite punitive for the US.

Now, the, the view that I had going into this, and the title of my latest outlook was the case for short term caution, but long-term optimism. And the basis of the long-term optimism was around that these tariffs are likely to be put in a way such that it will incentivize negotiations, and negotiations of trade barriers coming down ultimately. Unfortunately, the way that these tariffs have been structured, yesterday, given the fact that they are a function of, of the deficits to the US as a percentage of exports to the US, they're basically targeting the proportionality of the trade imbalance, but in goods and not in services. And by virtue of them excluding services, they've made these tariff rates far more punitive than they needed to be. And so that I think is contributing to a lot of the risk off that that we're seeing today.

Now the negotiation tool appears to be the 50% factor that they're applying to this trade imbalance intensity. What Secretary Besson suggested yesterday is that with retaliation that 50% sliding scale can go up. I suspect with some positive negotiations and good faith steps that ratio can come down. So, I think that there's a place for it to move up or down depending upon developments. But I would say because these tariffs are targeting market access more so than they are in, in terms of monetary barriers, the solutions are a lot more complicated and will take more time to carry through. And so, I don't think this is a one of those trade wars that will be quickly resolved. I think this is going to play out over a number of years. And so, for that reason, I think these tariffs are going to stick, especially the sectoral tariffs, which don't have a negotiation component and the 10% of the base universal tariff that was implemented yesterday effectively in all countries regardless of trade regime.

So, you know, tariffs are going to be a fixture of this administration. You know, that was the view before. There's going to be some universal mechanism to this tariff policy. And this is the route that the US has chosen. So, what does this effectively mean? What is the US asking of the rest of the world? The US wants to produce more, and it wants the rest of the world to consume more. That is fundamentally the equation that that is being put forward by this administration. They want to see more balanced world, but they don't want us to consume less. They want the US to produce more, and they want the rest of the world to consume more.

Now, if you look at the developments in the last couple of weeks, there's evidence to say a little bit of both happening. So, the measures that were announced in Europe in terms of military and infrastructure will certainly help boost demand. The word is, is that China is going to react to these larger than expected tariffs by putting on stimulus of its own. And I think with that process that is going to balance the equation to some extent. Who knows how much. Certainly, the world's very imbalanced right now. It's going to take a lot to bring it all back into balance.

Now in terms of market views, I think that this this being so much worse than expected means that the growth slowed down that we were already witnessing in Q1 is about to get a lot worse. I suspect that if the Fed is cautious in this backdrop and wanting to wait for hard data, they materialize. I suspect the market will force its hand. And so, if they, if they try to defer May and emphasize patience, we'll see another revisit of the August 2024 price action when 50 basis points started to get price into June intermediate cuts, etc. You know the, the signals from the market today are dire. Oil is down 7%, S&P is down 4%. Two-year yields are off by 15 basis points with the one year, one year terminal rate down over 25. And so, the market is screaming that the growth is slowing down and typically the market is right and not the Fed. I do suspect that if the Fed were to make a mistake and not try to accommodate into this, the market will force its hand.

For that reason, we had a very bullish call on U.S. Treasuries coming into this both outright and relative basis and on the back of growth slowing. I think this event certainly accelerates that view, strengthens that view. I'd say the moves today can certainly go further and they typically do. And so, with that, I suspect that there's going to be more US outperformance or relative basis, outright basis and the dollars likely to continue weakening.

So, with that, I wanted to pass it back to Bannon.

BK: Boris, thanks for that. I think we're going to hand it off to your colleague. Roger, you all set?

Roger Quick: I am all set. Yeah, an interesting day. So as Boris and Derek have already noted, you know, Canada and Mexico got through yesterday's tariffs comparatively well. You know, the Trump administration is more or less going with or following what's in the free trade agreement, the USMCA in terms of exemptions. But hitting as Derek and Boris have also noted, hitting the rest of the world harder. It ends up being worse for the US as well than we might have been initially guessing. So, on the one hand, you know, that's maybe not the, the immediate threat to Canadian growth is maybe postponed a bit, but the longer run outlook is outlook is still for significantly weaker growth. And that's still going to affect Canada, albeit more indirectly now than if we were getting hit with more of these tariffs right away.

So, in terms of what this means looking ahead, you know, I, I'm not sure if things have changed all that much for Canada, even though, you know, the initial tariff outcome is better. Um, I think maybe think it means things play out over a somewhat longer horizon than having us get hit immediately with tariffs. And of course, you know, depending on how, like we're seeing quite a negative equity market reaction. If, you know, depending on how bad things get there, then you know, the impacts on Canada can happen sooner. So, I think, you know, we're still looking at a situation of weaker growth going forward, albeit playing out somewhat slower.

In terms of what this means for government spending and elections and things like that. You know, it's tough to see how somewhat moderate tariff or a moderation of tariffs on Canada and Mexico, how that really changes the broader term political rift that's already happened with the US and its trading partners around the world. You know, I think we're still looking at governments here and elsewhere looking to try to fix some of our own economic problems, become somewhat more self-reliant. And in many ways, you know, as we've been saying in in previous calls we've been doing and other publications, the terror threats have been unnecessary wake up call for Canada in that we do have things in our economy that we need to fix. We need to, you know, improve our competitiveness, diversify export markets and find ways to enhance productivity. And those are important things to do. And I, you know, I'm kind of hoping and I don't think that that getting a reprieve with yesterday's tariff announcement is going to derail that too much. You know, maybe those things play out a bit of over a bit more of a longer horizon. But I think and, and kind of hope that those factors are still in play because I do think we need to do some of those things.

So, in terms of government spending, you know, I think that is still likely going up significantly. Deficits are going up significantly and you know, I hope this doesn't lose too much of that momentum for those things that we do need to do. So that in terms of the interest rate market, I think that does mean that that does keep pressure relatively on mid- and longer-term yields in Canada as issuance is likely to still be going up significantly. I do think there's a reasonable chance or a fair a good chance that the Bank of Canada will again, following the pattern that it's already done this year where, you know, it has to balance those growth and inflation factors. And it's so far, you know, taken out some preemptive cuts based on the risks to growth that are more immediate. I think that story probably plays out still. You know, there's still room to go just to get to the low side of their neutral range without talking about really easing.

But clearly, you know, with Canada escaping the worst of things yesterday, there isn't the urgency for them cutting this month. Of course, you know, the US administration may surprise us again. And so that argues for a steeper curve, although rate cuts are still, I think there's pretty much a full cut priced in for June already. So not a not, I don't have a big disagreement with that. But I do think, you know, longer term the risks are weaker growth led by, you know now it's US weaker growth, global weaker growth rather than tariffs hitting us directly to the to the same extent.

So steeper Canada curve in terms of spreads. You know, we've been talking before about the fiscal picture would have to put some up pressure on provincial spreads that's maybe somewhat lessened in if we're not getting hit immediately by the tariffs. But the growth, the weaker growth implications indirectly are going to affect growth in Canada as well. So, there will be some upward pressure still, I think coming from the fiscal side, but I think more so we're now looking at a much worse global risk environment.

So as corporate credit spreads widened, I think they widen more. Um, we'll have to see how equity markets respond, but you know, can't really argue with the direction that things are going today. You know, maybe the magnitude is, is excessive, but we'll see how that plays out. But I, so I do think, you know, corporate spreads would be at risk of widening more and that may put some further pressure on provincial spreads as well, but they should do relatively better. We've already built in a sub moderating increase in provincial deficits through the widening and spreads we've had this year. So some upward risk in spreads there, but more so on the corporate side would be my guess.

I think in the interest of time, I will leave it there because I know there's going to be lots of questions and there's all kinds of things we can be talking about. So, I will, I'll stop there and pass it over to Hugo on the equity and portfolio strategy side.

Hugo Ste-Marie: Thanks, Roger. So, I would say lots of clients were asking recently if the April 2nd date was a clearing even for markets, meaning that uncertainty and volatility would drop post a tariff announcement. Clearly that's not the case. I think even though we have the US game plan now that has injected a dose of volatility and uncertainty that could last for several weeks if not longer.

Negotiations with a lot of countries will start soon, but that could take time, and negotiation can fill as well. So that's not a clearing event. I suspect uncertainty, volatility, stays as I mentioned for some time when what's the most likely direction of travel for growth and inflation? I think as direct pointed out; growth appears most likely to shift into much lower gears from here. US inflation could maybe potentially rise or at least being quite sticky.

Where does that leave us in terms of positioning? Well, from an asset allocation standpoint, we've been underweight stocks since the beginning of March and this morning we reiterated that call. So, we stick with our underweight view on equities. Why is that? Well, the P correction we got so far is mild. If you looked at the S&P 500, probably with this morning, the P is down maybe 11-12% from its peak on a forward P basis. I would say that's modest by historical standard. We often add episodes where the forward P contracted 15, maybe 20% contraction without necessarily having an economic recession. So that's over the past 30 to 40 years. So that's on the PC side, more room for MBP contraction. When you looked at earnings expectation, well, clearly bottom-up consensus is calling, still calling I would say for double digit PS growth in 2025. I think the last time I checked the EPS consensus was calling for 12% earnings growth for the S&P 500. Well, if you have much weaker GDP growth in 25 and maybe margin could be eroded as well. We, we, we still don't have a lot of clarity, but if the tariffs are all passed through to consumers, clearly that could lead to more inflation. But if companies bite the bullet, maybe you have less inflation, but that could be a bigger hit to margin. So again, we're not sure there yet, but clearly you have weaker growth, maybe that has an impact on top line and certainly profit margins could to some extent be it as well. So that could lead to much weaker earnings growth that is anticipated by the market. So, I suspect we could see more negative revisions in coming weeks where the Q1 reporting season is just around the corner in the US. So, keep an eye on corporate guidance. If it's not great, clearly, I think analysts, Wall Street and Bay Street will have to be a bit more aggressive in terms of earnings cuts in in coming weeks.

So, in terms of equities, despite the decline so far, we still see downside risk unfortunately. So, we would prefer bonds where we have a market waiting exposure and cash which is overweight for us. We think in the short run cache still quite makes sense. So that's in terms of asset allocation. Again, I think it's too early to completely write off 2025. As I mentioned, many times, why it's too early to do that. Well, simply because we'll leave again, we might have a lot of countries trying to reach an agreement with the US administration. If we have an agreement, tariffs come down, maybe that could boost the sentiment again, not today, but in coming weeks, coming months. That's something we can probably expect eventually the less contentious parts of the Trump administration agenda, tax cuts, deregulation will resurface. So that again, that could potentially boost sentiment and maybe growth later in 25. And keep in mind at the global level, we still have the monetary easing cycle that has started a several months ago already. So eventually that could support economic activity.

In terms of regional allocation. I think that the biggest move we did last night was to downgrade US equities to underweight. Main reasons are as follows. We clearly see more visible negative GDP revisions, um, any US versus maybe Europe, probably more inflation pressure in US as well as well with all those tariffs and maybe retaliation as well putting pressure on growth. More inflation might mean valuation metrics will keep compressing as I mentioned earlier, especially in growth land. What I mean by that is grow the equities were trading last night at around 26 times forward earnings. That's well after recent peak of 31 times. But that remains well above the 20 times long run average and well above the lows seen in 22 at 22 times. For instance, when you look at the rest of the world, much cheaper already in easing mode. As I mentioned, some governments will provide fiscal support as well. You have monetary support as well too. So that's why to us, the US, because we that's why we downgraded US equities. I would add that U.S. companies might be at the disadvantage going forward with maybe corporate nationalism rising. We may see more buy Canada, buy Europe, buy Mexico programs, more foreign governments may want to limit the access to their data to US tech companies etc.

And keep in mind the long U.S. stocks, long trade U.S. stocks exposure has been very crowded for quite some time. So maybe foreigners will start to reassess their exposure to US assets downward in coming months, coming quarter. If they do so, that will likely reduce or have an impact on large gap mega cap tech stocks in the US and that might be supportive of international equity. So, we have under weighted EFI, EFI not underweight, underweight U.S. stocks, EFEE is market weighted. We upgraded Canada to an overweight. Why again, tariff related.

It's better off today than last night. I mean, it's not as bad as we feared for Canada. It's not great for sure, but this is a relative game. So TSX is cheaper, less levered to expansive growth tech stocks than in the US, more gold, maybe more defense as well. So that's the reason for the upgrade there. In terms of sector allocation, we have continued to add defense, we added the cache, staples, utilities. This is where we have our largest overweight recommendation in terms of underweight financials, banks, industrial technology, discretionary and energy. So essentially, the cyclical sectors might get hurt by the tariffs in terms of size, prefer large over small. And in the interest of time, I'll leave it there and pass it over to Bannon.

BK: Hugo and team. Thanks so much again to our listeners. If you have any questions for the speakers are there should be that Q&A box on your screen already have a number of questions coming in here, but please put them in and I’ll relay. And I did want to mention this call will be available on replay soon after.

Where should I start? Maybe, Derek, I've got a question for you. What do you think of the White House methodology to determine tariffs? Is it fair? Is it accurate? We also have a big placard Trump was holding yesterday. Is there a bit of political bias too? Any thoughts there?

DH: Yeah, that's a funny way of putting a big placard. For a minute there, I thought I was watching the price is right. The formula that they demonstrated was, was bizarre. I think that's perplexed economists around, around the world, how they came up with these tariffs. That doesn't make any sense to me what they've done. They've basically taken, I think the goods trade deficit the US has with the individual countries. Yeah. You divided by two and you, you round it up and you get to get to that kind of method. So, it's heavily weighted the world, a very simplistic understanding of the US trade imbalances with the rest of the world. And to that effect, we have to understand that there are complex reasons for why countries run trade surpluses or trade deficits.

The United States runs trade deficits because of its domestic policies. They save too little, they spend too much, and they have fiscal policy that constantly primes the pump. And so, at the margin, the United States runs large trade deficits, large current account deficits, and by corollary, large capital account surpluses with much of the rest of the world to fund those outflows through the current account deficit. There are fundamental sound reasons for that. I don't accept that it's all foreign parties that are guilty in terms of an uneven playing field. And across global trade, like the US administration tends to argue, there is some of that for sure. Everybody's hands are dirty. I mean, there's not, as you know, innocent party around the world, but that includes the United States. The United States spends hundreds of billions of dollars a year on the farm bill subsidizing corporate farms, and it spends enormous amounts of subsidies at a top list of all its corporations. Its military industrial complex spends a lot on subsidies. It does subsidies that other countries don't by choosing instead to rely more upon tariffs because they don't have the revenues to fund the subsidies.

On the auto sector. It's rich beyond belief to to argue that the rest of the world treats the US unfairly. the US has always had a 25% tax upon imported trucks. Now they've added a 25% tax on the passenger side of vehicle side of the picture. He wants to encourage tax subsidies for auto purchases if you're if you're making them in the United States with some generous financing now as part of the fiscal package. And we've seen many bailouts of auto companies in the past. I mean, this is a sector that has benefited from US largesse, including the fact that southern states siphoned off a lot of investment from Canada by providing billions in subsidies to companies to locate there.

So everybody's hands are dirtied here and everybody has to come to the table with a degree of humility, not threatening each other, but trying to achieve some agreement that cures everybody’s sins. And I, I'm very not terribly optimistic that that will be the, the outcome of all of this. The one last point, Banon, I'd, I'd make is always think of the balance of payments as connected on both sides. the US is trying to do something on the current account. There's going to be a cost on the capital account side of the picture as well here. And the added fear is that we start going down the path of some capital controls and some unhealthy measures on the capital account that could be, quite dangerous. I worry you've lit the fuse, and we don't know where it's going here.

BK: But yeah, maybe another one for Derek here. Derek, I'm hearing some senators are breaking from Trump and to reject Canadian tariffs. Can anything sort of happen there? It all seems so fluid. You know, their key dates to watch. You know, when and if can things change?

DH: You know, the way I read that is it was, it was a nice symbolic gesture of goodwill and friendship from a few people in the US Senate. But it stops at that. It's, it's not going on through the House. It wouldn't get passed by the House. The, the Republicans have owned the House to a greater degree. And it's a bit of a different bias. And it's, I think it's, it's symbolizing division within the Republicans on the very notion of tariffs. I mean, this is fundamentally against any libertarian’s sense of what government's role in an economy should be. It's a very, very heavy-handed stick that's interfering in private markets with tariffs and this kind of set of mechanisms. And there's still some Republicans that are of that, that that mindset that, you know, still a few, a few that are of in in support of free and fair markets. And so, it's but at the end of the day, it's Trump calling the shots. What I would say is the best hope for getting some sort of de-escalation here is a view that I've expressed for quite some time now.

That eventually, if you allow the pain to be so clear to the United States through the market response and through the retaliatory efforts and through the impact that we start to see upon US growth numbers, then you're going to go into the midterm elections. And I think the Republican Party is going to circle the wagons on some of this protectionist sentiment. If they don't and they don't deescalate through domestic channels in that environment and strike the next best, greatest, that's fantastic, fabulous, never been done before trade agreement in the history of trade agreements. And then I think they get their heads handed to them on the path to the midterm elections next year. And you lose 1 or both chambers of Congress given the Finn majorities they have. And Trump becomes potentially a lame duck president in the back half of his mandate, writing executive orders that get challenged in the courts, get challenged by labor unions, but get challenged on multiple fronts. And we see the protracted impact upon the, the US economy. And so, I think political mechanisms, market mechanisms, the US domestic business lobby, those will be the best.

BK: I think we lost Derek there. You know, we'll switch gears. We'll get back to Derek in a second. Maybe one for Hugo here. Hugo, I'm getting lots of inbound questions and stagflation and you've written about the topic recently, but any thoughts relating to that?

HSM: Well, clearly this is that's, I mean, when we talk about stagflation, clearly this is not a repeat of the 70s. I mean, I would not go down that path. What we wrote was stagflation vibes. When you looked at GDP expectation, it's going to come down in the US probably quite sharply from here. While inflation expectations and bunch of inflation metrics have started to rise. So, we've, as I mentioned, discussed inflationary vibes, but this is not a repeat of the of the 1970s when we add inflation in the 8-9-10 percent range. So that's not what we meant. But still, that could have an impact on stocks clearly multiples where stocks that have high multiples could be probably more on shaky grounds. This is what we're seeing today as well. My multiple stocks could get rerated downward so that that's clearly a risk. Probably more defense as I mentioned as well is probably the way to go for now.

BK: Boris, you may have an opinion on that. Any thoughts?

BS: Absolutely. So, from the US perspective, you know, stagflation as it's classically defined happens very rarely. As Hugo said, happened in the 70s. That's the only time we really saw negative growth and accelerating inflation in, in today's world. It's hard to see the mechanism for that. We see this dynamic of surge pricing, prices reacted demands real time. And so, to really see the stagflation regime really put into place, at least as it's classically defined, we would need to see shortages of product, right?

I think this is a world where it's not the pandemic where there is a reduction in the quantity of goods. The quantity of goods remains the same. It's they're relative pricing changes. With that, the, you know, your, your level of quantity doesn't change. And so, you know, depending upon how the US consumer ultimately responds, rule really dictate the degree to which this is going to be inflationary or not.

It really is up to the US consumer to decide whether they will pay the price and the question of what the tariff pass through rates an open question are still very much.

I'm of the view that the pass-through rates from the China tariffs will be very small given that they're industrial models very much to pursue market share. They were likely to eat the tariff along the chain. Whereas tariffs and other countries will have a greater amount of pass through, but nowhere near the 100% that that people are calling for because the US consumer is at a very low level of savings and multi decade low, and retailers and wholesalers in the US have record by profit margins. So, if I were to choose which one of that of those parties in the chain are likely to eat the tariff, I'm, I suspect it's the retailer and the wholesaler and much less the consumer.

And so, I think that the inflationary impacts of these much higher than expected tariffs is going to be more muted than just applying 20% on 10% of imported goods. So, if that basic math leads you to a 2% move higher in the PCE, I think we get something on the order of .7 or .8, which is a number consistent with what our economics team has put forward in the past.

HSM: I would just add, again, I think Boris is right in the sense that we the open question about the, pass through to consumer, we don't know yet. As I mentioned earlier, this is a key question for equity investors. If companies were to bite the bullet like Wall Street is calling for profit margins at the S&P 500 level to expand to record high in 2025. But again, if, if companies are biting the bullet, there's no way this happens. If you start to let’s, say, reduce profit margins expectation, clearly that would have a big impact on earnings expectations as well. As I mentioned, consensus is still calling for 12%.

BK: Thanks team. You know, getting some questions asking for more granularity on FX. Boris, you talked about U.S. dollar weakness, but is there a level where the USD, you know gets too cheap to ignore for you and actually should probably go to Roger after that just with more thoughts about C dollar. Boris, you want to kick that off.

BS: Absolutely. So going into yesterday's announcement, the core view that we had for the rest of the year is one of convergence of economic outcomes and convergence of yields and one of the things that really drives effects as interest rate differential. So as those yields converge, that pressure is the dollar lower. You know this is also certainly consistent with the administration's priorities. And then we believe that the amount of overallocation into the US has been massive. It's been 15 years of US exceptionalism. Global capital has flooded into the US, not just benchmark, there's certainly a large degree of over allocation to the US both on the part of foreign private investors but also foreign official accounts are over allocated to dollars.

And so and so there, once this trade gets going, it could unwind very quickly. And so I think that will be kind of that growth negative headwind for the dollar as this as capital gets reallocated to places that are stimulating such as Europe, potentially Japan, China, et cetera, and away from the US And given the fact this has been a 15 year trade, the unwind could be pretty massive.

BK: Roger, do you want to jump in on that? Thanks, Boris.

Roger:  Sure, yeah. I mean, you know, a weakening currency is the way that a country primarily a adjusts to tariff threats. With the tariff picture becoming more benign for now for Canada, yeah, you know, makes sense that the current, the Canadian dollars been strengthening. You know, we're not out of the woods. I think we're still looking at, you know, more on continued uncertainty. There's going to be the renegotiation of, of the free trade agreement coming up. But you know, for now, yeah. I think the Canadian dollar is looking better as it, as it should. But yeah, if, you know, if we get to a point where the tariffs come back on Canada, then the currency is a natural thing that that would adjust and weaken there. But we've escaped that for the moment.

And I, you know, I do think I agree longer term. I was thinking the weakening U.S. dollar, weakening U.S. economy, more isolationist U.S. economy. The one I was thinking the weak U.S. dollar story was a further down the road. But yeah, you know, with this kind of self-inflicted, um, uh, pain in the US, maybe, you know, maybe it becomes a, the, the, the theme a little sooner than I'd previously been thinking.

BS: And I'd say it's also worth mentioning that in the beginning innings, when Trump was elected in November and, and some of the tariff tweets came out, the dollar responded by going a lot stronger. And so that has been the historical textbook relationship. You know, tariffs go up and your dollar strengthens to offset the effects of the tariffs. That's certainly something that we saw in 2019. Now the fact that this isn't happening today, that the dollar is weakening on the back of higher-than-expected tariffs to me suggest that we're not going to get those second order buffering effects like we did in 2019. And so, if from the perspective of our trading partners, which are seeing higher trade barriers and a stronger currency, it's almost a double whammy. So, I, I do think that all things being equal, this the stronger especially in Europe, yen, et cetera, it will prompt a bigger response potentially on the monetary side as well. So that's something to keep an eye on.

BK: Thanks team. Another one for Derek here. He's back. Derek, we're talking Canada, US here, but what about the rest of the world? Some of these emerging economies, you know, obviously exporting to the US major changes. How do you think that could affect their capital markets?

DK: Yeah, that's, that's a tricky one. I mean, it's, I mean, one positive is that this isn't the 1970s. We've seen a lot of emerging markets that have liberalized their currencies. They've floated them. So, their currencies I think over time might be expected to respond to negative terms of trade shock like the US just imposed upon some of them. And some of that, some of these tariff moves applied to the EM space are massive.

That's not quite what's happening so far. I mean, and so I, I'm personally skeptical of the US dollar secular decline kind of narrative, the Fed massively easing in terms of an economics view. That's my opinion. I think you; you get supply chains being roiled here. You're dealing with people coming off a generational shock to prices when they're still nervous about price expectations. They're not going to sit around and wonder where's the inflation coming from? They're just going to see their gas prices, their food prices, they're imported prices going up again. They're going to go to their employers and either demand higher wages and or shirk more on the productivity side of things. That'll be a are relatively equal in terms of the outcomes in that sense. And I think you'll hear a Fed chair sounding quite cautious about the, the inflation passed through or argument.

When you've got an economy, and this is critically important, like the United States that's starting at a point of excess aggregate demand with a positive output gap, and you shock tariffs upon it. When companies already have pricing power, you're more likely to get passed through in terms of inflation than if you had said, a starting point of excess aggregate supply. So, slack in the economy.

On top of that, the United States is trying to apply expansionary fiscal policy. Some of that is just to avoid a tax hike because the Extending the Tax Cuts and JOBS Act measures into next year. But some of that is net incremental stimulus with bigger deficits for longer. Again, applied to an economy that's in excess aggregate demand. What they're doing on the supply side is important as well. It's not just weaker actual GDP growth we have to focus upon. It's the fact that they're curtailing immigration and discouraging investment by this spike in uncertainty and that's going to slow potential GDP growth in the US economy going forward.

I think it's uncertain in terms of how the Fed will play this, how will read things. I want to see what they have to say for other markets like China. I wouldn't expect a huge response by the yuan. The worst thing you want here is an abrupt movement in the currency. And I think the authorities are going to try to manage their dirty managed peg against the US economy accordingly with them still reasonably tight bands. Remember the last time we went through a shock to China's financial system when people were queuing up to get out of the yuan into the US dollar ten years ago was very destabilizing to the financial markets domestically in in China. And that's because you've got two billion plus people with their lifetime savings tied up in a banking system and seeking exits. And if you were to have an uncontrolled depreciation in the currency or the flip side, the US dollar significantly appreciating against the Chinese currency, you'd create that same problem all over again. It could be extremely destabilizing to Chinese markets and cause this massive outflow of savings from the country's currency instability imported and substantially imported in inflation. But I don't think the Chinese authorities want to court that kind of kind of risk just yet.

So, China is not really conforming to the definition of an emerging market any longer, but it's got a significant weight on the US dollar and a significant influence on a lot of the other EM currencies in its neighborhood that matter more in terms of those crosses than, say, the US dollar cross for some of them.

BK: Derek, thank you. I guess a, a bit of a crystal ball question maybe for you and maybe for Roger too. You know, we, I guess our ministers are meeting with Carney right now and, and we'll expect a response from them later today. You know, how do you think Canada is going to respond? And then, you know, $1,000,000 question too, you know, how would you like them to kind of respond to this? We obviously heard Doug Ford and his take or at least change your view on things. Any thoughts maybe Derek that Roger.

DH: Okay, Bannon. I heard Prime Minister Carney comment yesterday that they are going to retaliate after he meets with the first ministers and, and consults with his Canada, US cabinets. And so, I'm expecting, I'm not sure if it will be formal announcements today with, you know, a press release from, from the government or, or guidance that tease that up at afterward. But listen, we've imposed 25% tariffs on $60 billion worth of imports from the United States already. There's another $95 billion of imports waiting in the wings for another 25% tariff in terms of what they initially announced or about a month ago or plus. And so, it's they, they have that, that they can lean on.

And we have heard consistently that they don't want to match dollar for dollar tariffs against the United States. And we haven't all along in in Canada and it's been 25%, but against a lower volume of Canadian imports than the US has applied its tariffs against the volume of Canadian exports to the United States. So, net-net is a demand shock to Canada. I think what they're more likely to do is to stick to that script, but to they could effectively impose import bans in some areas by jacking up the targeted tariffs on parts of Trump's base and very politically sensitive areas to very, very high levels. At the top of the list might be things like Tesla’s, for example. And that would, you know, that could be much, much higher than 25% tariffs, but a small portion of the trade picture where you essentially throw a blockade on those types of imports. And that's possible.

I think we need to treat things like export taxes extremely carefully. You're talking about long run reliability as a supply partner to the United States for some key critical minerals and commodities. There are other options around the world. They're not as easy, they're not as close by to get and certainly on things like hydro, they're their long-term contracts at stake here. There are all sorts of complications and but I I would expect retaliation and for no other reason than twofold.

One, politics. We're in the middle of an election. I think the government doesn't want to look weak before the very irate electorate wondering what would what did we do to deserve this? And secondly, I think it's the right economics.

Traditional economists would say when another country comes along and whacks you with tariffs, you turn the other cheek, you just take it. Traditional economists are wrong. In my opinion, in that environment, I think you want to show your hand and retaliate pretty significantly against the US to make it clear that the costs are significantly the other way in order to try to get to an agreement faster and or to make it clear that if you try to come after us again the next time, it's not going to be cost less to you then either. So, there's a multiperiod, strategic game theory approach here that involves thinking beyond the immediate. And the longer run consequences. If you just roll over and take this right now, you could be stuck with a torment, torn up Kuzma, USMC, a trade deal for all of Trump's term or beyond. Who knows who's coming after him.

And so, I think you need to take a bit of a hardball tactic at first and then cross your fingers and hope both sides come to the table and, and, and cool their jets here. But in the interim period of time, I would expect Canada to be retaliating.

BK: Roger, do you want to jump in on that too?

RQ: I am going to disagree to some extent on that. I think after we didn't get hit with reciprocal tariffs yesterday, I don't think it, I don't think we should be retaliating immediately in a big way. At least I, I do think there's scope to, you know, retaliate on the sectorial tariffs to some extent and send, you know, use tariffs, sorry, use retaliation to send messages, which we have been doing. But you know, I think I think it may send the wrong message to retaliate after we didn't get hit with reciprocal tariffs yesterday.

DK: We've gotten hit with a lot of sector tariffs though they effective impact upon us on autos, on base metals that are steel, aluminum, copper, lumber, a lot of other products potentially going forward. That's we dodged one form of tariffs only to get a hit by quite hard on another form of tariffs and very, very highly integrated sectors. So, it's we can agree to disagree on that, Roger.

RQ: Yeah, next question.

BK: Thanks guys. And maybe one for Hugo here. Umm, I've got an equity investor that needs to stay invested. You mentioned a few sectors to prefer defensives and maybe more granularity on that, but more importantly, maybe sectors to avoid.

HSM: Well, I think to avoid on, on the cyclical side, it could become difficult. If you looked at the open this morning, clearly everything that is a bit more cyclical is lagging like the financials are lagging, the industrials. Let me pull my sheet. But this is where we could see probably a bit more damage going forward. Like industrials are down almost 3%, Financials are down almost 3% as well. Energy got it. As I mentioned, weaker global growth certainly bites into energy demand. So, all prices retreating. So, all those cyclical areas, technology which is extremely expensive despite, despite the pullback could be a bit more at risk in my opinion. So those cyclical areas of the market is where you want to be probably prudent.

BK: Thanks for that. You know, we're coming close to time here. So maybe time for one more question and maybe I'll pose it to Derek. And if the US is successful in bringing these manufacturing jobs back to the USA, unemployment is near record lows already. How will they find the workers to do these jobs? How do they make it happen?

DH: Great question, Bannon. And it's, I, I mean, yes, you mentioned the starting point for the labor market has already tight. the US is invoking tighter immigration policy. I mean, they're, they're maybe not as aggressive as what Trump would have liked by this stage. I mean, they're getting some push and shove back in both directions. And in terms of the feasibility and the practical aspects of removing that many people from the United States and some of the challenges that are that are involved. But regardless, I mean, you're, you're going to slow population growth into the United States quite markedly going forward. And so, you're, it's a, it's a mystery to me where you get the added workers.

There are other possibilities. Maybe a big productivity surge. Maybe you bring a bigger, you know, if, if they're very tight labor markets and you're doing these things, maybe you raise root wages enough to pull more people off the sidelines and raise the labor force participation rate. So, there are some possibilities, but on balance, I think it fits into the to the inflation picture. If you do see this, this happening, you just create more contestability for labor, more competition for them and whether it's wages and or productivity, you could wind up with further pressures at this point.

So I'd sum up this way, not all the different parts of what the Trump administration is trying to do necessarily add up in terms of consistency and by way of broad macroeconomic policies.

BK: Thanks Derek. Boris wanted to jump into Boris.

BS: Absolutely thanks. So, the unemployment rate is very low. Derek is right. But the one dynamic we've seen since the late 90s is the fall in the labor force participation rate of about five points. So, five points on the on the labor force is about 8 million workers. Now the bigger point is, is that like, why, why have they left the labor force? And, and one of the things that's being attributed is this hollowing out of the manufacturing base. This is at least the messaging from the administration. Now the reality is, is that even if they were successful in bringing back from this manufacturing, the new age of manufacturing is nowhere near as labor intensive as it used to be. So, we're not talking about directly that many jobs, but it's the broader activity and the broader spillovers and everything else that the US administration wants to see come back to some of those communities in the Midwest etcetera. They've been hollowed out.

So, this is a very much about politics. This isn't about really employing millions of people. It's the politics of bringing manufacturing back. And I think that's kind of the priority here.

DH: Very quickly, it's an aging population too. So that's where the big part of the reason why the part participation rates have declined.

BK: Thanks team. You know, looking at time and we're coming up to me here. So, I wanted to take a second and our listeners for joining us today. All the Q&A we were able to discuss also for to our speakers for taking the time. There's still so much more to unfold here. And I think discuss if, if any of you do want to dig into these topics further, please don't hesitate to reach out to our speakers, but certainly your Scotia representatives.

Thanks everyone. Have a great day.