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In my last column I discussed why a country might impose tariffs. With U.S. tariffs on Canada expected to hit next week, I thought I would expand on the theme, and discuss further the impacts of tariffs to countries imposing them, and paying them. But I will go further and discuss other U.S. policy initiatives as well and outline how the U.S. is playing with fire. It is entirely possible that the U.S., with tariffs and other measures, is going to quickly induce a recession, taking the world’s strongest economy down with some inane policy moves.
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Inflation
Tariffs do not “raise money” for a country. They simply make everything more expensive. Reciprocal tariffs result in costs everywhere rising. Remember 2022? Inflation rose to nine per cent, scared everyone, and stock markets plummeted. Do we really want to go through that again? Any student in Economics 101 knows that tariffs have never worked as intended. They didn’t work in 2018 and they won’t work now. Inflation ticked up in the U.S. in the last monthly report, and that is even before any real tariff impact. Inflation needs to be watched here, very carefully. Investors will likely take a conservative, risk-off approach for a period of time.
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Interest rates will not decline as fast as expected
Somewhat connected to the above points, the United States Federal Reserve has made it clear it is not in a big rush to lower interest rates further. Stock markets were counting on lower rates to help boost the economy and stock market valuations. Lower rates make alternative investments such as guaranteed investment certificates (GICs) less attractive, and can improve valuation multiples as future earnings growth is discounted to a lesser degree. The result: strong stock markets. If rates do not fall as fast as expected or, gulp, actually rise, then the stock market is likely going to struggle some more, and this week’s volatility might become more common.
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Job losses can induce a recession
Elon Musk wants to fire 2.6 million federal employees. Reducing government bloat and lowering the deficit can make sense. But it is the timing that is scary. You cannot just fire everyone at once. Again, any economics student knows about the trickle-down effect. One job loss results in lower spending by the poor soul out of work. This results in weakness at his or her local store and associated service providers. Now, multiply that by 2.6 million, and there is a giant economic impact. Even before we consider the impact of inflation, as noted above, demand for goods and services will fall if governments and corporations start laying off thousands at a time. Lower demand equals lower gross domestic product (GDP) equals lower earnings equals a lower stock market, in all likelihood.
Uncertainty causes businesses to simply freeze up
This is the big one. Even before any tariffs or job cuts, business executives are simply frozen with uncertainty, like a deer in the headlights. We have seen multiple government flip-flops already on tariffs, taxes and other issues. A single social media post over a weekend can wreak havoc with all sorts of investors and sectors. Imagine you are a CEO looking to expand, hire new employees and build a new facility. You now have no idea at all what is going to happen with steel and aluminum prices. You don’t know where interest rates and inflation are going. You don’t know what tax rates will be. The result? You delay your decision. We are starting to see this in company conference call discussions. Executives simply do not know what is going to happen, so they go into wait-and-see mode. This results in less spending, less investment and, once again, slower growth in the economy.
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Housing
We have seen reports that average house prices in Washington, D.C., are already down hundreds of thousands of dollars. Fear of layoffs has resulted in some real estate panic. Sure, for now it is regionally isolated. But as job losses expand, house prices in the U.S. could certainly come under pressure. Combine that with interest rates higher than expected, and huge uncertainty, as discussed above, and it’s hard to paint a picture of a robust housing market over the next 18 months. Along with consumer spending, housing is a key driver of the economy. If housing slows down, so too will the economy.
These five factors, if they become pervasive, could result in the U.S. economy going from super strong to mixed to weak or even really weak in a very short period of time, depending on how things play out. This is likely what caused all the investor concern over the past two weeks, and without some better clarity from Washington (which seems highly unlikely), investors may want to temper their expectations for a big market rally this year.
Peter Hodson, CFA, is founder of 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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