Economic Update Q2 - 2025

2025 has started in an unusually turbulent fashion. Since Donald Trump’s re-election in January, financial markets have been navigating a perfect storm of geopolitical and economic headwinds: a dramatic escalation in tariff policies, renewed tensions with China, intensifying conflict in the Middle East, and continued instability in Eastern Europe. The global environment has been marked by uncertainty and rapid shifts in sentiment. Nonetheless, we are approaching these events with composure, vigilance, and an active management strategy aimed at capital protection and long-term performance.

Tariff War

The return of aggressive protectionist policies has been one of the defining themes of Q2. Since March, the Trump administration has introduced sweeping new tariffs targeting strategic imports from China, Europe, and Mexico.

• Short-term impacts include a spike in input costs for U.S. manufacturers, renewed inflationary pressures, and abrupt market swings — particularly in industrials, autos, and consumer durables.

• Medium-term: Expect supply chains to continue fragmenting. Many multinationals are fast-tracking relocation of production capacity to Vietnam, India, and Eastern Europe to avoid direct U.S.-China friction.

• Long-term: If not resolved, the fracturing of global trade could erode decades of efficiency gains, accelerate regionalization, and create lasting price stickiness in traded goods. It also risks embedding protectionism into electoral platforms globally.

  
  

Retaliatory tariffs from Europe and Asia set to begin on July 7 may trigger another wave of instability.

U.S.–China Relations

Tensions between the world’s two largest economies have shifted from passive rivalry to active economic confrontation. Tariffs are only the visible tip of the iceberg. Below the surface, technological decoupling is accelerating.

• Current developments: The U.S. has restricted access to advanced AI chips, forcing U.S. firms to reroute production and Chinese firms to scale back key tech ambitions. Bilateral trade volumes have fallen ~18% YoY.

• Strategic shift: China's pivot toward ASEAN and BRICS+ for trade resiliency is reshaping global alliances. At the same time, U.S. firms are investing in “China+1” supply strategies to reduce exposure.

• Outlook: Expect the competition to intensify in cybersecurity, semiconductors, green tech, and quantum computing — sectors that could also provide long-term investment upside.

  
  

Inflation & Unemployment (U.S. & Canada)

Inflation across North America has moderated to a stable range of 2.7–3.1%, aided by energy price stabilization and easing supply chain constraints. Core CPI remains above central bank targets, however, largely due to elevated housing and services inflation.

• U.S. unemployment remains near 3.9%, with strong job creation in healthcare, tech, and construction.

• Canada has shown similar resilience, with unemployment at 5.6% and robust immigration helping to offset labor shortages in key sectors.

Conclusion: Economic activity remains solid, but the “last mile” of inflation control may prove difficult — especially if oil prices rise or tariffs amplify consumer prices.

Recession Risk Revisited & Stagflation Outlook

Recession fears have abated — but not disappeared. The U.S. now has a ~30% recession probability over the next 12 months (down from 65% in April), thanks to surprising consumer strength and private investment.

• Growth: Q2 GDP in the U.S. is tracking above 2.4%, with particular strength in services and AI-driven CapEx.

• Fed policy: The Fed’s pause in rate hikes has reassured investors, although it has made clear it remains data-dependent.

• Labor: Wage growth is outpacing inflation, supporting consumer demand but also complicating disinflation goals.

  
  

2026 Stagflation Watch:Should tariffs remain elevated and geopolitical risks worsen, stagflation becomes a real possibility. Early indicators:

• A flattening yield curve and modest inversion in 2s/10s.

• Sticky core PCE above 3%.

• Slowing productivity despite high employment.

  
  

Russia–Ukraine War

Now entering its fourth year, the war has become a chronic source of instability in Eastern Europe. Ukraine’s spring counteroffensive has stalled, and Russia remains entrenched in eastern territories.

• Impact: European energy dependency has shifted structurally, with natural gas imports from the U.S. and North Africa partially offsetting lost Russian supply.

• Market implications: Energy-intensive industries in Europe continue to underperform; defense spending is rising steadily across NATO.

  
  

A prolonged conflict will remain a wildcard for energy markets and risk premiums in Europe.

Middle East Conflict

Tensions have escalated in the Strait of Hormuz and Gaza region, with skirmishes disrupting shipping lanes. The Brent crude price has flirted with $83/barrel, fueled by fears of supply disruption.

• OPEC+ has maintained output discipline, aiming to keep oil above $80/barrel. This could reintroduce inflation risk globally.

• Investment angle: Energy equities, which had been underweighted, are seeing renewed inflows. Gold has also reclaimed its safe-haven role, up ~12% YTD.

  
  

We remain vigilant, as further escalation could create ripple effects in both commodities and currency markets.

Equity Market Performance & Volatility Outlook

Q2 saw sharp equity swings, driven by trade shocks and earnings resilience.

• Performance: The S&P 500 retraced ~8% before recovering to end Q2 with a modest +3.7% gain. TSX lagged at +1.2% due to weak materials.

• Volatility: VIX remains elevated (18–21 range), as geopolitical headlines dominate sentiment.

• Opportunities:

  • Tech and AI-related names continue to outperform, though valuations are stretched.

  • Clean energy and infrastructure benefit from fiscal stimulus packages.

  • Small caps remain undervalued, but investor appetite is cautious.

    
    

Markets may remain choppy through Q3, but positive earnings revisions could act as a buffer.

Portfolio Management & Strategy Outlook

We are adapting portfolios proactively:

• Equities: Active management is paramount. We’ve added selectively to U.S. growth and Japanese equities, where valuations and FX tailwinds are attractive.

• Fixed Income: Corporate bonds (BBB+ and above) offer 4.5–5.0% yield opportunities, with lower volatility than equities.

• Geographic diversification: We’ve increased allocation to Eurozone industrials and EM consumer tech — areas poised to benefit from global realignment.

• Cash: Strategic dry powder remains essential. Current holdings in short-term instruments yield ~4.2%, preserving optionality.

  
  

Capital Protection First

Our investment approach remains guided by prudence:

• Capital preservation is our anchor, especially during high-volatility phases.

• We’ve modestly increased allocations to ultra-short-duration instruments and gold.

• Tactical hedging has been employed in high-beta sectors to cushion downside risk.

If recession or stagflation risks escalate, we are prepared to raise cash positions and reduce cyclical exposure swiftly.

conclusion

Despite a turbulent start to 2025, we remain confident in the resilience of the global economy. While risks such as trade fragmentation and stagflation loom on the horizon, our portfolio strategy is well-balanced — favoring quality assets, tactical diversification, and capital preservation. We are here to help you navigate uncertainty and seize opportunity with discipline and foresight.

National Bank Financial - Wealth Management (NBFWM) is a division of National Bank Financial Inc. (NBF), as well as a trademark owned by National Bank of Canada (NBC) that is used under license by NBF. NBF is a member of the Canadian Investment Regulatory Organization (CIRO) and the Canadian Investor Protection Fund (CIPF), and is a wholly-owned subsidiary of NBC, a public company listed on the Toronto Stock Exchange (TSX: NA).

The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. The opinions expressed do not necessarily reflect those of NBF.

I have prepared this report to the best of my judgment and professional experience to give you my thoughts on various financial aspects and considerations. The opinions expressed represent solely my informed opinions and may not reflect the views of NBF.

The securities or sectors mentioned herein are not suitable for all types of investors. Please consult your Wealth Advisor to verify whether the securities or sectors suit your investor's profile as well as to obtain complete information, including the main risk factors, regarding those securities or sectors.