Rhythmic Reasoning_Full Report_Final_EN - Flipbook - Page 6
THE DRUMMER'S EAR | RHYTHMIC REASONING
We see these concerns clearly in consumer measures of inflation
expectations.
Fig. 2: U.S. tariffs averaged 10% in July
% effective duty rate
38.4%
14.5%
9.5%
2.3%
8.9%
3.0%
0.1%
World
10.7%
4.7%
Canada
1.5%
1.2%
0.2%
Mexico
E.U.
2024 average
Beyond inflation, our expectations for economic growth around
the globe remain highly sensitive to sudden shifts in tariff
policy. Eurozone GDP growth, for instance, could take a hit from
steep pharmaceutical tariffs, while a contentious renegotiation of
the U.S.-Mexico-Canada Agreement (USMCA) in mid-2026 could
reawaken the risk of double-digit tariff rates across North America
—and thus recessionary fears.
China
Japan
Jul 2025
Source: U.S. ITC, Scotia Wealth Management
Fig. 4: U.S. investment has flatlined outside of information
technology and intellectual property investment
160
2019 avg. = 100, real
Recent economic developments have evidently resulted in a
prioritization of labour and economic outcomes over inflationary
fears in North America, flipping our expectation for greater Fed,
BoC (and even Banxico) caution in rates-setting. We see this
shift in tone more clearly in the U.S, the originator of the trade
tensions roiling the global economy. Recent revisions to job
creation numbers in the U.S. show a significantly softer labour
market than earlier revealed by published data.
In the U.S., labour market weakness may seem surprising on
first blush considering the better-than-expected performance
of the U.S. economy so far this year, but looking beneath
the surface on GDP data suggests underlying challenges. The
U.S. is benefitting from an extraordinary surge in investment
in information technology and intellectual property that is
masking broader weakness in investment and struggles in U.S.
manufacturing activity (Fig. 4).
Fig. 3: Growth to remain muted in
the G-10, China, and Mexico in 2026
6%
140
120
100
80
4%
60
2015
2%
2019 avg. = 100
0%
2017
2019
2021
Nonres. investment ex. IT and IP
2023
2025
IT and IP investment
Source: BEA, Scotia Wealth Management
-2%
U.S.
CA
MX
EZ
2025 forecast
U.K.
JP
CN
CL
CO
PE
2026 forecast
Source: Scotiabank Economics, Scotia Wealth Management
The outlook for monetary policy depends critically on how inflation
evolves. The tension between inflation and growth is evident. The
balancing of these tensions is challenging given the unprecedented
nature of the U.S.’s policy actions (in trade but also immigration).
Key to striking the right balance is the extent to which inflation
pressures will prove to be transitory or not. It seems clear that the
Fed and Bank of Canada want to believe these pressures will be
temporary for the time being.
That is a reasonable, but risky, position to take. If all goes well,
tariffs should have a one-off impact on price levels. Given the
breadth of tariffs applied in the U.S., their staggered sequencing,
and the threat of even more tariffs going forward there is a real risk
that tariffs lead to a broader and more sustained rise in inflation.
We continue to think a recession will be avoided in the U.S.
but expect growth to slow from 1.8% this year to 1.4% in 2026.
Recession or not aside, these are weak numbers for the U.S. and are
well below potential growth suggesting the economy will transition
from excess demand to excess supply in 2026. The hope is that this
opening of spare capacity will put downward pressure on inflation
(offsetting tariffs price pressures), allowing the Fed to lower its
policy rate.
There is an added consideration of political pressure on the Fed
which can only increase the odds of lower interest rates. Recall
that President Trump has said numerous times that the U.S. policy
rate should be cut by 200–300 basis points. Shifts in Fed board
composition and the selection of a new Chair in May next year
clearly raise the possibility that the Fed will, at best, prioritize
arguments of a temporary inflation hit, and at worse, indicate great
comfort with elevated levels of inflation in the implementation
of monetary policy. Were commitments to on-target inflation to
slip, then we could see lower rates than our expected landing
point of 3.00%; a weakened mandate would come with a host
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