Is Cautious Optimism Warranted?

This week’s key economic updates came from both the Bank of Canada (BoC) and the U.S. Federal Reserve, which each opted to hold interest rates steady. However, it wasn’t the rate decisions themselves that grabbed attention; it was the context. Trade policy, particularly U.S. tariffs, dominated the narrative.

The BoC’s Monetary Policy Report highlighted the uncertainty, offering scenario-based projections rather than a single base case. Meanwhile, the Fed maintained its policy stance, citing continued risks that tariffs could lead to more persistent inflation rather than a one-time shock. Both central banks emphasized a “data-dependent” and patient approach, underscoring the need for more time to assess broader tariff impacts, particularly on employment, where effects typically lag.

Yet despite this caution, markets have surged since the April lows. So, what’s fueling the rebound? It largely comes down to four main factors:

1. Trade Risks Have Receded: Markets have generally priced in the U.S. administration’s stance on tariffs as strategic leverage rather than a threat. Although yesterday’s deadline brought some uncertainty, trade agreements are still likely to be reached in the weeks and months ahead, helping to stabilize the outlook. Recent deals with Japan, Europe, the UK, and Vietnam highlight the administration’s continued push to finalize trade agreements.
   
2. Earnings Strength: More than one-third of S&P 500 companies have reported Q2 earnings so far, with an impressive 81% surpassing analyst expectations, setting the stage for the highest beat rate since the second quarter of 2021. Notably, Apple, Microsoft, and Meta, which together account for nearly 20% of the index, reported strong earnings. Their forward guidance will likely play a critical role in shaping the market’s move in the coming months.
   
3. Resilient Economic Data: The labour market has remained steady, retail sales and industrial production have been stronger than expected, and global business activity has stabilized, easing concerns about a potential recession.
   
4. Tame Inflation: While certain tariff effects are emerging (e.g., durable goods and apparel), other categories like autos and lodging offset the pressure, keeping core inflation in check. Time will tell how recent changes to trade policies will impact future data.

Investor sentiment has shifted accordingly. Despite earlier worries about trade tensions and slowing growth, markets have continued to gain ground, supported by better-than-expected data.

All in all, it’s a good sign for both portfolios and what could be ahead in the coming months.