Shaken, Not Stirred

In the latest faceoff between fear and fundamentals, the health and resilience of the global economy seems to be prevailing for now.

Fear—which ripped through markets in April after widespread tariffs and policy changes were announced—has largely been sidelined as signs of economic health continue to emerge. This is not unusual. Behavioral finance studies indicate long-term investors tend to let emotions cloud their judgment when volatility spikes before returning to a focus on fundamentals. This typical progression suggests our outlook for 2025 has been shaken, not stirred.

While policy uncertainty and geopolitical risks could result in more volatility this year, global stocks are benefiting from this more sanguine view and have roared back to all-time highs as of mid-June. Meanwhile, we spy risks of more lasting change in currency markets—the U.S. dollar for one—with important implications for portfolio strategy over the medium-term.  

Coming into 2025, our outlook highlighted the fragile balance between healthy underlying U.S. growth and uncertainty from how the new administration would prioritize the four pillars of its economic agenda—tariffs, immigration, taxes and deregulation. With rich stock valuations and heightened policy risk, our portfolios entered the year defensively positioned, albeit moderately, with an emphasis on diversification across asset classes and global regions. 

President Trump’s “Liberation Day” tariffs shook that delicate balance and drove one of the sharpest selloffs in market history. While we couldn’t know where the dust would settle on tariffs, we saw potential for a pivot toward deals. More importantly, our sentiment indicators started to flag extreme risk aversion in markets—a bullish signal for forward returns on stocks and credit. Leaning into this insight, our portfolios took measured steps to lean back into markets near the early April lows. 

The U.S. administration hit the pause button on tariffs shortly thereafter, taking off all the reciprocal measures from Liberation Day. The pause proved decisive for markets, neutralizing the most extreme downside scenarios for the economy and revitalizing investor sentiment. While equity and credit markets have recovered as we approach the midpoint of 2025, volatility in policymaking and geopolitics is still reverberating across the economic landscape and asset prices.

Our global economic outlook is glass-half-full. Tariffs and trade policy uncertainty have driven a rift in the macro picture. The soft data—including surveys and measures of consumer and business confidence—are at levels normally indicative of a downturn. Meanwhile, the hard data—measures of actual consumer and business spending—shows resilience into early June. This tension leaves uncertainty but our more optimistic read reflects:

• Strong Balance Sheets
  The ability of the U.S. economy to power through a similar divide between pessimistic vibes and resilient fundamentals occurred as recently as 2022. We view this resilience as being supported by generally healthy household and corporate balance sheets.
• Softer Trade Policy
  In early April, tariffs looked large enough to push the economy close to stall speed, with risks amplified by extreme uncertainty and the sharp decline in financial markets. After the tariff pauses in April and May, those headwinds are receding. While there is still a risk for more changes in tariff policies to come, the pauses are still an important signal that there might be room for negotiation. 

• Spending Support
  The sharp recovery in markets is a tailwind for the economy. Higher stock prices are likely to support spending by high-income consumers, which account for roughly half of aggregate demand in the U.S.

Heightened geopolitical tensions and volatile oil markets pose additional risks to the outlook. However, the United States  is less vulnerable to energy shocks today than it was in the 1970s. We believe that it would take a period of persistently high oil prices to deliver a meaningful economic hit to the U.S. economy.

On balance, we expect slower but still positive growth in the second half of the year, reflective of a “soft-landing” scenario. Still, we continue to believe that macroeconomic uncertainty remains elevated, and we can’t rule out the possibility of a recession. Across the Atlantic, there are signs that U.S. policy could, counterintuitively, be a force that reinvigorates Europe. Germany’s election and subsequent stimulus package have the potential to transform the outlook, with an estimated doubling of economic growth in 2026 and 2027.

Meanwhile, the outlook for China was on a knife-edge in recent months until embargo-level U.S. tariffs were pulled back in mid-May. We expect Chinese policymakers to provide enough fiscal support to meet their growth target of “around 5%” for 2025.

We often get asked if U.S. exceptionalism is over. We see the potential for a pause in the outperformance of U.S. markets. But we believe the United States is likely to retain much of its strategic fundamental edge. America’s advantages include a stronger demographic profile than Western Europe, leading technology firms that remain at the cutting edge of AI and robust new business formation which is likely to support the country’s ongoing productivity margin.

Still, we see the balance of risks as being skewed toward U.S. dollar weakness over the medium-term. The greenback looks historically expensive, and its return patterns appear to be shifting with signs that global investors are hedging their exposure to dollar-denominated assets.

Our asset class preferences are measured with the extreme market volatility from early April having abated. But we think the outlook for a weaker dollar amplifies the strategic case for running globally diversified portfolios. In fact, our managers are finding attractive opportunities in non-U.S. investments across both the public and private markets.

Canada’s economy still faces challenges, with the unemployment rate reaching 7% in May, two percentage points above the 2023 low. Meanwhile, inflation reaccelerated in April, putting the Bank of Canada (BoC) in a difficult spot. Although trade tensions may boost prices in the near term, the bigger impact over the medium term will likely be a weak growth trajectory. We expect the BoC to cut rates by more than what’s been priced by the market. Higher cyclical risks in Canada but less stretched stock valuations keep us neutral on stocks. We think Canadian government bonds are a key defensive tool.

Defying gravity

The Canadian economy started 2025 at a point of fragility. Although headline growth in Gross Domestic Product (GDP) topped expectations in the first quarter, there was an important nuance to be mindful of. In an effort to minimize tariff impact, many U.S. businesses opted to place their orders for Canadian products earlier than normal. This resulted in a temporary increase in exports in Q1 which boosted overall headline GDP growth.  Final domestic demand—which strips out the effects of net trade flows—contracted by 0.1% on an annualized basis. 

Additionally, the Canadian labor market continues to show weakness. The unemployment rate reached 7% in May–a level not seen since 2021, and roughly two percentage points above the 2023 low.

The R Word

Unfortunately, the economic outlook for Canada will likely remain under pressure in the near term. The industry consensus indicates the Canadian economy may have contracted in the second quarter and may continue contracting in the third, which would put it into a technical recession. That scenario could see the unemployment rate rise even further from current levels and be a headwind for consumer spending.

Ongoing trade negotiations between Canada and the U.S. could play a key role in the depth and duration of a potential economic slowdown. While we anticipate the two countries will eventually align on a trade deal that could result in a rollback of most of the tariffs, that process likely won’t play out overnight. An extended period of elevated tariffs could significantly hinder Canadian economic activity.

Another challenge that the Canadian economy faces is elevated debt levels. Even though the Household Debt-to-GDP ratio in Canada has come down from its peak, it is still significantly higher than the comparable metric in the U.S. This could make it harder for Canadians to navigate an economic slowdown.

One silver lining is that the Canadian banking sector remains well-capitalized, meaning that banks are in a solid position to absorb potential losses from an economic slowdown. This can help dampen the adverse systematic impacts of a recession.

Playing limbo

Many investors have been playing a game of limbo: asking themselves how low interest rates in Canada can go. The Bank of Canada cut rates more aggressively than any other G-7 central bank this cycle, slashing its overnight benchmark rate by 225 basis points cumulatively.

Although the Bank of Canada paused rate cuts in April, we believe rate cuts could likely resume by July. Subdued economic activity should serve as a moderating influence on inflationary pressures, meaning the recent re-acceleration in core inflation may be temporary. And given that Canada has only placed retaliatory tariffs on a partial subset of imports from the U.S., the trade standoff may have a larger downward impact on Canadian economic growth than an upward impact to Canadian inflation.

Markets currently expect the Bank of Canada will cut interest rates a cumulative 50 basis points this year. We believe that estimate may be overly conservative. The central bank will likely need to cut rates more aggressively to stabilize the economy and ensure that medium-term inflationary pressures do not undershoot the target, particularly if a recession takes hold. 

Market views

Stocks: We are neutral on Canadian stocks. Although cyclical risks remain elevated, valuations still appear to be close to longer-term averages.

Bonds: We value Canadian government bonds for their defensiveness and capital appreciation potential should the Bank of Canada ultimately cut rates by more than what’s been priced in. However, elevated macroeconomic uncertainty keeps us close to longer-term targets on duration positioning.

Currency: Over the medium-term, we think  the Canadian dollar (CAD) may strengthen against the U.S. Dollar. Near term: the path is less certain. Higher oil prices could be supportive of the CAD, but if Canada does tip into a recession, that could put downward pressure on the CAD. However, near-term upside may be limited if Canada does tip into a recession.  

¹ Russell Investments’ calculations based on 2024 annual filings from the respective companies and top 10 constituents information sourced from the S&P/TSX Composite Index (CAD) factsheet