Economic Growth Is Holding Up Despite Numerous Geopolitical Risks

In the wake of its military operation in Venezuela, the US administration is ramping up threats to annex Greenland, which could have significant global geopolitical implications, especially for NATO member states. The United States has also threatened military interventions in other Latin American countries, including Cuba, Colombia and parts of Mexico. Given the circumstances, diplomatic and economic relations between the United States and other advanced economies could break down. Global uncertainty remains elevated on existing tariffs and the spectre of more, especially in light of the Greenland situation. Central banks may need to lower their key interest rates further if the economy deteriorates more than expected. Conversely, monetary policy may need to be tightened if inflation spikes due to new tariffs or supply chain disruptions. Geopolitical tensions could contribute to inflation by pushing up the price of some commodities, including oil. We’ll also need to keep a close eye on the threats to the independence and neutrality of key economic institutions in the United States, including the Federal Reserve (Fed), where a new chair is expected to take over in May. The issue of US federal government funding is likely to rear its head again in early 2026, although this year’s focus will be more on the midterm elections, the Supreme Court’s rulings on the Trump administration’s trade policy, and CUSMA review, all of which could disrupt the economy. The erosion of US institutional pillars may prompt some global investors to further reduce their exposure to the United States. But the rest of the world, including Europe, is facing its own political and budgetary challenges, as evidenced by the recent selloff in Japanese bonds. And there are risks of financial instability, especially if regulatory frameworks are loosened. A sharp correction in the stock market, which is in the midst of an AI boom, could shake confidence and trigger a wealth effect shock, while volatility in bond, currency and commodity prices could weaken the outlook for the global economy.

Interest rates in North America are expected to diverge this year. The BoC should remain on hold while the Fed is expected to resume its easing cycle in the latter part of the year. That said, the response across yield curves in both Canada and the United States will be complicated. In Canada, yields at the short end should move higher by year-end, reflecting growing conviction that the BoC will raise rates sometime in 2027. That said, long-end rates could actually move lower as markets begin to price in less term premium if investors continue to flock to Government of Canada bonds. In the United States, there’s scope for further steepening, driven by both a decline in front-end rates from Fed easing and rising term premiums from ongoing concerns about the political and fiscal trajectory in the United States.

Equity and credit markets should experience some volatility in the first half of the year but ultimately weather the storm in our base case outlook. Corporate profit margins remain elevated and economic activity is expected to remain resilient. The Canadian dollar should track a similar path to risk assets, experiencing volatility in the first half, followed by a gradual appreciation relative to the USD in the second half.