Potential Economic Outcomes
BMO predicts that if most new tariffs persist, the outcome could be stagflation, characterised by stagnant growth and inflation. A more severe outcome may involve a deeper recession, impacting consumer spending due to higher prices and reduced purchasing power.
Recent market volatility reflects an ongoing fragility in investor sentiment, indicating it is premature to determine a market bottom for risk assets or U.S. Treasury yields.
Bank of Montreal’s team has laid out a precise warning. They’ve observed that the rise in U.S.-China trade friction seems to be drifting further from any meaningful resolution. This isn’t just political theatre anymore; the numbers reflect real changes. Tariffs on Chinese imports have climbed to around 30%. That’s not a small shift—it’s up from earlier calculations of just over 20%, which already had markets on edge. Those increases aren’t just policy points either. They dig into costs, which then ripple across manufacturing and logistics, and ultimately push up the prices consumers see on shelves.
The current consensus seems to be clinging to the idea that these tariffs are all part of some longer-term strategy, one where both sides could pull back if negotiations get serious. The trouble is, that theory depends on the assumption of progress—evidence of which has been scarce. The backdrop now looks a good deal more structural than tactical.
Using their models, the analysts at BMO have outlined two credible outcomes. The first involves stagflation. A tough environment, where prices keep rising but the economy stops moving forward. That has real-world effects. Fewer jobs, less hiring, shrinking bottom lines across sectors. The harsher possibility is a broader recession. This would amplify cost-of-living pressures and lead households to tighten their belts several notches. When purchasing power falls—especially because of price increases that consumers can’t sidestep—spending naturally slows. That hits earnings, and the cycle worsens.
Market Strategies And Positioning
We’ve seen asset markets reflect this tension. Volatility isn’t coming from nowhere. Equities have swung sharply, and Treasury yields haven’t been able to settle into any reliable pattern. There’s discomfort—not just because of earnings uncertainties, but because growth itself now looks questionable. When real yields move like they have recently, it’s often a sign that investors haven’t yet come to any firm conclusion about what’s next.
So what does this mean for us? One should look past surface-level optimism. A wide variety of market participants still appear to be pricing in some eventual improvement in trade talks. But unless there’s new, verifiable momentum from policymakers, that view doesn’t stand up well under scrutiny. While headline flashing may cause temporary reversals, sustained positioning based on vague hope is unlikely to pay off.
In options and futures markets, repricing of downside tails suggests that risk is no longer considered as merely hypothetical. We can observe this in elevated implied volatilities, especially over medium-dated tenors, where increased uncertainty surrounding growth expectations and price stability is more pronounced. Short-term hedging costs remain high, which tends to limit aggressive positioning, but that doesn’t mean exposure is low—it’s more a case of constrained willingness to take directional risk.
Strategies now must reflect not only the price level, but the uncertainty around earnings reliability and forward inflation expectations. Derivatives pricing, particularly skew in equity indexes, confirms that markets are no longer discounting an easy path forward. That said, with real rates remaining unstable and yields not settling, trying to front-run stabilisation by loading up on rate-sensitive assets seems premature.
As macro data comes in weak or mixed, we should be ready to review duration and convexity exposure regularly. The environment has become more reactive than proactive. Data surprises—both positive and negative—are carrying oversized impact, particularly in fixed income volatility. That makes outright conviction trades difficult. Instead, relative value and spread-based positioning, especially those that remain neutral to outright market direction, seem more suited.
In currencies, especially EM crosses sensitive to U.S.-China flows, increased hedging demand speaks volumes. Risk reversals have widened. That tells us traders are not searching for upside, but rather trying to protect downside scenarios they now view as likely. For us, that suggests staying underweighted in risk-heavy assets until news flow consistently builds in one direction—not just a few positive headlines followed by silence.
Be alert. Policies are affecting fundamentals, and markets are reacting on a delay. That delay is narrowing. Now isn’t the time to bet on a turnaround pretending it’s already been confirmed.
