By Douglas Porter

July 25, 2025

You know it’s a slow summer week when the biggest focus for markets is Japan, and a tour of a certain U.S. government building renovation. But it’s telling that even in a near-void of new info, equities continued their seemingly natural progression higher—it has been a remarkably smooth ride up for global bourses over the past three months, and the MSCI World Index is now up a cool 15% y/y. Corporate earnings provided a tailwind, but the preliminary trade deal with Japan also proved to be a small positive surprise. The relative calm will be tested next week by key central bank decisions; a wave of important data; and, of course, the August 1 ‘deadline’ for trade deals. While we are not in the business of calling weekly moves, here’s guessing the market navigates this coming tricky course with relative aplomb as well.

The deal with Japan was important on a number of levels. First, this is the only deal (so far) with a top-5 partner, and one that has long been a focus of the President. Second, given the LDP’s thrashing in Sunday’s Upper House election, and with PM Ishiba’s reign in peril, it’s impressive that a deal was done at all. That’s especially the case when negotiations had, by all accounts, been struggling, and potentially stuck on the auto sector. That brings us to the third reason the deal was key: Japan’s autos will now face “just” a 15% tariff, a notable cut from the 25% that others face, and showing that even sectoral tariffs are not set in stone. This relief was apparently won by the promise of massive Japanese FDI flows of $550 billion (although it’s not clear whether corporate Japan has signed up for this!). Finally, the 15% base tariff likely sets an important benchmark for other major trading partners, and drums home the point that meaningful tariffs are here to stay.

Canada’s PM Carney more or less echoed that sentiment by cautioning that any deal with the U.S. may well include some semi-permanent tariffs. At the same time, he warned that the August 1 deadline may not hold, and that Canada would not be rushed into a bad deal. Intergovernmental Affairs Minister LeBlanc said “a lot of work” still needs to be done. President Trump showed just how much “work” by suggesting on Friday that, for Canada, it may just be a tariff—not a negotiation. Ok then. While Canada faces the prospect of a 10 ppt hike in its tariff to 35%, that’s only on the narrow slice of non-USMCA compliant goods, so the bigger issue is the sectoral hits on autos and metals. We would note the quirk with Japan’s deal, that a vehicle produced in Yokohama with zero American content could face a lower tariff than a vehicle produced by a U.S. company a river away from the U.S. in Windsor Ontario. Not surprisingly, American auto companies are not amused by this irony, and some warned of the direct cost of tariffs in their Q2 earnings calls.

While trade will rumble away in the coming week, market attention will turn to the FOMC (and BoC) meeting on Wednesday. While there is almost no debate on what rates will do—nothing—the focus on the Fed will be whether there are any dissents, and Chair Powell’s latest take on the economic/trade landscape. The market is leaning heavily to a renewal of rate trims in September (and we concur), and a solid possibility of another move later in 2025. Powell is unlikely to shake that narrative, although it’s also doubtful that he will cement that view.

It’s true that the economy seems to have perked back up in June, with jobs, housing starts, retail sales and manufacturing sales all solid.

Next week’s data flow will also play an important role in shaping rate expectations. The same day as the FOMC, we’ll see whether the U.S. economy bounced back in Q2 from that 0.5% drop in Q1 GDP; we say yes, although our call of 1.6% growth is almost a point below consensus. More importantly, we’ll also get a good read on how growth fared in July from Friday’s payroll report (expecting +114k and an uptick in the jobless rate to 4.2%), auto sales (stable at 15.6 mln), and the factory ISM (uptick to so-so 49.8). Both of the major consumer confidence surveys will also be released, and we suspect that they will show some improvement, as households are probably more relaxed about the inflationary threat from tariffs. If our calls hold up, that will do little to dissuade prospects of Fed cuts in the final four months of the year.

For the Bank of Canada, the odds of a rate cut next week are not zero, especially given looming permanent U.S. tariffs, but the recent core CPI performance is a very high hurdle. And, in contrast to Fed pricing, the market is far from certain that any further rate trims are coming. At this point, there is a bit less than a 50% chance of even one cut priced in for the rest of 2025. Of course, some of that gap with the Fed is due to the fact that the BoC has already delivered 225 bps of cuts versus just 100 bps from the Fed (Chart 1). Still, we lean to the dovish side of the market, with a somewhat pessimistic view on the prospect for U.S. tariffs, and a relatively optimistic view on underlying inflation.

The latest quarterly Business Outlook Survey, while a tad outdated (seemingly everything this year is outdated within minutes), showed sentiment remains soft. And, importantly, firms are now looking for a small dip in output prices and a further moderation in wages. After last year’s hot streak, wage trends have quietly steadied this year—the LFS shows that average hourly wage gains have chilled from more than 5% y/y last summer to just 3.2% in June. This, and calmer shelter costs, should help set the stage for slower core inflation trends in the year ahead.

At the same time, the early read on Q2 GDP—out on Thursday, the day after the BoC decision—is expected to print negative. With both April and May monthly GDP slipping, and export volumes absolutely skewered in the quarter, the table is set for an outright decline in Q2 GDP. We suspect that when the official figures are released in a month, the drop will be even deeper, as net exports weigh much more heavily in the quarterly data than the monthly figures. It’s true that the economy seems to have perked back up in June, with jobs, housing starts, retail sales and manufacturing sales all solid.

But given the relentless uncertainty on the trade front, it’s far too early to sound the all-clear signal for growth. The economy has no doubt held up better than expected, but two huge sectors face heavy headwinds: (1) home sales remain stagnant with rates stuck, a fog of uncertainty lingering, and affordability still challenged. And, (2) auto production continues to wilt, falling for the fifth month in a row in June, and down to a record-low share of overall North American assemblies in Q2 (at 7.6%). The BoC can’t do anything about auto output, but it can set the conditions for other sectors to step into that void. Ultimately, the question is that given those challenges and a growing output gap, does it make sense for the Bank to keep its lending rate dead-set neutral at 2.75%? That’s a hard ‘no’ from this space.

Policy Contributing Writer Douglas Porter is Chief Economist for BMO.