By Douglas Porter

July 24, 2026

Markets have been dealing with first one conflict; and, then, a second one over the past 18 months, and those two battles coalesced into a two-front war this week. The older of the two—the U.S. trade war—leapt back into the forefront with the Trump administration threatening a usurious 50% tariff on US$20 billion of Canadian exports, followed shortly by formalizing a 10%-to-12.5% tariff on a wide swathe of goods from all major trading partners, under the guise of Section 301 and forced labour.

The latter step comes with a large footnote, as it mostly just steps right into place of the expiring Section 122 tool, which had been wheeled out to replace the IEEPA tariffs struck down by the Supreme Court in February. For the most part, markets have long since become inured to the trade wars and mostly shrugged off the latest tariff news.

However, the series of announcements and threats served as a rather loud reminder that trade will act as a drag on growth for some time yet, particularly so in Canada.

The more recent conflict made more of a mark on markets this week, as hostilities with Iran broadened to tankers coming under attack in the Red Sea. With the relief valve for Saudi Arabia’s crude exports now also in the line of fire, and the Strait of Hormuz closed until further notice, oil prices vaulted roughly 7% on net for the week, with Brent hitting $100/barrel at one point and WTI ending close to $88.

Perhaps the only surprise is that prices haven’t more quickly reverted to pre-MOU levels—WTI averaged $98 through the first three months of the conflict, and short of a ceasefire there is no obvious reason why prices couldn’t glide past that level with the Houthis now involved.

The snap-back in oil prices, as well as another turn of the screw in tariffs, complicates the job of central bankers everywhere, and lands with a thud ahead of the FOMC meeting on Wednesday. The renewed threat to headline inflation from higher fuel prices is adding to pre-existing upward pressure on real interest rates, arising from the expected growth boost from AI spending.

Combined, this drove U.S. 10-year Treasury yields to an 18-month high above 4.7%, and 30-years close to their highest since 2007 at nearly 5.2% on Thursday, before easing slightly to end the week. Shorter-term yields also bounced, sweeping aside the brief relief from June’s benign CPI—so last week!—with 2s rising above 4.3%, levels not seen since early 2025 (i.e., pre-wars). Markets are now pricing in roughly a one-in-three chance of the Fed hiking rates next week, an unusual degree of uncertainty this close to a meeting.

Adding to the mix of rising inflation pressures are generally rollicking equity markets and a U.S. economy that keeps chugging along. The eye-popping economic stat in a quiet data week was a steep drop in initial jobless claims to just 187,000. That’s the lowest reading since September 1969—or two months after the first lunar landing and a month after Woodstock.

(For further perspective, the Beatles were still together, the top-grossing movie that month was Butch Cassidy and the Sundance Kid, and the number one hit was Sugar, Sugar by the Archies, one of the few songs not performed at the 2026 World Cup final half-time show.) That’s a ringing sign of the “no fire” portion of the job market, while a further cooling in the weekly ADP readings to an average job gain of 16,500 points to the “no hire” part.

The sustained upward pressure on yields, and the absence of a clear off-ramp from either of the two conflicts, undercut equities for a second week. While the S&P 500 is still holding onto a quite sturdy 9% year-to-date gain, it’s been mostly see-sawing for the past two months. Tech stocks have particularly been wobbling after a formidable run, with the Nasdaq now down 7% from the early-June high amid renewed concerns over the pace of capital spending on AI.

While Q2 earnings have mostly hit the mark, investors are now focusing more closely on the mounting tab of all those data centres, and the reality that even old reliable profit machines in the Mag 7 are suddenly burning cash. If the Fed now starts openly warning about rate hikes—and pricing is leaning heavily to a September move—still-lofty valuations will come under even more scrutiny.

The bombshell announcement of a possible 50% U.S. tariff on Canadian goods shattered the trade calm. As the Wall Street Journal put it, the U.S. Administration “exhumed” Section 338 of the (disastrous) 1930 Smoot-Hawley act as the basis of the new tariffs, which are scheduled to go into effect on August 19.

Aimed at C$28 billion of exports, they would hit the equivalent of 0.8% of Canadian GDP, and affect items as diverse as chemicals, plastics, forest products (e.g., plywood), dairy, wine & spirits, cement, as well as horticulture, horsehair and hockey sticks. (Probably the biggest reaction to the announcement in Canada after the shock and outrage was: “we sell horsehair?”)

After the initial shock, most analysts quickly came to the view that this latest threat was primarily a pressure tactic to get Canada to the table soon, on U.S. terms. U.S. Trade Representative Greer came close to openly allowing that very point at his testimony to Congress the next day. And, recall that the short list of irritants behind the new tariffs was very much in line with items that the U.S. had previously noted needed to be addressed as the price of admission to trade talks—an entry fee that Canada had refused to pay.

Prime Minister Carney’s response has been a mix of pledging to intensify talks, but also maintaining the possibility of retaliation should the new tariffs actually go into effect.

While we lean to the view that these tariffs ultimately will not be imposed, we certainly can’t rule it out—woe to those who have dismissed earlier threats as mere bluster. Estimates of the economic effect of the new tariffs have ranged from a 0.1% nick to GDP up to causing a recession. Naturally, we land in the middle—a 50% tariff would likely shut down sales of most of these goods, with the hit landing most heavily on B.C., Quebec and Ontario. We estimate that, if maintained, the levies could clip national GDP by roughly 0.5%, stacked up against consensus estimates of 1.8% growth over the next four quarters.

The combination of a worsening of both conflicts this week very much leaves the Bank of Canada on the horns of a dilemma (their word). The quick snap-back in oil and product prices will almost assuredly push headline inflation back above 3% in coming months, after the reprieve to 2.8% in June. And Governor Macklem warned after last week’s rate announcement that the longer oil prices stayed high, the greater the risk that inflation would fan out beyond energy costs.

However, the Bank has also previously stated that a serious flare-up in the trade war—and it doesn’t get much more serious than a 50% tariff—could prompt rate cuts. In combination, markets see the BoC on hold in the near term, but are back to pricing in very real odds of a rate hike by the end of 2026, apparently brushing aside the tariff threats.

Our view is that the trade trauma will persist, in one form or another, and that the Bank is much more likely to stay on hold, especially with core inflation now below the 2% target for the first time since 2020.

Policy Contributing Writer Douglas Porter is Chief Economist for BMO.