Economic Overview
The first quarter of 2025 was marked by heightened economic uncertainty, driven by geopolitical tensions and the disruptive policies of a reinstated Trump administration. Market volatility remained elevated as investors contended with shifting policy risks, – particularly around trade – alongside fluctuating interest rate expectations, widening regional economic divergence, and the impact of artificial intelligence on productivity, capital expenditures and labor markets.
In the U.S., economic signals were mixed early in the quarter but weakened as the period progressed. While employment and consumer spending remained resilient, headwinds from rising trade frictions, rising mortgage and auto loan delinquencies, and declining consumer and investor confidence weighed on the outlook. Business investment softened, with the ISM Manufacturing Index falling to 49.0 in March, as production, employment, and new orders declined. The Services PMI also eased to 50.8, from 53.5 in February signaling slowing growth.
The Federal Reserve held rates steady, adopting a cautious stance amid uncertainty. At the March meeting, the Fed revised its GDP forecast from 2.1% to 1.7%, with inflation projected at 2.8%—well above its 2% target. Inflationary pressures were evident in the Prices Paid Index, which surged to 69.4 in March from 54.9 in January, its highest level in six months, fueling stagflation concerns.
Global PMI data highlighted regional divergence. China’s manufacturing PMI rose to 50.5 in March—its second consecutive month in expansion and the highest in a year—driven by demand in electronics and machinery. In contrast, the Eurozone economy remained in contraction territory as Germany and France continued to report output declines.
Amid these headwinds, the EU appears to be at a strategic inflection point. In response to President Trump’s threats to scale back U.S. defense commitments, member states have agreed to accelerate military spending. This pivot could lead to significant deficit spending—especially from Germany, which retains greater fiscal flexibility than many of its peers.
In Canada, the departure of Prime Minister Trudeau signals the beginning of a new political era. The Liberal Party has selected former central banker Mark Carney as its new leader. Whoever wins the upcoming election will face significant challenges: reviving a sluggish economy, navigating U.S. trade tensions, and restoring policy credibility. Reflecting these headwinds, the OECD slashed Canada’s 2025 growth forecast from 2.0% to 0.7%. The Services PMI echoed this weakness, plunging to 41.2 in March from 46.6 in February—its lowest level since the COVID shock—highlighting growing domestic strain.
Equity Markets
The quarter marked a sharp reversal for global equity markets. After reaching a record high on February 19, the S&P 500 Total Return — was up nearly 5% year-to-date at its peak—fell into correction territory, ending the quarter down 4.2% (CAD). The selloff reflected a decisive shift in sentiment, driven by rising policy uncertainty, weakening technical indicators, and growing investor anxiety. Volatility spiked, particularly around trade tensions and recession risk. In contrast, European equities outperformed U.S. markets by the widest margin in over 30 years, delivering double-digit gains across several countries as investors rotated into more attractively valued international opportunities.
Much of the early-year rally was driven by large-cap technology stocks, particularly the so-called “Magnificent 7.” These names, which had powered much of the previous year’s advance, also led the decline. Technology (-12.8%) and Consumer Discretionary
(-14.0%) sectors posted steep losses, posting steep losses (all in USD). Growth stocks significantly underperformed value, while small- and mid-cap equities suffered even more, deepening the overall market weakness.
Despite the selloff, defensive sectors like Consumer Staples and (+4.6% USD) benefited from a shift away from speculative growth toward more stable, income-oriented holdings. High-dividend-paying stocks also outperformed, as investors favored companies with consistent yield, low valuations, and strong domestic fundamentals.
Outside the U.S., equity markets delivered notably stronger results. Canadian equities rose 0.8% on the quarter, driven by sharp gains in Materials (+19.9%) and Gold (+33.9%), though Technology and Health Care lagged (all in CAD).
International developed markets, as measured by the MSCI EAFE Index, gained 6.9% (USD). European markets particularly stood out, with Germany and Spain finishing up 10.5% and 17.0% (EUR), respectively, supported by attractive valuations, fiscal stimulus and strong performance in banks, industrials, and luxury goods.
Emerging markets also posted gains, with the MSCI EM Index up 3.0% (USD), although performance was uneven. China stood out, with the MSCI China Index climbing 15.1% (USD) as sentiment improved on the back of interest rate cuts and targeted fiscal support.
In sum, the first quarter of 2025 marked a turning point in market sentiment. The dominance of growth stocks gave way to defensives, and international diversification paid off. Investors sought safety in dividends, commodities, and markets less exposed to high-valuation tech.
Fixed Income
The global bond market has been navigating a complex environment shaped by softening economic data and elevated geopolitical tensions, fueled demand for safe-haven type assets. U.S. Treasury yields moved lower, with the 2-year and 10-year declining about 35 basis points (bps) to 3.89% and 4.21%, respectively, reflecting increased economic uncertainty and growing expectations that the Federal Reserve may need to ease policy later this year.
In Canada, ongoing concerns about slowing domestic growth and rising protectionist pressures from the U.S. prompted the Bank of Canada to cut its overnight rate by 25 bps twice during the quarter. This preemptive policy action was intended to bolster business confidence and support trade-exposed sectors. Canadian bond markets responded accordingly, with the 10-year government yield falling 25 bps to end the quarter at 2.97%. Short-term yields declined more significantly, helping to drive a 2.0% return for the FTSE Canadian Bond Universe on the quarter.
Within Canadian credit markets, despite persistent concerns around economic growth and trade policy, corporate bond spreads tightened across maturities and sectors, reflecting strong balance sheets, stable earnings, and low defaults. By contrast, U.S. credit markets showed some divergence, with investment-grade spreads continuing to narrow albeit marginally, while high-yield spreads widened modestly, suggesting a cautious shift in sentiment.
While North American yields fell, European sovereign yields rose on increased fiscal support and infrastructure spending. Germany’s 10-year bund yield climbed 33 bps to 2.70% following major spending announcements, with similar moves in Italy (up 33 bps to 3.86%) and Spain (up 30 bps to 3.37%) amid growing fiscal concerns. This fueled a broad repricing of rate expectations and renewed volatility in European bond markets.
Bond funds attracted record inflows during the quarter. According to State Street Advisors, bond ETFs drew in approximately $100 billion during the quarter— putting them on pace to surpass the previous record of $300 billion set in 2024. Investors have clearly sought refuge from equity market volatility and broader macroeconomic uncertainty.
Overall, the 2025 bond market has been shaped not only by central bank actions, but by a broader narrative of the potential global trade realignment, fiscal expansion, and deglobalization pressures. As major economies continue to reassess their industrial and trade strategies, fixed-income markets have become increasingly sensitive to macro and policy developments.
Looking Forward
The global economic environment is expected to remain volatile into Q2 and most likely beyond. Uncertainty around the direction of growth and inflation—driven by persistent trade risks and unpredictable policy—will likely continue to influence market behavior.
As the quarter concluded, tariff tensions escalated significantly, with multiple rounds either implemented or imminent—most notably between the U.S., Canada, Mexico, and China. The early March announcement of broad U.S. tariffs triggered a wave of downward revisions to GDP forecasts and upward adjustments to inflation expectations. Canada, deeply integrated with both the U.S. economy and national security apparatus, is particularly vulnerable. Should tariffs remain in place, the likelihood of a recession in Canada becomes increasingly high. While the U.S. is somewhat insulated by the strength of its domestic market, initial data on new orders and consumer sentiment have already pointed to elevated recession risks and mounting market volatility.
In the U.S., the Federal Reserve remains in wait-and-see mode, with future rate decisions closely tied to inflation data and broader financial conditions. While rate cuts remain on the table, the Fed is unlikely to act decisively unless growth slows more substantially, or inflation eases in a sustained way.
In Canada, policy uncertainty looms as the country approaches an election. Growth expectations have been revised sharply lower, and softening consumer activity suggests the Bank of Canada will maintain an accommodative stance. However, improved political clarity and easing trade tensions could help stabilize sentiment and support a modest rebound.
In Europe, stagflation remains a concern. The ECB’s recent cuts reflect deteriorating conditions. Structural inefficiencies and fiscal limits—especially in Southern Europe—constrain recovery. That said, a coordinated increase in defense spending, particularly by Germany, could provide a modest but meaningful economic boost.
From a portfolio perspective, the current environment favors resilience and flexibility. High-quality fixed income has become increasingly attractive, offering both competitive yields and downside protection in a slower-growth regime. On the equity side, an emphasis on durable, high-quality businesses with strong balance sheets and consistent cash flows remains prudent. Maintaining liquidity will also be essential, allowing investors to respond quickly as risks or opportunities emerge.
Regional diversification and active risk management will be critical as monetary policy, economic fundamentals and trade policy continue to vary globally. Notably, the traditional inverse correlation between equities and fixed income has reasserted itself—underscoring the value of balanced, multi-asset strategies.
