Oversupply of cash, inflation, stock rallies and bond market skepticism were among the key topics making news at the start of 2025, as markets waited to see exactly what incoming U.S. President Donald Trump plans to do when he takes office on January 20th.
The experts at Canso Investment Counsel broke down some of the key issues shaping the Canadian and U.S. economies in their January 2025 Market Observer.
Here are a few highlights:
COVID’s M2 money trail
The investment team at Canso has written at length about the way central bank attempts in Canada and the U.S. to limit the pandemic’s economic strain have led to an oversupply of money, which they see as a continued problem.
“In our opinion, the vast amounts of money produced by central banks during their Covid hysteria continue to spill over into the investment markets,” they say in their latest commentary.
To stabilize the economy, the Bank of Canada and the Federal Reserve introduced measures such as rate cuts, stimulus cheques, quantitative easing, and programs like CEBA – flooding the economy with cash. These efforts led to an unprecedented surge in the M2 money supply (a classification that tracks the cash, deposits, and near-money circulating in the economy).
From the time the pandemic monetary stimulus began in April 2020, Canadian M2 grew by 27 per cent in under a year, while U.S. M2 expanded by 40 per cent in just over a year – and as Canso points out, “all that money created needed to go somewhere”.
In the end, much of it found its way into both rising consumer prices and the financial markets. In Canso’s view, the oversupply in M2 exceeded what was necessary to support economic activity, contributing to inflation and asset price increases.“Canadian M2 is about $191 billion over where its pre-pandemic growth rate would have been, and the U.S. is about $1.5 trillion higher”, says Canso. This excess provided governments with funds to issue bonds and stimulate their economies while temporarily propping up inflated prices for goods and services. Regular consumers spent much of this extra cash on higher living costs, shown by the 22.8 per cent increase in the U.S. CPI since December 31st, 2019. Meanwhile, wealthier investors funnelled their surplus into financial markets, which Canso believes has driven a cycle of gains and market enthusiasm.
Amidst the optimism in risk assets, Canso wonders how sustainable the financial euphoria will be and what will happen when the spillover dries up.
Are we in an infamous “Financial Bubble”?
While loose monetary policy makes borrowing cheaper with an aim to boost economic growth, it also carries the risk of stoking inflation, as seen in the 1970s. Back then, inflation fell temporarily before increasing again to over 14 per cent, forcing the Fed to take drastic action and raising interest rates to above 19 per cent.
The current situation draws eerie parallels. Inflation has cooled from over eight per cent to below three per cent, but optimism in today’s bond market assumes we’re heading back to a two per cent CPI future – a belief Canso experts warn “very well might not be the case.”
“We’ll really never know until it’s over, but a necessary precondition for a financial bubble is a substantial expansion of money supply, and we have that in spades,” they say.
Trump’s market shake-up
Canso experts highlight the stark contrast between the optimism in equity markets and the skepticism in bonds as the U.S. stock market posted a stellar year. The S&P 500 surged 23.3 per cent in 2024 – its “best two-year performance since 1997-98” – a rally fuelled by AI-driven enthusiasm and Trump’s election.
However, the bond market tells a different story. Long-term U.S. Treasuries were down 6.4 per cent as rising yields eroded their value, reflecting concerns about inflation, fiscal deficits, and Trump’s election.
“The bond market is not as enthusiastic about Trump as the equity market,” the Canso Market Observer reads.
It also notes Trump’s proposals for tax cuts, increased spending, and “beautiful tariffs” are estimated to add “$15 trillion to the U.S. deficit over the next 10 years.”
These policies, paired with Trump’s history as the “King of Debt,” have sparked fears about the price at which the U.S. Treasury will be funding its debt obligations.
Trump’s economic gamble: Inflation, promises, and political realities
Trump’s economic policy plans include eliminating taxes on social security, overtime wages, and tips.
These initiatives reduce government tax revenues while increasing expenditures, which widens the same deficit he promised to cut down.
And while tariffs could recover some of the lost revenue, they could also inadvertently drive inflation higher, impacting the very groups most concerned about rising costs.
Meanwhile, potential cuts to government programs to offset the tax revenue drop may disproportionately affect low-income Americans, further straining his support base and creating economic tension.
While Trump prioritizes market performance, economic realities often clash with political promises, as Canso notes.
If fiscal policies destabilize the Treasury or markets, his administration may face difficult choices, as past leaders have. The challenge lies not just in fulfilling campaign promises but in managing the long-term consequences of these economic gambles.
For a deeper dive into the current market trends and what they mean for investors, read the full analysis in the latest Canso Market Observer.
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