-With contributions from Vivien Lee, Aaron Ma and Eric Savoie

Big new developments

Economic outlook

We are fairly positive on the 2026 economic outlook, with upgraded forecasts that find themselves above the consensus for the majority of markets (see next chart).

Developed markets’ 2026 GDP outlook shows U.S. and South Korea leading the charge

Consensus forecast as of 02/02/2026. Numbers shown in chart are current RBC GAM forecast as of 01/23/2026. Old forecast as of 10/24/2025. Sources: Bloomberg, RBC GAM

Consistent with this, the closely watched U.S. Institute for Supply Management (ISM) manufacturing index just leapt from 47.9 to 52.6 – a big increase and the highest level since 2022 (see next chart). The new orders sub-component managed a particularly enthusiastic increase (47.4 to 57.1).

A word of mild caution: some of the increase may be temporary, related to a) post-Christmas restocking and b) inventory building to get ahead of possible further tariff-driven price increases.

U.S. manufacturing sector has expanded, reaching highest level since August 2022

As of January 2026. Shaded area represents recession. Sources: ISM, Macrobond, RBC GAM

-EL

Warsh for Fed Chair

On the heels of the U.S. Federal Reserve’s latest rate decision (a pause), President Trump finally put an end to speculation over who he would nominate as the next Fed chair, picking Kevin Warsh for the job in late-January.

Warsh had been in a three-way race since last fall, with Trump economic advisor Kevin Hassett the front runner for much of the race. Blackrock’s Rick Rieder was a late-breaking favorite as recently as last week (see chart). We had correctly flagged Warsh as the most likely victor.

In January alone, there were three different favourites for Fed chair

As of 02/02/2026. Sources: Bloomberg, Polymarket, Macrobond, RBC GAM

As noted in our previous #MacroMemo, Warsh was an inflation hawk during his time as Fed governor between 2006-11, opposing quantitative easing (QE) following the financial crisis. He has since become more dovish by favouring a lower policy rate today – he wouldn’t have been in the running otherwise. But he is still seen as a balance sheet hawk wanting to shrink the Fed’s asset holdings. That’s a little bit like pumping the gas and the brakes at the same time, but the point is that he may be less dovish than his rate-cutting advocacy initially suggests.

Concerns about Fed independence returned to the fore early this year with the Department of Justice’s (DOJ) investigation into the Fed and potential indictment of Chair Powell. There is also a Supreme Court case over the administration’s efforts to oust Governor Lisa Cook. Warsh is certainly perceived as more independent than Hassett – who is part of the Trump administration as director of the National Economic Council (NEC) – but less so than Rieder, who is more of a private sector outsider.

Warsh’s dovish pivot could be seen as a blatant attempt to curry favour with Trump and position himself for the job. But his contention that deregulation and rising productivity will allow the economy to expand without generating extra inflation might have some merit. The economy grew faster than expected in 2025 (more on that below) even as the labour market softened and services inflation – an indicator of domestically generated price pressure – slowed. If that doesn’t continue and inflation becomes problematic, Warsh could very well revert to his previous hawkishness and oppose unwarranted rate cuts.

Warsh’s balance sheet views argue for a somewhat steeper yield curve. However, that is muddied somewhat by less concern about Fed independence (at least relative to Hassett), which reduces inflation risks. Warsh might not immediately push to resume quantitative tightening (QT) and shrink the Fed’s balance sheet. In any case, he is just one vote on a Federal Open Market Committee (FOMC) that seems to see few issues with its current ample reserve framework. It’s possible that financial deregulation could reduce demand for reserves and allow the Fed to further reduce its asset holdings without pinching liquidity.

As a former Fed governor and well-qualified candidate, Warsh is likely to be confirmed by the Senate, although that process could be delayed by the DOJ investigation into Powell. At least one Republican on the Senate Banking Committee has pledged to hold up approval until that issue is resolved. Governor Miran’s term expired at the end of January so Warsh should be able to join the Fed in his place at any time, although Chair Powell’s term as head of the committee doesn’t end until mid-May.

Our forecast continues to be for the Fed to cut its policy rate by 50 bps this year after the new chair takes over. That is roughly what is priced into the market, and more than the single-cut median in the Fed’s December dot plot. We think it will be difficult for Warsh to get a divided committee – 7 of 19 FOMC participants didn’t want to cut at all this year, as of December – on board with more than that, barring an unexpected further deterioration in the labour market.

-JN

Market turmoil

Financial markets have been in considerable motion in recent weeks. Prior to a few days ago, the focus would have been on the weakening U.S. dollar and rising Japanese yields.

The dollar rapidly lost 3% of its value over the second half of January. This is a significant downward move after nearly nine months of rangebound behaviour (see next chart). This took the dollar to its weakest reading in four years. Drivers included the criminal investigation initiated against Fed Chair Powell in early January and the country’s recent pivot toward expansionist foreign policy.

U.S. dollar in decline

As of 02/02/2026. Shaded area represents U.S. recession. Sources: Intercontinental Exchange (ICE), Bloomberg, RBC GAM

But the dollar then abruptly regained half of that loss when the Warsh Fed appointment was announced. This suggests markets are focusing upon his background as an independent Fed governor and his preference to shrink the balance sheet, as opposed to his dovish view on the fed funds rate. Framed more simply, Warsh is not a highly politicized candidate, and that’s a good outcome.

However, the market response is also a bit perplexing as the prior favourite had been Rieder, who was arguably even less political than Warsh, and the prospect of a win by Hassett – the most political of the candidates – had already declined to nearly zero a few weeks ago according to betting markets. As such, it is not clear that the market’s expression of relief about the long-term value of the dollar was the right response.

Precious metals responded similarly, with gold and silver prices both collapsing (see next chart). These assets were arguably much more vulnerable to decline given their nearly parabolic increase over the prior month (and indeed extraordinary increases over the past year).

Gold and silver prices suffered flash crash after historic rally

As of 02/02/2026. Sources: Bloomberg, RBC GAM

Although not shown in the chart, gold has since staged a significant if partial intraday rebound on February 2 as this report goes to press. Meanwhile silver is trending sideways near its recent lows. In both cases, technical support at the 50-day moving average appears to be holding.

It is likely that these initial responses to Warsh are overblown. Precious metals – especially gold – may resume their upward trajectory as investors resume their pursuit of a dollar substitute. (Of course, whenever the end of this bull market in gold does occur, the prior three such episodes dating back to the 1970s then gave back about half of whatever was initially gained).

-EL

Mini-government shutdown

Another partial shutdown of the U.S. federal government began on January 31. Fortunately, this episode should be much shorter than last year’s record 43-day closure – it might be resolved by the time you read this.

While last year’s shutdown was due to a drawn-out fight over health care subsidies, the present issue is funding for the Department of Homeland Security (DHS), one of six appropriations bills within omnibus legislation passed by the House in January. The other six appropriations bills to fund government operations were already passed following the last shutdown. Those departments are fully funded through the end of the fiscal year.)

Senate Democrats opposed the package, wanting to attach conditions to DHS funding that would increase oversight and impose limits on Immigrations and Customs Enforcement (ICE). They struck a deal with the White House to pass the other five appropriations bills and extend DHS funding by two weeks while a more sustainable solution is negotiated.

But with the House not sitting during the final week of January, it was unable to pass the revised bill in time to avoid a partial shutdown. Congress is expected to move the legislation forward in early February, avoiding many of the pain points that accompanied last year’s shutdown. Unfortunately, the February 6 payroll report will be delayed.

-JN

Nervous bond market focuses on Japan

The Japanese 30-year yield has increased massively over the past five years. It has risen from just 0.66%to 3.66% today (see next chart). That’s an increase of more than five-fold.

Japanese 30-year yield has risen significantly over the past five years

As of 02/02/2026. Sources: Macrobond Financial AB, Macrobond, RBC GAM

Much of the move can be relatively tidily interpreted as that of a country emerging from deflation while delivering several doses of monetary tightening. In effect, Japan is a country transitioning from ultra-low rates to more normal rates, and this is mostly appropriate given its new economic and inflation regime.

But one might also conjecture that the particularly sharp increase in Japanese yields in recent weeks (albeit partially unwound in recent days) is also an expression of fiscal concern. Japan goes to the polls on February 8 and is expected to grant a majority to the incumbent Liberal Democratic Party, in turning unleashing additional fiscal stimulus.

The bond market may not be entirely pleased about this – a warning not just for Japan but for many of the world’s developed nations that also continue to push their luck with large fiscal deficits stacked on top of sizeable public debt-to-GDP (gross domestic product) ratios. It is not a coincidence that yield curves have steepened and long-term yields have resisted declining even as most of the world (albeit not Japan) have cut their policy rates.

Our own fixed income view is that long-term yields are at greater risk of rising than falling in the near term. Fiscal excesses remain a notable macro risk across a fair swath of the developed world.

But back to Japan – will these higher yields break anything?

For the moment, it is reassuring that nominal yields remain lower than nominal GDP growth, rendering the higher borrowing cost theoretically manageable at the economy-wide level.

But what about Japanese banks, which have large holdings of Japanese government bonds? Fortunately, the big Japanese banks have very little exposure to the long end of the bond market where most of the capital losses are occurring. They tend instead to hold a relatively short bond duration of 2-4 years. Furthermore, Japanese banks can hold the great bulk of this as “hold-to-maturity” bonds, meaning they don’t have to mark any notional losses to market.

Still, one cannot completely rule out problems when interest rates make big moves. As Silicon Valley Bank showed in the U.S., banks might ultimately have to mark their bonds to market if they are forced to sell them in response to a run on deposits. But this seems less likely in Japan given that Silicon Valley Bank’s clientele was so large, homogenous and informed. For the moment, Japanese bank stocks actually seem to be celebrating higher long-dated yields, presumably given the benefit it delivers to net interest margins.

-EL

Greenland in focus

Not since the days of Erik the Red has Greenland attracted such attention as it has today. President Trump has long expressed a yearning for the territory, but the rhetorical pressure ratcheted higher over the past month and the threat suddenly felt very real after the U.S. invaded Venezuela.

The last time the U.S. was a seriously expansionist nation was 1898-1917, when Puerto Rico, Guam, the Philippines, Hawaii and the Panama Canal Zone were all acquired. Today, a renewed Monroe Doctrine (see the December 16 MacroMemo), recent foreign policy actions (see the January 13 MacroMemo on Venezuela), and recent comments from President Trump all suggest the return to an expansionist mindset. It is quite common for American presidents to prioritize foreign policy in their second term.

Motivations

The U.S. seemingly has several motivations in its pursuit of Greenland:

1. Military significance: Greenland has a strategic significance for the U.S., not just because its small population and remoteness renders it vulnerable to being taken over by an adversary, but because it is geographically well located for intercepting intercontinental missiles from China or Russia (which would travel over the Arctic on the way to the continental U.S.).

2. Natural resources: Greenland is believed to possess 37 of the 50 minerals that the U.S. has designated as “critical” and the territory already hosts a handful of mines.

3. Greater Arctic presence: While the U.S. already has a western Arctic presence with Alaska, it lacks the equivalent eastern Arctic clout. Acquiring Greenland would certainly do this, allowing greater control over Arctic Sea routes and undersea resources.

4. Expand U.S. footprint: Setting aside the military and economic rationale, President Trump also seems enamoured with the idea of adding Greenland to the U.S. map for its own sake. The move would be a legacy move for Trump, lifting him into the exclusive echelon of presidents who added significant territory such as Thomas Jefferson (the Louisiana Purchase) and Andrew Johnson (Alaska). It would also be an ego boost for the U.S., elevating the country from third to second largest land mass in the world.

5. Nobel Peace Prize snub: President Trump indicated he has become more serious about acquiring Greenland after he failed to win the latest Nobel Peace Prize. Thus, there is now potentially a retaliatory aspect.

6. Unify North America? Much more speculatively, it is hard not to notice that a U.S. that combines not just the continental states but also Alaska to the northwest and Greenland to the northeast would effectively encircle Canada – another country the White House has expressed a desire for.

Flawed premise

Despite that long list of motivations, the first two – Greenland’s military significance and natural resources – are the most repeated and seemingly the central ideas.

But these motivations rest on flawed premises.

The U.S. already has a military presence in Greenland, with approximately 150-200 personnel at one primary installation. Furthermore, the U.S. has actively chosen to reduce its presence in Greenland over the decades, with an approximately 98% reduction of personnel from peak Cold War levels, and the retirement of approximately 30 military installations on the island.

American companies are already allowed to open and run mines in Greenland. Australia, Canada, Switzerland and the UK already do so, and exploration is underway by a Chinese-Australian company and a U.S.-Australian venture.

Finally, the U.S. could fairly easily ramp its presence back up as per existing law: a 1951 treaty between the U.S. and Denmark. In the context of defending the North Atlantic and Arctic, the treaty says that the U.S. may construct, operate and expand military facilities in Greenland as required. Denmark and Greenland would have to approve, but six prior rounds of expansion were always agreed upon.

This is not to say it would be completely straight-forward. Some past expansions have been politically contentious in Denmark, and the country bans the presence of nuclear weapons on its territory. The U.S. is thought to have sometimes violated this.

Similarly, American companies are already allowed to open and run mines in Greenland. Australia, Canada, Switzerland and the UK already do so, and exploration is underway by a Chinese-Australian company and a U.S.-Australian venture. Greenland does control mining licenses and prioritizes the environment in its evaluations, but this is not vastly different than the traditional U.S. approach to its own territory.

While Greenland has a great deal of minimally inhabited territory and seemingly an abundance of minerals, that doesn’t mean it is an attractive place for securing such minerals. The harsh weather, 80% glacier coverage, small workforce and minimal infrastructure – few roads, rails or ports – hardly render it an obvious place to go all-in on mining. President Trump has in fact more recently suggested that Greenland is not actually viewed as being important for minerals.

Conflict

Inevitably, the U.S. desire for Greenland has created fierce conflict between the central actors.

Greenland and Denmark have both insisted the territory is not for sale. Reflecting their willingness to defend Greenland from attack, Denmark and Germany have both sent a small number of troops to the territory. Eight European countries have said they would defend Greenland if required – including not just Denmark and Germany, but Norway, Sweden, Finland, France, the Netherlands and the UK.

President Trump’s rebuttal that “you’ll find out” how far the U.S. is willing to go in its quest for the island did not inspire confidence in a peaceful solution.

But, in practice, the U.S. appears to be more focused on buying access rather than invading. The U.S. military leaked that it has been given no instructions to plan for an invasion of Greenland. Secretary of State Rubio downplayed the possibility of an invasion when speaking to Congress.

Still, the U.S. has floated the idea of paying Greenlanders to join the U.S. or create a “compact of free association” as the U.S. has with three Pacific nations. Furthermore, President Trump threatened a 10% tariff as of February 1 on the European countries opposing the U.S. plan – a rate that would rise to 25% in June without a deal.

For their part, a survey of Europeans showed a remarkable 67% willing to stand up to the U.S. even if it meant accepting higher tariffs.

De-escalation

Fortunately, calmer minds now appear to be prevailing. In addition to the U.S. disavowing the idea of a military invasion, the White House has since paused its tariff threat – rates did not rise on February 1.

Furthermore, President Trump announced a “framework deal” in which the U.S. would not buy Greenland but instead gain greater access via other means. What this exactly means is not yet known, nor is it entirely clear whether the framework deal was agreed upon by Denmark and Greenland or instead simply with the head of NATO, Mark Rutte. He is among the most pro-U.S. political figures in Europe and so not necessarily in line with the rest of the continent.

The framework appears to include an enhanced U.S. military presence – likely with greater collaboration for the Golden Dome defence system, and greater access to Greenland resources – perhaps granting mineral rights within U.S. military sites (which, in practice, seems like quite limited access). Russia might also be banned from mining in Greenland. It does not currently have mines, nor aspire to them.

It is unclear how the legal jurisdiction for any such agreement would work. For example:

• Would it primarily operate within the confines of the existing 1951 accord (or a slightly reworked version)?

• Would it be achieved via new long-term U.S. leases on parts of Greenland?

• Or would it be a hybrid approach akin to the Sovereign Base Areas the UK has in Cyprus? In this agreement the territory involved is administered under the sovereignty of the UK but is something less than a colony, with a civilian population that remain citizens of Cyprus.

The first option is surely the most likely.

Of course, the White House has become famous for reversing course and so we should not pretend any of this is ironclad. The disagreement could yet flare up again. If it did, we would be inclined to fade any resulting market distress since the U.S. likely does not have an appetite for a major international row with Europe in an election year.

Lasting military repercussions

Still, this Greenland chapter may have lasting military repercussions. It reiterates that the U.S. now has an expansionist foreign policy mindset. Who’s next? Iran and Cuba come particularly to mind, though the Panama Canal Zone, Colombia and even Canada have caught Washington’s eye.

The Greenland saga also emphasizes that, in addition to being an unreliable trade partner, the U.S. is now an unreliable military partner. NATO is accordingly weakened. It is therefore an even more dangerous world.

Russia is emboldened by the internal discord, and if it wasn’t already clear in the context of Ukraine, the rest of the world cannot count on the U.S. coming to the rescue in future international conflicts. There is even the previously unfathomable risk that, as with Venezuela and Greenland, the U.S. could be the next adversary.

As a result, the rising military spending theme has become even more supercharged over the past month and, one would imagine, with an accelerated emphasis on pivoting away from U.S. procurement.

Economic/financial repercussions

There are several obvious economic and financial takeaways from all of this:

• Higher military spending is unlikely to be offset by lower government spending elsewhere, so there is a significant fiscal stimulus coming – perhaps even greater than conventionally imagined.

• Declining trust in the U.S. argues more powerfully than ever for a weaker U.S. dollar and a steeper U.S. yield curve – trends that we expect to play out (fitfully) over the span not just of months but years. Notwithstanding recent market shifts, one might argue this benefits precious metals and other physical stores of value.

• The European (and indeed international) strategy of appeasing the U.S. – accepting the worse side of every trade deal, and the like – could be ending. What is the point of striking trade deals with the U.S. when the White House keeps coming back with demands for further concessions? This was always a collective action problem, and there could now be a more united front against U.S. trade and foreign policy going forward. This might be the year to make that pivot given the White House’s heightened sensitivity to the cost of living before the midterm elections. Or, despite all their tough talk, perhaps the rest of the world will continue to bend the knee.

-EL

Iran in focus

Briefly, Iran could yet be the next country in geopolitical focus after the U.S. positioned an aircraft carrier near Iran’s shores. President Trump has issued repeated condemnation and warnings to the country’s leadership regarding the regime’s response to public protests in recent weeks.

Polymarket assigns a 50% chance that the U.S. strikes Iran by June 30. Of course, the U.S. already struck Iran back on June 22, 2025, so this might be less extraordinary than it first seems, depending upon the scale and purpose of any attack.

The better question is whether regime change might occur in Iran. Polymarket odds give a smaller 19% chance that the Iranian regime falls by June 30 – down sharply from a 40% chance assigned in the first half of January. The odds are falling in part due to recent U.S. inaction, and in part because nuclear talks between the two countries are seen as increasingly likely.

The country has an elevated market significance given its oil production. A bad outcome could see Iran blocking the Strait of Hormuz through which about one-fifth of the global oil supply transits. A good outcome might eliminate Iran’s nuclear threat and greatly ramp up its oil production as sanctions are lifted.

Looking elsewhere, Cuba is under particularly intense pressure – due both to its loss of access to Venezuelan oil and further sanctions from the U.S. that pressure other countries not to trade with Cuba. Regime change there is more conceivable than it has been in a decade.

-EL

Busy White House

The White House has been moving at a gallop for the entirety of the past year. Even as tariff announcements and tax cuts have slowed (though see the tariff section of this report for recent action there as well!), foreign policy and a range of industry-specific policy balloons have taken their place and must be watched closely.

On January 7, President Trump proposed to increase the defence budget by more than 50% for fiscal 2027 – requiring about US$500 billion more in annual funding. If enacted – and there is reason to be skeptical it will come close to being fully delivered – this would seem to be relevant to the Treasury market and constitute a major source of fiscal stimulus for next year.

On the same day, President Trump also said he would block defence companies from paying dividends or engaging in stock buybacks until they fix their problems delivering on government contracts.

Housing affordability is back in focus. Much as the White House is prioritizing getting the price of gasoline below US$2 per gallon (Venezuelan crude is a key element of that objective), it is also keen to reduce the 30-year mortgage rate well below 6.00% and increase the supply of housing.

A quick summary of January policy proposals

On January 8, President Trump announced a plan to acquire up to US$200 billion in mortgage-backed securities – theoretically lowering mortgage rates – with the thought that more purchases could follow that initial step. On that same day, he also announced a plan to limit large institutional investors from purchasing single-family homes.

On January 9, President Trump proposed capping credit card interest rates at just 10% – less than half the 20%-plus industry norm. Of relevance to investors, this would obviously be bad for credit card companies and banks as they would earn far less interest income. But it might not be as positive for credit card customers as one might initially imagine.

Capped rates would force lenders to drop lower income households. Roughly 35-45% of customers might no longer be eligible for a credit card. We should thus be dubious that this exact proposed change will occur, but it is possible that less radical changes favoring borrowers will be enacted given the White House’s focus on cost-of-living concerns right now.

On January 10, the DOJ served grand jury subpoenas to the Federal Reserve, meaning Fed Chair Powell is under criminal investigation. This appears to be political pressure, undermining the independence of U.S. monetary policy.

On January 26, the federal government proposed an unexpectedly stingy cap on payment rates to private health insurers (an annual increase of 0.1% versus an expected 3-6% increase). This resulted in a sharp decline in stock market valuations across the industry. Those insurers will now likely respond in part by reducing the benefits they offer to their clientele and perhaps even exiting certain unprofitable markets.

As part of the U.S. takeover of Venezuela, the White House has also been pressuring American energy companies to re-enter that market. It isn’t clear that many actually want to enter the Venezuelan market given the lack of security on the ground, the decayed infrastructure, potentially insufficient U.S. refining capacity and the relatively low price of oil.

What to do with this cascade of policy proposals?

It is probably correct to start with a degree of skepticism. Many are just policy balloons that won’t be delivered in full. But don’t underestimate the volatility such decisions could create and the speed at which the White House could continue to move, especially if polling continues to look unfriendly for the Republicans for the approaching midterms.

The cost-of-living theme is an important one, a reason why more fiscal stimulus would not be a shock in 2026, and why further unconventional ideas may continue to spring forth. Some of these ideas clearly advantage households while disadvantaging businesses – another important theme and one for investors to be aware of.

-EL

Earnings supportive of stock strength

Stock markets have enjoyed a strong rally in 2025 and are off to a good start in 2026. A variety of tailwinds have boosted performance, such as easier monetary conditions, continued economic growth and optimism regarding the benefits of AI. That said, the intensity of the rally over the past year may have investors concerned about its sustainability given that valuations have stretched to elevated levels.

Fortunately, the outlook for corporate profits has also been improving and provides some justification for the high prices being paid for stocks.

S&P 500 earnings growth has consistently exceeded analyst estimates over the past year and expectations have been steadily revised higher to reflect companies’ ability to grow their profits at a rapid pace in this environment. In the past quarter, 85% of S&P 500 companies exceeded the consensus of analysts’ estimates, marking the fourth consecutive quarter of increasing incidence of earnings beats (see next chart).

S&P 500 companies reporting results above consensus forecasts

As of 01/22/2026. Source: Refinitiv

This sustained strength in earnings and the broader macro environment have led analysts to upgrade expectations going forward. The upward revisions are particularly noteworthy because profit forecasts have historically tended to decline as a year progresses given that analysts often start the year with too much optimism (see next chart).

Analysts upgrade consensus earnings estimates for S&P 500 Index

As of 01/22/2026. Sources: Bloomberg, RBC GAM

S&P 500 profits grew 12% in 2025, and analysts are forecasting an acceleration to 16% growth in 2026 (upgraded from 12% a quarter ago). This would potentially be followed by an additional nearly 15% gain in 2027 (upgraded from 11% a quarter ago). Earnings expectations are broadly in double digits for other countries as well, especially for 2027. Markets have likely not yet fully priced this in (see next table).

Earnings expectations rise across major stock-market indices

As of 01/30/2026. Sorted by 2026 Earnings Per Share (EPS) growth. Sources: Bloomberg, RBC GAM

An important part of what is driving the tailwind to corporate profits is the expansion in profit margins as companies have displayed an impressive ability to control costs while continuing to grow their revenues. The chart below plots S&P 500 profit margins over the last 45 years. For the past three decades, they have been in a durable upward trend. The gains over that period were helped by access to cheaper supply chains offshore, falling interest rates, lower tax rates, improved operational efficiencies and rising economies of scale.

S&P 500 shows steady upward trend in profit margins

As of January 2026. Sources: Bloomberg, RBC GAM

While profit margins may not be capable of rising forever, the consensus profit outlook suggests they can continue expanding in the near term and so extend their long-term trend.

In our view, companies appear to have further room to secure efficiencies and achieve greater scale via technological improvements. AI remains a particularly fruitful avenue.

This margin expansion is the very reason why even moderate GDP growth rates can translate to impressive double-digit corporate profit growth. This, in turn, supports stock prices and validates elevated valuations so long as these tailwinds for corporate profits remain in place.

-ES

Tariff noise mounts – but deals dominate

After a blissfully quiet period, the White House has returned to making big tariff threats, briefly pushing trade policy uncertainty to its highest level since Liberation Day 2.0 last August (see chart). But the administration hasn’t followed through, and actual trade policy continues to become slightly less restrictive overall. Meanwhile, other countries are taking steps to diversify their trading relationships and reduce reliance on the U.S.

Trade policy uncertainty jumped higher in January after quieter end to 2025

As of 01/29/2026. Sources: Bloomberg, Macrobond, RBC GAM

Here are some of the key developments in recent weeks.

Greenland tariff threats add urgency to European Union (EU) push for trade diversification

In mid-January, President Trump threatened an additional 10% tariff starting February 1 (rising to 25% on June 1) on imports from countries that opposed his ambition to acquire Greenland. These include Denmark, Norway, Sweden, the UK, France, Germany, the Netherlands and Finland.

In response, EU leaders threatened retaliation including potential use of the bloc’s anti-coercion instrument – sometimes referred to as the “trade bazooka” – that could broadly restrict U.S. companies’ access to the EU’s single market. That raised the risk of a tit-for-tat trade war that had been avoided in 2025 when the EU continuously delayed retaliation against U.S. tariffs and struck a framework agreement last August.

Trump eventually backed down on those tariff threats after announcing a framework deal on Greenland, but not before the European Parliament delayed approval of last year’s U.S.-EU trade deal. The ratification process is now expected to resume, perhaps with some additional safeguards against Trump’s threats. The EU also plans to extend its suspension of retaliatory measures – which were set to expire on February 7 – by another six months.

So, a trade war has been avoided, but as discussed above we think some further, permanent damage was done to the EU’s relationship with the U.S.

The episode also lent greater urgency to EU efforts to diversify trade. In January, after decades of negotiations, the EU signed a trade deal with Mercosur (Southern Common Market) and announced an agreement with India.

The Mercosur deal – once fully ratified – will eliminate tariffs on more than 90% of EU exports to Argentina, Brazil, Paraguay and Uruguay while those countries’ food exporters will have greater access to the EU’s single market. Ratification could be an arduous process, though, with legal challenges potentially delaying implementation by a year or more. An interim trade agreement covering only trade matters could take effect sooner.

The EU-India agreement will eventually eliminate the vast majority of tariffs between the trading partners, with European exporters of autos, wine, and pharmaceuticals among key beneficiaries while Indian textile and apparel exporters are also set to gain. The two sides hope to formally sign and ratify the deal later this year.

These are positive steps toward trade diversification, although the deals need to be followed by a strong trade promotion push to increase commercial ties. The EU has its work cut out, as combined bilateral trade with Mercosur plus India is currently the equivalent of just one-quarter of EU trade with the U.S. (see chart).

EU trade with India and Mercosur is significantly less than with the U.S.

As of 01/30/2026. Sources: Eurostat, RBC GAM

Canada-China deal and White House reaction

The push to fill the trade void created by the U.S. is also happening elsewhere. Canada and China announced a strategic partnership that effectively resets their trading relationship to mid-2024, before Canada imposed a 100% tariff on Chinese EVs (in coordination with the U.S.). At that time China responded with levies on Canadian canola and other food products.

Under the agreement, Canada will import up to 49,000 Chinese EVs annually at a 6.1% Most Favoured Nation (MFN) tariff rate – that’s close to the peak volume of imports in 2023-24 before the 100% tariff took effect (see chart). That quota, which represents less than 3% of current vehicle sales in Canada, is set to rise by 6% annually. The government expects the deal will result in “considerable” new Chinese investment in Canadian auto production.

100% tariffs halted Canadian EV imports from China

As of 01/30/2026. 12-month imports from China peaked at 46,500 unites in April 2024. Sources: Statistics Canada, RBC GAM

In exchange, China will lower retaliatory tariffs on Canadian canola seed to around 15% from 84% currently. Canadian exporters will also get temporary relief from anti-discrimination tariffs on seafood and other products.

Improving trade relations with China is part of an effort to diversify exports away from the U.S. and ultimately double non-U.S. trade over the next decade.

Canada also concluded a strategic partnership with Qatar and is negotiating deals with India, ASEAN, Thailand, Philippines and Mercosur. Canada and South Korea recently signed a non-binding Memo of Understanding (MOU) intended to encourage Korean automakers to invest in Canadian manufacturing.

But warming relations with China goes against the U.S.’s trade and foreign policy objectives, including the updated Monroe Doctrine (discussed in a recent #MacroMemo) that asserts the U.S.’s pre-eminence in the Western Hemisphere and seeks to curtail China’s influence in the region.

President Trump’s initial response to the Canada-China agreement was surprisingly benign, but he subsequently threatened Canada with a 100% tariff if it strikes a trade deal with China. Treasury Secretary Bessent clarified that the recent strategic partnership doesn’t qualify, and Prime Minister Carney says Canada has no intention of negotiating a broader trade deal with China.

So, we’re inclined to dismiss the 100% tariff threat, although we wouldn’t be surprised to see more negative headlines leading up to the joint review of the USMCA (United States-Mexico-Canada Agreement) given President Trump’s negotiating style. Indeed, the White House also floated a 50% tariff on Canadian aircraft exports if Canada doesn’t expedite regulatory approval of U.S.-made Gulfstream jets.

Trump’s 100% tariff threat also highlights that Canada must walk a fine line between facilitating greater trade with the world’s second largest economy and keeping relations with its biggest trading partner from deteriorating further. More broadly, Canada and other middle powers are likely to face greater challenges navigating an increasingly multi-polar, power-based geopolitical order.

U.S.-Taiwan deal and Section 232 investigations

In addition to not following through on tariff threats, the Trump administration continues to strike trade deals and has generally taken a pass on new sectoral tariffs.

In January, the White House announced a framework agreement with Taiwan featuring now-familiar terms: the U.S. will lower its general tariff rate on imports from Taiwan to 15% from 20% previously and, in exchange, Taiwan will invest $250 billion in U.S. chipmaking.

It’s worth noting that exemptions for technology products already allowed most of Taiwan’s exports to enter the U.S. tariff-free – its average effective tariff rate is only 3.5%. But the deal will provide relief to sectors like pharmaceuticals and aircraft parts. On the investment side, chipmaker TSMC has already pledged to invest $100 billion in U.S. manufacturing, which will reportedly count toward the deal’s total.

The U.S. Commerce Department also concluded Section 232 investigations into semiconductors and critical minerals. The former resulted in a 25% tariff that will only apply narrowly to chips imported for non-domestic use – effectively a legal workaround for the proposed export tax on chips sold to China. Chips used for data centres, industrial applications and other domestic purposes, as well as derivative products like consumer electronics, are exempt.

The critical minerals investigation was the first during Trump’s second term to yield no new tariffs or quotas. The U.S. will negotiate with its trading partners to adjust imports, and action could be taken within 180 days if deals aren’t reached.

There are still outstanding Section 232 investigations into drones, polysilicon, robotics, medical tech and wind turbines, though these cover a relatively small share of imports compared with earlier investigations.

Hot off the presses as this goes to print, India and the U.S. report agreeing to reduce tariff barriers and for India to stop importing Russian oil. On the latter, it is unclear whether India will actually be able to do this without creating a global oil shortage, and so there is reason for skepticism.

Overall, the Trump administration’s growing focus on affordability appears to have halted the shift toward more protectionist trade policies. Notwithstanding the mid-January spike in trade policy uncertainty, we think tariff concerns will be less of a domestic headwind in 2026. The U.S.’s effective import tariff rate (based on tariffs actually paid rather than the theoretical rate) isn’t expected to rise significantly from its recent 10-11% range.

-JN

Understanding U.S. GDP outperformance

The Atlanta Fed’s Q4 GDP tracking suggests the U.S. economy closed out last year with a 4.2% annualized gain. If confirmed, that would represent a third consecutive quarterly increase in the 4% range and leave 2025 growth at 2.9% on a Q4/Q4 basis. That’s a healthy pace in its own right, but all the more impressive considering the consensus forecast was as low as 1% last spring when tariff threats, policy uncertainty and recession fears were at their peak.

But the surprising resilience in GDP growth wasn’t mirrored in other indicators:

• Job gains last year were less than half of consensus expectations at the start of 2025.

• The unemployment rate ended the year 0.3% higher than economists and analysts predicted.

• Sentiment indicators were also generally weak, particularly for the household sector.

On an annual average basis, the Conference Board’s measure of consumer confidence was the lowest in a decade – even worse than during the pandemic. The University of Michigan’s consumer sentiment indicator, which dates back to the 1950s, recorded its worst-ever annual average (see chart).

U.S. consumers were pessimistic in 2025

As of 2026. Sources: Conference Board, University of Michigan, Macrobond, RBC GAM

Business sentiment measures weren’t quite as grim, but also didn’t point to strong GDP growth. The ISM manufacturing index fell below 50 – indicating contraction – in March and only materially rebounded this January. The ISM services measure remained in expansionary territory but was subdued relative to historical norms.

Meanwhile, our gauge of sentiment in the Fed’s Beige Book, while relatively stable, was nearly one standard deviation below average.

How do we square strong GDP gains when everything else was so lacklustre?

The gap between GDP and employment comes down to productivity. Businesses were able to get more output from their existing employees without much new hiring. U.S. productivity growth has picked up in recent years relative to its pre-pandemic trend, including more than 4% annualized gains in the middle quarters of 2025.

Several factors could be contributing to the acceleration in productivity growth. Workers and businesses are likely continuing to adapt to significant labour market shifts during the pandemic, with employees that switched roles (or careers) gaining on-the-job experience while companies that over-hired are right-sizing headcount. More recently, a significant slowdown in immigration is likely boosting average productivity, with immigrants more likely to work in lower wage, less productive jobs.

We think rising AI adoption has also been a key contributor to productivity growth, which began to accelerate shortly after new AI tools became commercially available (see chart below). That timing might be somewhat coincidental, but researchers at the St. Louis Fed think most of the recent increase in productivity can be attributed to time savings from AI adoption.

U.S. labour productivity growth has accelerated since ChatGPT’s release

As of Q3 2025. Sources: St. Louis Fed, Macrobond, RBC GAM

There isn’t a great deal of macro research linking AI adoption with job losses, although one notable study found a significant impact on early career employment in roles most exposed to AI. But there is growing anecdotal evidence of companies freezing hiring or shedding white collar jobs, driven in part by AI-related efficiencies.

Most recently, Amazon announced it would lay off another 16,000 corporate workers. It is thus understandable why consumer sentiment lags the overall economy.

Looking at hiring trends in 2025, there certainly appears to be a link between industry-level job growth and reported time savings from AI adoption (see chart below). Health care and social assistance, which was by far the biggest contributor to job gains last year, reported limited time savings from AI.

At the other end of the spectrum, mining, oil and gas and information services were among the biggest net job losers and reported the most time savings from AI.

Industries reporting more time savings from AI are hiring less

As at 01/28/2026. Sources: Generative AI Adoption Tracker (Bick et al.), U.S. Bureau of Labor Statistics (BLS), RBC GAM

While we expect AI adoption will be a sustained driver of productivity growth in the coming years, AI CapEx (capital expenditure) is also providing a near-term lift. AI-related investment was a key contributor to U.S. GDP growth in 2025, but that activity was associated with relatively modest employment gains.

Data centre construction creates jobs in building and trades, but a good deal of the investment is intangible – think semiconductor research and development (R&D) or AI model training – which creates significant economic value with limited labour input. Once up and running, data centres require few permanent staff.

Business surveys have also been below levels typically consistent with the pace of GDP growth seen in 2025. That might be partly due to the somewhat concentrated nature of growth, with tech spending accounting for most of the increase in CapEx and health care the bulk of hiring. The closely followed ISM indices are diffusion measures that capture the breadth of growth, not its intensity. On that basis, one industry seeing 10% sales growth is fully offset by another seeing a 1% decline.

Trade policy also seemed to have an outsized impact on business sentiment last year. Respondents’ comments alongside the ISM surveys (both manufacturing and services) were littered with references to tariffs. But Trump backed away from many of his worst threats, and the effective tariff rate on U.S. imports has been about one-third lower than announced tariff policies suggest (see chart). Protectionism’s bark was worse than its bite in 2025, and likely weighed on business confidence more than actual economic activity.

Customs revenue points to a lower actual tariff rate vs. expectations

As of 01/08/2026. Estimated tariff rate based on customs revenue and assumed trade flows. Sources: U.S. Treasury, U.S. Census Bureau, Evercore International Strategy & Investment (ISI) Tariff Tracker, Macrobond, RBC GAM

While tariffs compressed corporate margins, productivity growth softened the blow. Unit labour costs – the extra labour cost associated with producing an additional unit of output – declined as productivity grew faster than wages. That also suggests productivity gains are accruing more to businesses (in the form of higher profits) rather than employees (in the form of higher wages). This might help explain relatively worse consumer sentiment.

We expect productivity growth will remain strong in 2026 amid an ongoing tailwind from AI adoption. That means some divergence between GDP growth and hiring is likely to continue. That said, we expect the labour market will build on recent signs of stabilization, which might help to repair consumer confidence somewhat.

AI CapEx is likely to remain a key contributor to growth, but we see some broadening out of business investment amid less policy uncertainty, an ongoing deregulatory push, and fiscal incentives in last year’s tax bill. OBBBA (the One Big Beautiful Bill Act) will also boost tax refunds for middle income households, providing a lift to consumer spending and possibly confidence as well. Many households are likely underestimating the size of refunds.

Still, the economy is likely to remain heavily reliant on higher income consumers, wealth effects and AI spending. That represents a key vulnerability if AI sentiment reverses and the stock market sells off. But to be clear, we don’t see any immediate catalyst for that.

2025’s divergence between actual GDP growth and surveys also highlights some limitations of the latter in tracking and predicting economic outcomes. We are comfortable with our above consensus forecast for U.S. GDP growth in 2026 despite unimpressive sentiment readings early this year.

-JN

Quick Canada checkup

The Bank of Canada opted to leave its overnight rate unchanged in late January, with expectations for further pauses stretching into the future. Whereas our economic forecasts for most developed countries in 2026 are above the consensus, Canada is an exception. Our cautious forecast was recently validated when the Bank of Canada came out with a similarly below-consensus outlook at its most recent meeting.

In turn, we do not actively price in a rate hike for 2026 – in contrast to the market. We also flag that it remains possible the central bank could even be persuaded to ease slightly further, especially if inflation continues to ebb.

Prime Minister Carney’s “Middle Power” speech at Davos attracted attention and international acclaim, alongside criticism from the White House. The build up to USMCA negotiations later this year is likely to be a hair-raising one for Canada. The U.S. is fairly likely to add pressure by triggering the required six months’ notice for its unilateral exit from the pact. We believe there will ultimately be an agreement and that the deal will largely crystalize recently implemented sectoral tariffs and otherwise keep the core of the existing USMCA intact.

An enduring schism is unlikely given the importance of the deal to both parties. This is obvious from a Canadian standpoint, but the price of oil and food prices (via potash) are also in focus for the U.S. in the run-up to midterm elections in the fall. Canada is simultaneously hedging its bets with some new trade deals, discussed in the tariff section of this report.

Getting tongues wagging that the Liberal government might be contemplating a snap election at some point in 2026, a tax cut was unexpectedly announced on January 26, with low-income households set to receive a boost to their quarterly GST rebates starting in the spring of this year.

-EL