~With contributions from Vivien Lee and Aaron Ma

Our latest quarterly economic outlook is now available online, entitled “Important tailwinds ahead.” It is a part of a larger Global Investment Outlook, which includes not just specific forecasts for gross domestic product (GDP) and the consumer price index (CPI), but also a wide range of market views.

There are several important macro- and market-relevant events set to be triggered fairly soon. Let’s run through them.

Next Fed Chair

President Trump said he will name the next Fed chair in early 2026. He even suggested a decision has already been made, although interviews are reportedly ongoing.

Chair Powell’s term ends in mid-May and it’s standard procedure to name a successor several months in advance to allow for Senate confirmation. A vacancy on the Fed’s Board of Governors when Stephen Miran’s term expires at the end January could even allow Trump’s pick to join the board before taking over as chair.

The list has reportedly been narrowed down to four candidates, listed here in order of current betting market odds:

• Kevin Hassett (42%) was the prohibitive favourite (according to betting markets) in early December until Trump said Warsh is also at the top of his list. Hassett is already part of the Trump administration, serving as director of the National Economic Council, and would seem to be the most aligned with the president on policy issues. This presumably makes him the most dovish candidate and the one most likely to raise concerns about Fed independence. At the margin, that combination could result in a steeper yield curve, with lower short-term interest rate expectations but more of an inflation premium in longer-term yields.

• Kevin Warsh (38%) was historically an inflation hawk – he opposed quantitative easing when he was on the Federal Open Market Committee (FOMC) from 2006-11 – but he has spoken out in support of lower interest rates more recently. He might be seen as slightly less dovish and less politicized than Hassett – arguing for a slightly flatter curve – although he remains a balance sheet hawk which could put upward pressure on longer-term yields.

• Christopher Waller (9%) is already a member of the Fed’s board, having been appointed by Trump in 2020. He has generally voted alongside the majority but was against slowing quantitative tightening (QT) in March 2025 and dissented in favour of a rate cut in July 2025. But unlike Stephen Miran (a more recent Trump appointee) he didn’t dissent in favour of larger rate cuts late last year. In that sense Waller is not an extreme dove and his existing position on the Fed arguably makes him more of an establishment candidate.

• Rick Rieder (6%) is the Chief Investment Officer at BlackRock. He has advised the Fed in the past and was previously a member of the U.S. Treasury’s Borrowing Committee.

While Trump’s pick will surely favour somewhat lower interest rates, none of these candidates stand out as uber-dovish or a major threat to the Fed’s credibility. They all have solid economic and financial market backgrounds and are generally well regarded in investing and policymaking circles. That said, it’s hard not to see the next Fed chair as politicized given Trump’s loud calls for rate cuts and threats to the central bank’s independence.

Those threats rose to a new level in January when the Fed was served grand jury subpoenas by the Department of Justice. This raised the possibility of a criminal indictment related to Powell’s testimony to the Senate Banking Committee in June 2025 regarding renovations at the Fed’s headquarters.

Powell was unusually outspoken in his reaction, calling the renovations and testimony a “pretext” and saying the threat of criminal charges is a consequence of the Fed not following the president’s preferences on monetary policy.

A number of Senate Republicans have spoken out in favour of Powell, with one member of the Banking Committee saying he would hold up any nominations to the Fed (including Powell’s successor) until the matter is resolved. This pushback helped to soften the initial Sell America market reaction to the indictment (higher yields, lower U.S. dollar and equities). Trump seems to be distancing himself from the investigation, saying he doesn’t know anything about the subpoenas.

This is an encouraging reminder that checks and balances still exist within the U.S. political system. Financial markets also have some power to keep the executive branch in check.

Powell’s newly pugilistic tone raises the risk that he won’t step down from the Fed’s board when his term as chair ends in May. It is fully within his rights to stay on the FOMC until his term on the board ends in 2028. There is historical precedent, but it is unusual. Doing so, assuming the Supreme Court doesn’t allow Trump to fire Lisa Cook, would leave Trump appointees in the minority on the Fed’s board and limit the extent to which the administration might influence monetary policy.

-JN

Supreme Court on tariffs

The U.S. Supreme Court is set to render judgement over the fate of tariffs imposed under the International Emergency Economic Powers Act (IEEPA) quite soon – potentially in the next few days to weeks. Likely dates include January 14, January 16, January 23 or January 30. Betting markets strongly expect these tariffs, which are the flat-rate tariffs applied to a country’s entire U.S.-bound exports, to be cancelled.

It does not matter if a country has struck a flat-rate deal with the U.S. – the deals have not been passed by Congress and so they are still subject to IEEPA legislation.

This outcome could create a brief period of uncertainty and even an inventory restocking surge. But the reality is that the U.S. can virtually instantaneously introduce temporary 15% tariffs and then, after some obligatory research and hearings, impose just about whatever tariff rate it desires at a later date. Thus, the White House should be able to get where it wants to go even without the convenience of IEEPA tariffs.

There has been some speculation that the Supreme Court could also require the federal government to reimburse businesses that paid the tariffs. This is quite unlikely with betting markets assigning no more than a 1% chance. That would have been chaotic as most businesses have passed at least a portion of their tariff costs up and down the supply chain, with no clear way to properly compensate other parties.

Another shutdown risk

Hard as it is to believe, the U.S. government could again shut down on January 31. Only three of the twelve budget spending buckets were funded for the entire fiscal year., The other nine will expire later this month.

Fortunately, the risk of this outcome is fairly low. It has fallen, from nearly 40% in mid-December to 26% today (though the risk is again rising slightly according to Polymarket). The Democrats in particular don’t appear to have the appetite for another fight.

If another shutdown did occur, we suspect it would be short-lived as the tolerance of the public and essential workers might be quite limited.

Purchases of mortgage-backed securities

President Trump announced on January 8 that he had instructed Fannie Mae and Freddie Mac – government-sponsored enterprises – to purchase US$200 billion of mortgage-backed securities (MBS). The goal is to reduce mortgage rates, stimulating the housing market.

A bit of context here is useful.

1. It appears these agencies were already buying mortgage bonds in the second half of 2025. Their portfolio size has increased by US$69 billion since the end of May 2025. So this is not a brand new pursuit.

2. US$200 billion represents just under 2% of the total U.S. MBS market – a significant fraction, but not a game-changing sum. One might expect mortgage rates to theoretically decline on the order of something like 10 basis points rather than multiple percentage points. Encouragingly, the U.S. 30-year mortgage rate has been declining modestly in recent months even as the underlying 10-year and 30-year Treasury yields have been flat to higher.

In all, this move is unlikely to be a major catalyst but should contribute to a slightly happier housing market.

Japan election?

Japan appears to be on the cusp of calling a snap election that would be held on February 8 or February 15. That would pull forward an election that might otherwise have been delayed until October 2028.

The Liberal Democratic Party (LDP) clearly believes polls that show it to be enjoying strong support. It perhaps even hopes to capture an outright majority in the House of Representatives, as opposed to continuing to rely upon coalition partners.

An election would also provide a clear mandate for new Prime Minister Takaichi and support her pro-growth and pro-market efforts including relatively easy money and fiscal stimulus. This would likely be yen negative, equity market positive and result in a steeper yield curve.

Note, however, that the lack of an Upper House majority promises to constrain any outsized policy zeal. Here the LDP governs with the support of coalition partner Komeito.

-EL

Venezuelan regime change was meant to be on our “key events” list, above, but then the U.S. struck, with major implications we’ll explore here. Also refer back to our broader discussion from December 16 about President Trump’s updated version of the Monroe Doctrine with relevance to the entire Western Hemisphere, including the prophecy that “the U.S. could soon seek to impose regime change on [Venezuela].”

The term “decapitation” arguably best describes what transpired on January 3 when Venezuelan President Maduro was captured in a U.S. military operation and brought to the U.S. to face charges. It hasn’t quite been the expected full-on regime change given that Maduro’s political party remains in charge with his former number two Rodriguez now in the lead role. In theory, the U.S. now calls the shots and her durability in the role will be largely a function of whether she follows U.S. orders. The U.S. has said it will run Venezuela until there is an orderly transition of power at a later date.

What motivated the U.S. action? Several things:

• President Trump’s foreign policy is newly focused on the Western Hemisphere and the Trump White House also appears to be rapidly swiveling from isolationist to interventionist (and even expansionist in the context of stated Greenland aspirations).

• Venezuela has long been a pariah state in the Western Hemisphere, with deep ties to China, Cuba, Russia and Iran. From the U.S. perspective, regime change might usefully reset the relationship. Some have argued that taking control of Venezuela might even cause a domino effect whereby Cuba’s communist government falls if it can no longer count on cheap fuel from Venezuela.

• Venezuela’s last two elections were widely thought to be fraudulent by independent observers, which argues that the ruling socialist PSUV government is illegitimate. That said, the U.S. has so far declined to elevate the rightful winners to power.

• Venezuela nationalized oil assets within the country in the 2000s, including those of U.S. companies, and the White House is now seemingly intent on reclaiming these.

• It is undeniable that the country’s economy has been badly mismanaged, with GDP per capita down by an unfathomable 72% since 2013 (see next chart). It should be noted that while some of this is a function of economic mismanagement, some is also due to ever-more severe sanctions imposed in 2015, 2017 and 2019.

• Venezuela’s problems have spilled over to its neighbours, including 7.9 million refugees, migrants and asylum seekers who had fled the country by late 2024. A stabilized Venezuela might bring positive benefits to its neighbours, and even help the U.S. with its efforts to limit illegal immigration.

• With specific regard to Maduro, the White House has framed its military operation as a campaign against drug trafficking, which allegedly involved high- level government officials including Maduro.

Period of instability

As is often the case during a regime change, there will be a period of instability.

Perhaps this will be lessened if the ruling political party is allowed to smoothly pivot toward pro-U.S. policies.

But it is not clear how compliant the government will actually be as its foundational beliefs are challenged, whether the military will be in alignment with the new president, and how the shadow military – armed pro-government civilian collectives – will behave. It is also unclear whether the U.S. will be willing to put boots on the ground, which is normally necessary to properly steer a country. For that matter, how will any American oil companies that opt to return to the market be protected given reports that the civilian collectives are now hunting for Americans.

Suffice it to say that it is rare for U.S. military interventions in foreign lands to yield a stable politically and economically positive outcome. Post-World War II Germany and Japan constitute exceptions, as does post-Korean War South Korea and perhaps Panama in 1989. But more recent U.S. actions in Iraq and Afghanistan did not yield the desired-for transformations, and the U.S. interventions in the 1980s in Nicaragua, El Salvador, Guatemala and Honduras were broadly failures.

So, it is far from certain that positive political or economic outcomes will result from these latest actions. On the other hand – from a more long-term perspective – it is hard to fathom the economy doing much worse than it has done over the past decade-plus.

Oil implications

From an economic standpoint, the price of oil is always in focus when Venezuela is in the news. Incredibly, Venezuela has the world’s largest proven oil reserves (see next chart). However, due to a mix of sanctions, poor governance, insufficient investment and human capital decay, the country is currently producing just under 1 million barrels of oil per day. That’s down from approximately 3 million barrels at the turn of the millennium and radically short of the country with the second largest oil reserves – Saudi Arabia and its 10 million barrels per day of production.

In the short run, should the price of oil go up or down? It depends on whether Venezuelan oil supply rises or falls. This is surprisingly unclear.

If the U.S. lifts its sanctions and embargo, Venezuelan oil might be capable of fairly immediately rebounding by a few hundred thousand barrels per day – perhaps an excuse for global prices to fall by a paltry dollar or two per barrel. This additional product is seemingly destined for the U.S. given its compatible refiners and the expectation that the U.S. will claim 30 million to 50 million barrels of Venezuelan oil production over a period of time.

However, the idea that Venezuelan oil production will rise isn’t certain. The U.S. is busily capturing the shadow fleet that has historically transported much of Venezuela’s oil exports and seems keen on restricting China’s access to the product. China is the current destination for nearly half of Venezuelan oil exports.

Over the long run, one can certainly envision a scenario in which Venezuela manages to restore a significant fraction of its lost oil output. But that is unlikely to happen over the next few years, let alone the next few months. It is arguably a 10–to-15-year process, and depends on the country stabilizing, plus the infusion of a massive amount of capital to revive oil operations (estimates include US$80 billion and even US$183 billion).

At current relatively low oil prices and given the challenge of working with Venezuela’s heavy oil, it isn’t likely that oil companies will be leaping at that opportunity. Perhaps conditions will change in the coming years, permitting additional Venezuelan supply and contributing both to lower oil prices and lower global inflation.

Canada is threatened by a Venezuelan oil revival as the two countries compete for U.S. Gulf refinery capacity and demand. Even if Venezuela does not manage to significantly increase its oil production over the next few years, its existing production could shift significantly from the likes of China to the U.S., displacing a fraction of what Canada provides. This adds even greater urgency to Canada’s efforts to diversify its energy exports away from the U.S. toward the Pacific.

Other thoughts

From a broader risk asset perspective, past U.S. acts of war (or equivalent) have generally yielded a lower U.S. stock market, but to a surprisingly limited degree – normally no more than a few percentage points.

There are a few geopolitical risks stemming from this latest U.S. action. One is that the U.S. will be emboldened. It has also uttered threats against Colombia, though the odds of an invasion there seem quite low. The U.S. is also now talking about capturing or buying Greenland – a more plausible scenario, though one that would risk shattering NATO.

In its newly activist foreign policy mode, the White House is also threatening to intervene in Iran if the country violently suppresses new protests, which Iran now seems to be doing. There is the usual range of oil- and Middle East escalation-related risks. The situation in Iran needs to be watched very closely in the coming weeks.

Simultaneously, as the U.S. wields its power in its own stated sphere of influence, Russia and China may be emboldened within their own spheres, with Ukraine and Taiwan potential targets of escalation.

-EL

The Chinese economy is stumbling, with continued housing weakness, cautious consumers and a recent pullback in capital expenditures (CapEx). The latter is discussed later in this #MacroMemo.

We continue to assert that the country’s economic prospects remain good over a longer time horizon as China proves its capacity not just to copy existing technologies and best practices, but to innovate. In several instances, China now demonstrates world-leading practical capacity. For a country that only ranks approximately 70th in (purchasing power parity-adjusted) GDP per capita, that’s fairly amazing and highlights a great deal of room for rapidly rising income in the future.

It is easy to lose sight of how fast Chinese productivity is rising because its shrinking population conceals this in the headline GDP numbers. GDP per capita gives a clearer view and continues to rise at nearly 5% per year – not much slower than a decade ago (see next chart).

This Critical Technologies Index from the Harvard Kennedy School shows the U.S. leading across all five key technological categories for the future (see next table). Yet China is a clear second in each. Yes, it is relevant that China is not the leader, but it is still incredible that a developing nation is now seemingly technologically ahead of the collective might of Europe, bests Japan, and finds itself miles beyond every other developed nation on the planet.

China’s research and development spending as a share of GDP doesn’t particularly impress relative to its peers, though it is rising fairly steadily (see next chart).

But that obscures a more important point in China’s favour, which is that due to the country’s massive economy, even that relatively moderate GDP share represents a huge total sum of money. China already towers ahead of every other country save the U.S. by this metric and appears set to pass the U.S. before too long (see next chart). Scale matters when it comes to pushing the technological frontier forward.

Consistent with this, China now files more than three times as many patents per year as the U.S. (though the comparison is imperfect and flatters China due to different incentives and types of filings in each country). The point is that China may not remain behind in the Critical Technologies Index forever.

From a practical perspective, China’s rising technological clout – even if it is not necessarily the world leader – is allowing it to rapidly move up the economic value chain, abandoning low-value products for more sophisticated, differentiated and lucrative ones.

Let us take a quick look at several key economic sectors where China is increasingly making a global mark.

Autos

China’s auto sector has exploded in recent years despite efforts in North America and to a lesser extent elsewhere to protect legacy domestic manufacturers from China’s rapid advance. Over just the past five years the country has gone from a minor player in global auto exports to by far the largest exporter (see next chart). The metric is admittedly imperfect since many countries including Japan, South Korea and Germany produce their vehicles within their target foreign markets, which doesn’t show up in this chart.

Still, China’s auto capabilities are undeniably astonishing: the country’s rising middle class has embraced motor vehicles and now consumes roughly twice as many new vehicles per year as the U.S. (see subsequent chart).

China’s auto sector is also increasingly skewed toward electric vehicles, with Chinese brands responsible for 62% of global electric vehicle sales in 2024. As this segment increases in popularity, China has a distinct advantage due to this initial head start, its lead in battery technology and production – discussed next – and its own large domestic demand. China’s domestic demand for electric vehicles is now thought to constitute more than half of all new motor vehicle sales.

The quality of the country’s light vehicles is also generally thought to have increased substantially over the past half decade, now competing successfully with longstanding brands.

The next stage of Chinese auto production will presumably be the construction of assembly plants within major foreign markets, allowing it to skirt tariffs. Significantly further growth is possible.

Batteries

China is the undisputed leader in battery production, a field undergoing rapid technological change and taking on great importance given the rise of electric cars, the ubiquity of mobile phones and myriad other portable devices, and the exploding need to store energy due to the intermittent nature of new energy sources such as wind and solar.

China now produces more than three-quarters of the world’s lithium-ion battery cells, with a single company – CATL – producing 35-40% of the world’s electric vehicle batteries.

Upstream, China also has strong supply chains and superior refining capabilities for many of the critical minerals needed for batteries, including lithium, graphite, nickel and cobalt.

Solar

Solar energy is now the world’s lowest-cost source of new electricity. It also enjoys extremely short build times (useful for responding to electricity demand and supply shocks) and the ability to deploy at different scales.

The intermittency problem – solar panels don’t work at night, and sub-optimally on cloudy days – is being solved by the aforementioned battery technologies. In fact, the combination of solar plus storage is now cost-competitive with gas peaker plants (which are admittedly famously expensive, but nevertheless currently play an important role in meeting moments of peak electricity demand).

Accordingly, global solar demand is rising fast. More than half of the new power capacity being added around the world is solar.

China is by far the world’s largest producer of solar panels. The country produced an astonishing 86% of all solar panel modules in 2024, and controls more than 95% of some upstream components. Further, the country is consolidating its lead as the location of approximately 95% of new solar manufacturing facilities under construction as of 2023.

China is also the biggest user of solar, with about 47% of the world’s installed capacity and approximately 60% of capacity additions in 2024.

Given the importance of electricity to the successful rollout of artificial intelligence models, any lead in electricity-generating technologies takes on an additional degree of importance.

Robotics

China is becoming the clear leader in industrial robotics, meaning the sort of robots used in factories.

It does the most installations, indeed more than the rest of the world combined as per recent data: 295,000 of the world’s 542,000 new industrial robots in 2024. China now operates roughly 40-45% of the world’s industrial robots. On a robot-per-worker basis, China is also now catching up to and in several cases passing traditional developed-world powerhouses such as Japan, Korea and Germany.

China has special incentives to prioritize robotics. It is extremely manufacturing-oriented, having built its global dominance via ever-declining costs. Robots are a key ongoing contributor to the cost savings needed to sustain this business model into the future. China’s population is also declining, meaning that it benefits more than most by substituting away from labour toward capital such as robots.

The burgeoning world of “dark factories” – factories that operate with minimal human intervention – is arguably being pursued to the greatest extent in China, for similar reasons.

Artificial intelligence

The U.S. is definitely ahead in its development of large language models, though China is pushing hard. China has certainly had its moments, including the shock introduction of the DeepSeek model in January 2025 that revealed similar performance to Western models but at 100 times reduced development cost and with an open-source approach that allowed greater community collaboration.

China is closing in on American AI models both in an aggregate sense (see next chart) and specifically with regard to language, reasoning, math and coding (see subsequent chart).

Semiconductors

China lags in the semiconductor space. But its loss of access to the highest-end Western chips and clear government prioritization has the country moving quickly to try to catch up. There has been significant progress in chip design, but the country reportedly remains multiple generations behind in semiconductor manufacturing.

Pharmaceuticals

China’s pharmaceutical sector is starting to progress beyond its copycat history, with some unique drugs now becoming available – though for the moment these are rarely first-choice therapies for the rest of the world. Part of the issue is that Western regulators do not yet trust Chinese approval standards – in some cases for good reason as its late-stage clinical rigour is still considered substandard. Another problem is that China does not yet excel at the commercialization aspect of drug development, including the marketing necessary to reach doctors and patients.

But China enjoys a significant speed advantage given huge patient pools and lower trial costs. The time it takes to receive approval for human trials has declined from 501 to just 87 days over the past decade. Chinese companies conducted one-third of the world’s clinical trials last year, suggesting a pipeline of important Chinese medicines will eventually be on their way.

The quality of Chinese pharmaceutical R&D is now quite high, especially for cancer drugs and engineered drugs such as cell therapies and antibody drugs.

The pharmaceutical sector is thought to be one in which China could soon start to play a major global role. It may do so in a way that doesn’t crowd out other countries to the same extent as it has in more traditional manufacturing given the heterogenous nature of drug development and the massive untapped demand for medical solutions that do not yet exist.

The bottom line is that China’s technological push is very real, and likely a driver of economic prosperity for the country over the coming decade and beyond.

-EL

AI made several important contributions to the U.S. economy’s surprising resilience in 2025:

• Data centre investment was the main driver of business CapEx.

• AI-led stock market gains supported spending by wealthier households.

• Rising adoption of Generative AI likely provided a modest boost to productivity.

Each of those factors is expected to remain supportive in 2026. Consensus is for further albeit more moderate equity market returns in 2026. Lagged wealth effects from earlier gains should act as an ongoing tailwind. Productivity growth is likely to pick up further as AI tools become ever-more capable and adoption continues to rise.

As far as investment goes, CapEx by the big 5 AI hyperscalers is expected to accelerate to $534 billion in 2026 from an estimated $400 billion last year (see chart). While growth is slowing on a percentage basis, incremental investment dollars are only slightly lower, which is what matters for the GDP growth impulse.

In fact, the consensus CapEx estimate might be conservative. As the chart below shows, forecasts for hyperscalers’ CapEx have been consistently revised higher in recent years. The latest estimate of 2025 CapEx is 45% higher than consensus expectations this time last year and double the estimate from two years ago.

While 2026 CapEx expectations have already increased considerably over the past year, recent history suggests the distinct risk is further upward revisions.

Data centres and other tech investment accounted for most U.S. business CapEx growth through the first three quarters of 2025:

• Computers and peripheral equipment made up two-thirds of business machinery and equipment spending growth.

• Software accounted for three-quarters of incremental intellectual property investment.

• Data centres (the structures themselves, leaving aside graphics processing units, equipment, etc.) were the fastest-growing component of non-residential construction. The construction of data centres has tripled since ChatGPT was introduced three years ago and is on trend to surpass investment in office buildings and warehouses in the coming years (see chart).

Hyperscalers have generally been able to finance this investment with cash from operations (CFO), but their ability to do so is becoming stretched despite strong profitability. Last year’s spending by the big 5 hyperscalers amounted to about two-thirds of CFO, up from half in 2024. Forecasted spending this year would amount to three-quarters, on average.

As such, these companies are looking to other sources of financing, including the corporate bond market. We count more than $100 billion in gross issuance by the big 5 last year, most of which came to market in Q4 (see chart). That represented a more than 5x increase relative to 2024.

Expectations are for another significant jump in issuance this year. J.P. Morgan says AI and data centre CapEx-related sectors now account for 15% of its U.S. investment grade corporate index, more than U.S. banks.

New issuance was digested relatively easily by a market hungry for high quality debt, although spreads widened somewhat. This is particularly true for Oracle, which is investing well beyond its current cash flow and is rated at the lower end of investment grade.

Other funding options, including private credit, are also being pursued and are expected to be a key source of financing as the AI data centre buildout continues.

Leaving aside whether all of this spending will ultimately generate a sufficient return, we think AI-related CapEx will remain an important driver of economic growth in 2026. AI investment added something in the range of one-half percent to GDP growth in 2025 and could make a similar contribution this year.

-JN

U.S. customs collected a record $287 billion in tariff revenue in 2025, nearly three times the previous year’s haul. The effective tariff rate on imports stood at 11% as of October. It averaged 7.3% through the first 10 months of the year, a full 5 ppts higher than in 2024.

Tariff costs were the key driver of core goods inflation. Costs accelerated to around 1.5% in recent months from zero at the start of the year and -1% in 2024. Yet that upward pressure hasn’t been as intense as expected (see next chart). A recent Fed study found that, as of August 2025, only about 35% of predicted tariff-driven price increases had materialized in Personal Consumption Expenditures (PCE) inflation data.

Our own rough math, based on PCE inflation and import price data through September, similarly finds that about one-third of tariff costs were passed onto consumers via higher goods prices. We think roughly half of tariff costs were absorbed by domestic firms, while the remainder was paid by foreign exporters (via lower U.S. import prices). Goldman Sachs also estimates U.S. businesses have absorbed roughly half of tariff costs thus far.

Limited pass-through to consumers doesn’t just soften the inflation impact – it also reduces the hit to the U.S. economy. This is for two main reasons.

1. While foreign exporters are only absorbing a modest share of tariff costs, that is significantly greater than expected given historical studies showing full pass-through to import prices.

2. The domestic distribution of tariff costs matters as well. Econometric models typically assign a higher short-run fiscal multiplier (i.e., economic impact) to a dollar raised from personal taxes relative to corporate taxes. That is, consumer spending is typically thought to respond faster to tax changes than business investment and hiring.

We’ve previously framed tariffs as a less efficient but politically feasible tax hike. At this point, they appear to have acted more as a tax hike on business inputs rather than a consumer sales tax, which might be softening the economic blow.

Notably, through the first three months of the current fiscal year (Oct-Dec 2025), tariffs generated $91 billion in revenue, exceeding the $81 billion raised by corporate taxes (see chart). That’s a major shift from a year earlier when those figures were $21 billion and $109 billion, respectively.

While on that basis it appears the corporate tax burden has eased, when taking into account tariffs paid by domestic firms, we think the corporate tax bill has actually increased.

We continue to think there is scope for further tariff pass-through to consumers as today’s higher tariff rates become entrenched, inventories are replenished, and businesses bristle at sustained margin compression. We budget for a bit more inflation and economic hit to materialize in 2026. On the whole, however, the impact of tariffs on growth and CPI looks like it will ultimately be less than models originally suggested.

-JN

China appears to have achieved its 5% GDP growth target in 2025 despite some loss of momentum as the year progressed. Most notably, fixed investment slowed sharply during the second half of the year (see chart) and likely contracted on an annual basis for the first time since the late-1980s.

Some of that decline reflects the country’s well-known property sector woes, which we discussed in a recent #MacroMemo. Indeed, real estate investment was down 16% year over year in 2025 (year-to-date through November) and represented a sizeable drag on overall fixed investment.

But that’s not the whole story. Infrastructure investment is also on track to decline in 2025, and manufacturing investment growth has slowed substantially (see chart).

The slowdown in infrastructure investment is in some ways a second-round effect of the country’s property sector downturn. In 2025, government revenue from residential land sales was down 65% from its 2020 peak. This added to the financial challenges faced by debt-laden local governments and constrained their ability to fund infrastructure spending.

The central government’s stimulus efforts have focused more on boosting consumption. Some funding has gone toward repairing local government balance sheets (via debt swaps) rather than investing in new infrastructure.

The pullback in manufacturing investment is a symptom of industrial over-capacity that has contributed to falling producer prices and weighed on profitability. Industries with growing excess capacity, like chemicals and pharmaceuticals, have unsurprisingly seen the sharpest decline in fixed investment.

Intense competition in some sectors, referred to as “involution” and discussed in a previous #MacroMemo, has also weighed on profitability. Industrial profits were flat year-to-date through November, having contracted in each of the three previous years. In November alone, profits were down 13% year-over-year (see chart).

Weak profitability and low margins constrain and discourage new investment. An anti-involutionary push to rein in excessive competition and over-capacity is also deterring CapEx. The pullback in investment has been broadly based across regions as local governments reportedly hold back on incentives to attract new manufacturing facilities.

There are bright spots, though. Investment in advanced manufacturing, clean energy and tech infrastructure continues to grow. Meanwhile, R&D investment has consistently increased as a share of GDP, a trend that is expected to continue in the coming years. On an aggregate dollar value basis (PPP-adjusted), Chinese R&D spending has nearly closed the gap with the U.S.

The country is also seeing strong growth in AI-related investment. Goldman Sachs estimates Chinese cloud service providers increased their CapEx by around two-thirds in 2025 – similar to the pace of growth seen in the U.S. – although an expected $70 billion in AI investment by top internet firms in 2026 is just a fraction of the U.S. total.

The slowdown in fixed investment in the second half of 2025 might have been an over-correction, with the government possibly withholding policy support when growth appeared on track to hit its 5% target. Further policy stimulus looks forthcoming in 2026 with government bond issuance on the rise. Support for households and consumer spending is likely to remain a priority, though efforts to boost bank lending and incentivize business CapEx could support investment.

Overall, we think another annual decline in fixed investment will be avoided in 2026, though it’s hard to pencil in a significant rebound given ongoing headwinds in the property sector and less policy focus on traditional infrastructure investment. Still, additional investment in advanced industries and innovation is likely and could provide a welcome boost to Chinese productivity growth as well.

-JN

The Canadian government’s effort to cap population growth by curtailing non-permanent residents is having its intended effect. The country’s population contracted outright for the first time in the post-war period with a net decline of 76,068 (-0.2%) in Q3 2025. That offsets slight gains in the prior two quarters and leaves Canada’s population effectively flat year-to-date at 41.6 million.

The decline was driven by continued net outflows (-176k) of non-permanent residents (NPRs). Their share of the overall population fell to 6.8% from a peak of 7.6% a year earlier. The government intends to further reduce that share to less than 5% by the end of 2027 (the previous timeline was by the end of 2026). This would imply net NPR outflows averaging slightly less than 100,000 per quarter over the next two years.

Most of the net decline in NPRs came from study permit holders, about half of whom also held work permits (e.g., international students in co-op programs). About half of NPRs only hold a work permit and their ranks are shrinking more gradually. While study permit holders without a work permit are still generally allowed to work part-time (and slightly more than one-third do), the concentration of students in NPR outflows suggests the labour force impact isn’t quite as significant as the overall slowdown in population growth.

In contrast to NPR outflows, the number of permanent residents increased by slightly more than 100,000, similar to the pace seen in recent quarters and on track to meet (if not slightly exceed) the government’s target of 395,000 admissions in 2025. That target will be set at 380,000 annually over the next three years with a growing tilt toward economic immigrants (as opposed to family and refugees).

Natural population growth amounted to just 18,000 in the quarter. Canada’s fertility rate dropped to a record low of 1.25 children per woman in 2024, well below the “replacement rate” of 2.1 needed to stabilize population growth without immigration. That puts Canada in a group of several advanced economies with “ultra-low” fertility (below 1.3).

Based on the government’s immigration targets, we don’t expect population declines will become the new normal. But near-term growth is likely to be very modest, both in a historical sense and particularly relative to the pace seen in recent years. The upshot is that the country can’t continue to rely on an expanding labour force to drive economic growth, as was the case over the past decade (see chart).

That makes productivity growth – extracting more from the existing workforce – all the more important. Revisions to Canada’s productivity data suggest the recent track record is less dire than previously thought, but the trend still isn’t inspiring. Sluggish business investment amid trade policy uncertainty – real M&E investment hit an 8-year low in Q3 2025, outside of the pandemic – doesn’t bode well for a near-term turnaround.

That said, new tax incentives for private investment and a more business-friendly regulatory environment should help. We also think trade policy uncertainty will ease over the course of 2026 with USMCA trade agreement expected to survive re-negotiations albeit in a less free-trade form.

As we discussed in our previous #MacroMemo, AI could boost productivity growth significantly over the next decade, and might already be doing so in the U.S. Certainly Canada is a relative laggard in AI adoption but its use is nonetheless rising, which could act as a productivity tailwind in the coming years.

In the near term, we think improving productivity is unlikely to fully offset slower population growth, resulting in a slower potential (or non-inflationary) growth rate for Canada’s economy relative to the past several years.

-JN